India’s GDP Growth Slows: Key Challenges Ahead

Source:

GS-2:

Government Policies & Interventions

GS-3:

Growth & Development

Focus:

The Indian government has released the First Advance Estimates for 2024-25, showing a slowing GDP growth rate. Real GDP growth has declined to 4.8% CAGR since FY20, highlighting challenges like weak private consumption, sluggish investments, and negative net exports that hinder India’s economic progress.

India’s GDP Growth Slows: Key Challenges Ahead

Introduction: India’s Economic Growth and the Reality Check

  • The Indian government released the First Advance Estimates (FAEs) for FY 2024-25, providing a snapshot of the expected economic growth.
  • FAEs are forecasts based on available data and past trends, reflecting anticipated economic output by the end of the financial year.
  • According to these estimates, India’s nominal GDP is expected to be ₹324 lakh crore by the end of FY 2025, a growth of 9.7% from the previous year.

Key Data and Forecasts for FY 2024-25

  • Nominal GDP: India’s nominal GDP for FY 2025 is expected to be ₹324 lakh crore. At an exchange rate of 85 INR to 1 USD, this translates to around $3.8 trillion.
  • This forecast is slightly lower than the estimates in the interim Budget (₹328 lakh crore) and the full Budget (₹326 lakh crore) from earlier in 2024.
  • Real GDP: The real GDP (adjusted for inflation) is expected to be ₹184.9 lakh crore, which represents about 57% of the nominal GDP.
  • Real GDP growth is a more critical metric as it removes the effects of inflation and highlights the actual increase in production and services.

Decelerating Growth Trajectory

  • Since FY 2020, India’s real GDP has grown at a Compound Annual Growth Rate (CAGR) of just 8%, significantly lower than the nearly 7% growth rate observed since the 1991 economic reforms.
  • Prior to FY 2020, India’s economy had been growing at an average rate of around 5% in nominal GDP, with real GDP growth averaging about 7%.

Factors Holding Back Economic Growth

India’s GDP is calculated based on four major categories of spending, which serve as the engines of growth:

  • Private Final Consumption Expenditure (PFCE):
    • This category constitutes around 60% of India’s GDP. It represents personal spending by individuals and households.
    • Spending by individuals has grown at varying rates: a sharp decline in 2020-21 due to the pandemic (-52%) was followed by a recovery with an 6% growth in 2021-22, and an expected 7.3% growth in 2024-25.
    • The growth rate in PFCE is vital for overall GDP performance. If this growth slows down, it affects business investments and overall economic expansion.
  • Government Spending (Government Final Consumption Expenditure – GFCE):
    • GFCE accounts for approximately 10% of GDP and includes government expenditures for day-to-day functions, such as salaries and welfare.
    • Government spending has increased by just 2% in the current year and shows a modest average growth of 3.1% since FY 2019.
    • Though government spending can stimulate the economy, it has not grown at a significant pace recently, limiting its role as an economic stimulus.
  • Investment and Productive Capacity (Gross Fixed Capital Formation – GFCF):
    • This category accounts for around 30% of GDP and includes both public and private investments in infrastructure, machinery, and buildings.
    • The growth in investment has been subdued, with a modest expected rise of 32% this year. Over a longer period, the average annual growth rate for investments has been only 5.3%, which is lower than expected.
    • Without robust investment growth, both private and public sectors may struggle to boost the economy’s productive capacity.
  • Net Exports:
    • Net exports, which reflect the difference between India’s exports and imports, have a negative impact on GDP, as India typically imports more than it exports.
    • In recent years, the negative gap between imports and exports has decreased, but net exports still drag down overall GDP growth.

Long-Term Growth Outlook: The Challenge Ahead

  • Despite India’s recent strong GDP growth rates post-COVID-19, much of this growth is a result of a low base effect from the contraction in FY 2020-21.
  • The average real GDP growth since FY 2019 has been under 5%, almost half the required growth rate to transform India into a developed economy by 2047.
  • The country’s growth trajectory is now facing several headwinds, including slower private consumption, modest government spending, and declining investment rates.
  • Decelerating Growth Rate:
    • India’s real GDP growth has slowed significantly since FY 2020, with a CAGR of only 4.8%, compared to the pre-2020 average of nearly 7%.
    • A significant part of recent growth was driven by a low base effect, distorting true economic recovery.
  • Weak Private Consumption:
    • Private Final Consumption Expenditure (PFCE), which constitutes around 60% of GDP, has seen slow growth, particularly during the pandemic years.
    • Low consumer spending discourages private sector investment and overall economic expansion.
  • Sluggish Government Spending:
    • Government Final Consumption Expenditure (GFCE) has grown at a modest pace, limiting its role as an economic stimulus.
    • Inadequate government investment in infrastructure and welfare affects overall growth.
  • Declining Investment Rates:
    • Gross Fixed Capital Formation (GFCF) growth is weak, impacting the country’s productive capacity and potential for long-term economic growth.
    • Both public and private sector investments are insufficient to boost capacity.
  • Negative Net Exports:
    • India’s persistent trade deficit (more imports than exports) continues to drag down GDP growth.

Way Forward:

  • Boost Private Consumption:
    • Improve consumer confidence and increase disposable income through targeted policies.
  • Increase Government Investment:
    • Focus on expanding infrastructure spending to stimulate economic activity and create jobs.
  • Encourage Private Sector Investments:
    • Implement policies to improve the ease of doing business and incentivize private investments in critical sectors.
  • Enhance Export Potential:
    • Focus on expanding export markets, especially in manufacturing and services.
  • Focus on Structural Reforms:
    • Introduce labor and taxation reforms to ensure sustainable, long-term economic growth.

Conclusion: A Reality Check for India’s Economy

  • While India’s nominal GDP may show impressive growth in the short term, real GDP growth tells a different story.
  • The economy needs stronger, sustained growth in key sectors such as private consumption, government spending, and investment to ensure long-term economic health.
  • India must accelerate efforts to boost productive capacity and address the structural issues hindering investment growth. Only then can it sustain higher growth rates and achieve its long-term development goals.

Source: The Hindu

Mains Practice Question:

India’s economic growth has significantly slowed in recent years. Analyze the key factors behind this slowdown and suggest policy measures to address these challenges and ensure sustainable economic development in the coming years.