Part of the slowdown can be blamed on what looks like a one-off, offbeat quarter. Specific things went wrong. First, a string of climate change events hurt agricultural production and, second, in the midst of a series of high-stake elections, the government’s expenditure slowed.
Both are already showing signs of easing, and some of the slowdown could reverse over the next quarter.
Temperatures have normalized, with reservoirs full again after a long hiatus and, as a result, agricultural production has picked up. So far, farmers are using their earnings to build back savings or repay debt, as evidenced by rising cash balances in rural accounts.
If the winter crop does well, it is likely that a larger share of that income will be used for rural spending, igniting a part of the economy that has been rather subdued.
Elevated inflation, pulled up by high food prices, has hurt mass purchasing power. The seasonal winter food disinflation, expected on the back of stronger agricultural production, could revive some of that purchasing power, boosting mass-level consumption.
However, this is just one part of the story. The other is a reality check, and this needs to be assessed carefully. Based on our analysis of a host of different metrics, we estimate that India’s potential growth—its ability to grow sustainably without stoking inflation or external balances—is actually around 6.5%, not the 7.5%-plus number of the last two years.
We believe that the bulk of the growth exuberance over the past few years has been led by the rise of ‘new India’, a small (15% of GDP) but fast growing (15% year-on-year annually) part of the economy, which comprises several high-tech sectors.
The rise in manufacturing in selected sectors (like mobile handsets), the expansion of global capability centres and the proliferation of digital startups led to high growth and incomes at the top of the pyramid. The rise in the GST rate on luxury items and real estate demand were offshoots of the rise of ‘new India’.
After several heady years, the base of ‘new India’ is rising, and growth in these sectors is normalizing to more sustainable levels. For instance, growth in services exports has softened from a heady 27% year-on-year average in 2022-23 to a still-high 14% in 2023-24. Understandably, urban consumption is normalizing as well. And overall GDP growth is converging to its 6.5% potential rate.
The good news is that 6.5% growth is still pretty impressive in the current global order. The challenge now is to maintain this level, and for that, growth needs to be more broad-based.
Unbalanced growth, as we have seen in the past, can lead to excesses and eventually become unstable. Recall how urban consumption over the last year expanded strongly alongside an unfettered rise in unsecured consumer loans, eventually requiring the central bank to clamp down.
So, what’s the best way to ensure that growth is more widespread? In other words, how to diversify from capital- to labour-intensive growth?
The rise in agricultural production is likely to help in the short term; however, in an era of weather disruption and climate change, this can’t be a permanent solution. Something more tangible is needed.
And, here, an opportunity might be opening up. During Donald Trump’s first term as US president, trade tensions with China ultimately led to a diversion of trade and investment to other markets, such as Asean, which saw faster growth as a result.
With tariff fears engulfing the world once again, supply chains may get rejigged again should high tariffs be levied on economies that run large trade surpluses with the US. And this could be an opportunity for India, which was not a primary beneficiary of the previous US trade tensions.
Looking at this through the lens of foreign direct investment (FDI)—an important marker of which economies are benefitting from rejigged supply chains—India has so far not been a prime recipient of FDI in mid-tech sectors like textiles, small electrical gadgets and toys.
These are also sectors that are more labour-intensive than the high-tech FDI sectors where India has done better. Attracting mid-tech FDI could be an important way to create the jobs needed to uphold growth and make it more broad-based.
However, it also means working hard on several fronts to seize the opportunity—expanding free trade agreements (FTAs), enhancing infrastructure development, developing a skilled workforce and streamlining business practices.
In particular, bilateral trade agreements with advanced economies like the US could benefit India by reducing tariffs levied on labour-intensive Indian exports. Indian textile exporters, for one, have long blamed the preferential access to US markets enjoyed by economies that already have FTAs.
India’s old problems, such as the need for better jobs for its teeming millions, are well known. Nevertheless, opportunities are knocking on the door as well. Whether the country seizes the day will define its fortunes in 2025 and beyond.
The author is chief India and Indonesia economist at HSBC
