Moderation in India’s GDP growth to 5.4 per cent in Q2 of 2024-25 raises concerns of possible downturn in growth over the medium term. Growth is expected to be in the 5.8-6.2 per cent range, from the earlier estimates of 7-8 per cent. We assess how monetary policy should react in this scenario.

The downturn arises from decreasing consumption growth, persisting inflation (particularly food), necessitating a sticky monetary policy and lower private investment. Analysts have reduced their forecast for corporate profitability growth to 5 per cent in 2024-25 — single-digit growth for the first time in the last five years. In the first-half of 2024, the corporate profit to GDP ratio for the Nifty-500 universe and listed companies increased to 4.8 per cent and 5.2 per cent, respectively, indicating sustained investment and a leg-up for growth. However, by the second-half of 2024-25, earning growth estimates have been lowered. Reduced hiring in technology sectors, lower growth in inflation-adjusted urban wages and other pointers indicate moderation in growth over short to medium term. High interest rates, low fiscal impulse and moderating corporate profitability indicate downside risk to be even greater.

RBI’s fears

The RBI believes inflation of 6.21 per cent in October 2024 is a serious risk to macroeconomic stability. Overall GDP growth (excluding the Covid period decline and later upsurge due to a lower base), growth of consumption, CPI inflation, and ratio of gross fixed capital formation (GFCF) to GDP indicated in the graph reveal the following:

Moderation in GDP growth persisted in the pre-pandemic year of 2019-20 and later in Q2 and Q3 of 2022-23. It is being witnessed again in the current quarter. Moderation in consumption growth has persisted in the last eight quarters. GFCF as a ratio to GDP has been in the 29-32 per cent range for last 14 quarters. Incremental capital output ratio (ICOR) has averaged 4.5, excepting in the outlier quarters.

These factors, while indicating that there is no possibility of a downturn in GDP growth over the medium term, they do not suggest a likely upsurge in growth given declining corporate profitability, particularly in the manufacturing sector and the near-sticky wages.

According to PLFS 2023-24, overall wage increase has averaged 3.8 per cent for salaried class and 1.6 per cent for the self-employed. At an average inflation of around 5 per cent, real wage increase has been negative for both wage earners and the self-employed. The existence of a large number of persons (over 32 per cent) in the age group 15-29 who are neither employed nor in education and training (NEET) indicate persons in the pipeline waiting for a salaried job. This is income forgone by the economy.

PLFS quarterly data shows a decline, though a marginal one, in the number of persons employed in the secondary sector in July-September 2024 compared to the similar period in 2023. Hence the demand side concerns cannot be wished away. As per RBI, as on October 18, 2024, deposit growth at 11.8 per cent surpassed credit growth of 11.7 per cent after about 30 months, showing decline in credit growth.

Laffer curve analysis of CPI inflation and GDP growth post 2014 indicates that the growth maximising CPI inflation is close to 4.5 per cent. Though current headline inflation is higher, core inflation and non-food inflation have been below 4 per cent and 3 per cent, respectively, in the last four quarters. Core inflation is likely to remain subdued and so is the non-food inflation, below the benchmark level of the RBI.

Food inflation is more supply dominated and it is seasonal. Inflation expectations may not go up as Food Security Act applies to 80 per cent of households. Housing, health, education and personal care components of CPI have been more or less static and at reasonable levels. The external situation seems to be stabilising except for the Trump effect, which can reduce growth in the short term.

More investment needed

There is evidence that ICOR is on the rise and a linear trend suggests that it is increasing by over 1.5 from 2014-15 to 2024-25, indicating a greater need of investment for a given growth. With fiscal consolidation being an agenda of the government, it is the private investment that has to take the lead. Further, the RBI prefers to be ahead of the curve than following it. It is, therefore, time to tinker with the monetary policy if we are to escape a moderating growth scenario. Accommodative monetary policy would compensate for the lower fiscal space that the fiscal consolidation now provides for.

Moderation in credit growth, corporate profit, consumption growth and income growth with sticky employment in high growth sectors together with core inflation within the targeted range suggests that it is time for a rate cut and an accommodative policy. Liquidity management is crucial. We presume that ease of doing business will be a top priority, including on regulations, and structural changes will continue.

Gopalan is former Secretary, Economic Affairs, and Singhi is former Senior Economic Adviser, Ministry of Finance. Views are personal

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