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Between July and September, India's economy shrank to its lowest level in seven quarters, at 5.4%.
Is the world's fastest growing major economy losing steam?
The latest GDP figures paint a sobering picture. Between July and September, India's economy shrank to a seven-quarter low of 5.4%, well below the Reserve Bank of India's (RBI) forecast of 7%.
Although it remains robust compared to developed countries, this figure signals a slowdown.
Economists attribute this to several factors. Consumer demand has weakened, private investment has been sluggish for years and public spending – a key driver in recent years – has been cut. Indian exports of goods have long struggled, with their share accounting for only 2% in 2023.
Fast-moving consumer goods (FMCG) companies are reporting tepid sales, while publicly traded company payrolls, a gauge of urban wages, declined last quarter. Even the previously bullish RBI revised its growth forecast to 6.6% for the financial year 2024-25.
“All hell seems to have broken loose after the latest GDP figures,” says economist Rajeshwari Sengupta. “But it's been building up for some time. There's a clear slowdown and a serious demand problem.”
Finance Minister Nirmala Sitharaman paints a brighter picture. She said last week that the drop was “not systemic” but resulted from reduced government spending during an election-focused quarter. She expects third-quarter growth to offset the recent decline. India is likely to remain the fastest-growing major economy despite challenges such as wage stagnation affecting domestic consumption, slowing global demand and climate disruption in agriculture, Sitharaman said.
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Inflation in India jumped to 6.2% in October, mainly driven by high vegetable prices.
Some – including a senior federal government minister, economists and a former member of the RBI's monetary policy group – say the central bank's focus on controlling inflation has led to lower interest rates excessively restrictive, likely to stifle growth.
High rates make borrowing more expensive for businesses and consumers, and can potentially reduce investment and dampen consumption, two key drivers of economic growth. The RBI has kept interest rates unchanged for almost two years, mainly due to rising inflation.
Inflation in India jumped to 6.2% in October, exceeding the central bank's target of 4% and reaching its highest level in 14 months, according to official data. This increase is mainly due to the prices of food products, which represent half of the consumption basket – the prices of vegetables, for example, increased by more than 40% in October. There are growing signs that rising food prices are now influencing other daily costs, or underlying inflation.
But high interest rates alone may not explain the slowdown in growth. “Cutting rates will not boost growth unless consumer demand is strong. Investors borrow and invest only when demand is there, and that is not the case now,” says Himanshu (he only uses 'one name), development economist at Jawaharlal Nehru University, Delhi.
However, outgoing RBI Governor Shaktikanta Das believes that “India's growth story remains intact”, adding that “the balance between inflation and growth is well balanced”.
Economists point out that despite record retail credit and an increase in unsecured loans – indicating that people are borrowing to finance consumption even in a context of high rates – urban demand is weakening. Rural demand is more dynamic, benefiting from a good monsoon and higher food prices.
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India's central bank has kept interest rates unchanged for almost two years, citing inflation risks.
Ms Sengupta, an associate professor at the Mumbai-based Indira Gandhi Institute of Development Research, told the BBC that the current crisis was borne out by the fact that the Indian economy was operating on a “two-speed trajectory”, driven by divergent performances in its sector of activity. “old economy and new economy”.
The old economy, which comprises the vast informal sector, including small and medium-sized industries, agriculture and the traditional private sector, is still awaiting long-overdue reforms.
In contrast, the new economy, defined by the post-Covid boom in service exports, saw robust growth in 2022-2023. Outsourcing 2.0 has been a key driver, with India emerging as the world's largest hub for global capacity centers (GCCs), which carry out high-end offshore services.
According to Deloitte, a consultancy firm, more than 50% of the world's Gulf countries are now based in India. These centers focus on R&D, engineering design and consultancy services, generating $46 billion (£36 billion) in revenue and employing up to 2 million highly skilled workers.
“This influx of CCGs fueled urban consumption by supporting demand for luxury goods, real estate and SUVs. For 2-2.5 years after the pandemic, this led to an increase in urban spending. With CCGs largely established and changing consumption patterns, urban spending has been fading,” says Ms. Sengupta.
Thus, the old economy seems to lack a catalyst for growth while the new economy slows down. Private investment is crucial, but without strong consumer demand, businesses will not invest. Without investments to create jobs and increase incomes, consumer demand cannot recover. “It’s a vicious cycle,” says Ms. Sengupta.
There are other confusing signals as well. India's average tariffs have risen from 5% in 2013-14 to 17% today, higher than those of its Asian counterparts that trade with the United States. In a world of global value chains, where exporters rely on imports from multiple countries, high tariffs make goods more expensive for businesses to trade, making it harder for them to compete on global markets.
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Car sales fell 14% in November – another sign of weakening demand
Then there is what economist Arvind Subramanian calls a “new twist in history.”
Even as calls grow for lower interest rates and more liquidity, the central bank is supporting the rupee's decline by selling dollars, which tightens liquidity. Since October, the RBI has spent $50 billion of its foreign exchange reserves to protect the rupee.
Buyers must pay in rupees to buy dollars, which reduces market liquidity. Maintaining a strong rupee through interventions reduces competitiveness by making Indian products more expensive in global markets, leading to lower demand for exports.
“Why is the central bank supporting the rupee? This policy is bad for the economy and exports. Maybe they are doing it because of appearance. They don't want to show that the Indian currency is weak” , said Mr. Subramanian, a former economic adviser. to the government, told the BBC.
Critics warn that the “exaggerated narrative” that India is the fastest growing economy is hampering essential reforms aimed at boosting investment, exports and job creation. “We are still a poor country. Our GDP per capita is less than $3,000, while the United States' GDP is $86,000. If you say we are growing faster than them, that makes no sense “, says Ms. Sengupta.
In other words, India needs a significantly higher and sustained growth rate to generate more jobs and raise incomes.
Stimulating growth and consumption will not be easy in the short term. In the absence of private investment, Himanshu suggests raising wages through government-run employment programs to raise incomes and boost consumption. Others, like Ms. Sengupta, advocate for reduced tariffs and to attract export investment from China to countries like Vietnam.
The government remains optimistic about the situation in India: banks are strong, foreign exchange reserves are strong, finances are stable and extreme poverty has declined. Chief economic advisor V Anantha Nageswaran says the latest GDP figure should not be overinterpreted. “We shouldn't throw the baby out with the bathwater, because the underlying growth remains intact,” he said at a recent meeting.
It is obvious that the pace of growth would need some acceleration. This is why skepticism persists. “There is no nation that has been so ambitious for so long without taking (adequate) steps to realize that ambition,” says Ms. Sengupta. “Meanwhile, the headlines are talking about India's age and decade. I'm waiting for that to materialize.”
