In a two-part piece, we look at the post-pandemic recovery of the Indian economy. GDP grows because demand for goods and services produced in an economy grows. There are broadly four sources from where this demand originates — household (consumption of goods and services), business (small or large business spending in building factories, offices, etc.), government (spending on social sector schemes), rest of the world (exports). A part of each of these sources is imported, which means they contribute to the GDPs of those countries from where they come. That’s why imports are subtracted from the total demand to arrive at net domestic demand.
Chart 1 shows the contributions of these factors (here exports are net of imports) since the pandemic. The line shows the growth rate (y-o-y) and the bars show the contribution of each of these factors in achieving that growth rate. There are two significant upward movements in the growth rate, 2021-22Q1 and 2022-23Q1, the first one with a greater role of investment and the second with both consumption and investment. We look at the role that households and business may have played in the recovery in this piece.
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Chart 2 shows the role that consumption and investment may have played in this recovery. Chart 2a shows that the share of consumption and GDP growth have moved in opposite directions (except in 2022-23Q1), which means that household consumption has at best played a passive role in this recovery. Chart 2b shows that investment moved concurrently with the growth rate. This means that investment has played a significant role in this recovery. Can investment (and consumption) keep playing ball? If they do not, recovery may actually be fragile.
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What we consume can be financed from our current incomes as well as consumer credit we can take from a bank. Similarly, investment can be financed through the profits that firms retain for reinvestment and business credit they are awarded by banks. If these two factors have been driven by credit, state of credit may become an important factor in their sustainability in the medium run. Chart 3 presents consumption and investment together with the total credit in the economy (all as a share of GDP). The two have moved coterminously. This means credit has played a crucial role.
Availability of credit assumes importance, particularly if there are signs of tightening. In a world of globalised finance, it is difficult for countries to have the cost of loans determined according to their own needs. So, if the U.S. Federal Reserve increases the interest rates, the RBI has to follow suit irrespective of its impact on inflation. Chart 4 shows that the RBI had to do this. Footloose finance flows into developing countries based on the extra returns they offer, over and above what they would get in the U.S. This extra return can be seen in Chart 4 as the gap between the Fed rate and the Repo rate. If the former rises, the RBI has to increase the Repo (at least to maintain the differential); otherwise capital will fly out, which will lead to loss in value of our currency. In fact, despite this rise in Repo, capital has still flown out, which has devalued the rupee. In the absence of this rise, there would have been a greater flight and a further loss in value of rupee.
With the obsession and resurgence of inflation targeting by central banks, it is more likely that the only way the interest rates are moving, at least in the near future, is up. Rising interest rates in a fragile recovery, especially where credit has played an important role, may have a dampening effect on this growth. The role of the fiscal arm of the State, in such a situation, becomes even more critical, an issue which we will discuss in a subsequent piece.
Rohit Azad and Indranil Chowdhury teach Economics at JNU and PGDAV College, Delhi University, respectively
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Source: Ministry of Statistics and Programme Implementation (MOSPI), RBI, U.S. Federal Reserve
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