The headline news about the Indian economy is that a new growth cycle began in financial year 2021-22. Put forward in the Finance Ministry’s Economic Survey 2022-23, that is a storyline officialdom has since clung to tenaciously. Agencies such as the IMF have underlined the official optimism, with a firm prognosis that India, among the major global economies, will register the best growth rate in the current year, and perhaps into the future.
This has been occasion for self-congratulation, for flaunting India’s economic resilience despite severe odds. Since 2020, no meaningful conversation about the global economy has been possible without reference to the pandemic, which held the world in a vice through the next two years. Economies were forced to shut down to preserve human life. And yet, the course of the virus across the globe managed to confound every hopeful prediction of an early end to the trauma.
Livelihoods were sacrificed to save lives since they seemed the lesser loss, and a recoverable one. Global economic output through 2020 shrunk by an estimated 4.3 per cent, with total income losses of about $10.3 trillion. India’s economic contraction through the first quarter of the year 2020-21, of which two months were in a state of total economic lockdown, was estimated at 23.9 per cent.
Just as the world was beginning to find its way out of the deep disruption came the first outbreak of armed hostilities between states on European territory since 1945. Russia’s war against Ukraine, a recurrence of the power-bloc politics that seemed banished in the 1990s, caused a spike in energy prices, throwing balance of payments into a brief turmoil. As the RBI stepped in to defend the rupee value, it suffered a significant haemorrhage of foreign exchange reserves.
Following the first wave of the pandemic, optimistic forecasts spoke of a likely “V shaped” growth curve recovering part of the losses in the second quarter, aided by what Economic Survey 2020-21 described as wide-ranging economic liberalisation measures across all sectors.
Consistent with the ideology that has dominated Indian and, indeed, global economic thinking since 1980, a pivot towards greater reliance on the market was seen as key to enhancing growth. But that early optimism evaporated from about April 2021, when India suffered a massive second wave of infections, on a scale the country was completely unprepared for.
Economic recovery has been the headline story since then, but evidence is building up that it has not followed the expected “V” shape but rather of the alphabet “K”. The story is not one of a plunge into the abyss followed by an equally sharp recovery but of a forked trajectory. One arm has begun a rapid rise, restoring a sense of well-being among the affluent, but the other has continued to droop, speaking of stagnant if not declining living standards among the vast majority.
Evidence of the “K-shape”recovery1 is available from various sectors, including automobiles, housing, and luxury consumption. And yet, because of the paltry overall contribution of upper-class consumption, the aggregate growth figure has remained at anaemic levels.
An economy already slowing down has, in other words, still some way to go before living standards are restored, even to the precarious levels that prevailed before the pandemic. And for all the rosy prognoses both in India and abroad, the story of growth remains an enigma since investment levels in the economy have shown a curious sluggishness. Over the last decade, gross fixed capital formation in the economy has fallen from just over 34 per cent of GDP to under 30 per cent (Figure 1). This, as the economist R. Nagaraj recently wrote,2 is a decline unprecedented since Independence.
Looking at the components of gross fixed capital formation over the decade, it is clear that public sector contribution, overall, has shown a very moderate upward trend. Clearly though, the boost in infrastructure investment that the government unfailingly claims as its principal achievement is as yet unreflected in national accounts statistics. Again, rather unambiguously, this has not shown up as the expected “crowding in” of private sector investment, which remains even more modest in terms of ambition.
A blame game of sorts has ensued. Finance Minister Nirmala Sitharaman has upbraided private industry lobbies at every opportunity for their failure to match the commitment of the public sector in investment matters. But, the overall decline, curiously, is not attributable to either of these sectors. Rather, it originates in a sharp fall in fixed capital investment by the household sector (Figure 2). The shift from physical to financial assets here is clearly discernible, though it follows a fluctuating course (Figure 3). And contrary to the general belief that Indian households are fixated on gold and turn to it in insecure times, the shiny metal has, if anything, been less favoured as a destination for household investment over the last decade.
As with all inferences drawn from statistics aggregated over the national economy, this requires careful dissection. Household fixed capital is counted, first and foremost, as housing investment, and then in terms of the various durables that a typical Indian family may buy. That this component of household savings has declined in a fairly unmistakable trend over the last decade is an economic fact that deserves attention at the level of policy.
The other side of this transformation is equally deserving of attention. Households are increasingly putting their savings in financial assets, which is undoubtedly a significant indicator of economic transformation. It has for long been believed, and not yet disproven, that lower-income households save mostly in physical assets: either in secure housing or in gold and other assets that are a solid hedge against depreciation. The clear evidence of a shift towards financial assets could be used to support two kinds of narratives: one a good news story, the other not quite so.
- The headline news about the Indian economy is that a new growth cycle began in financial year 2021-22 and this has been occasion for flaunting India’s economic resilience despite severe odds.
- This is not entirely true as the aggregate growth figure has remained at anaemic levels.
- But, the autonomy of the Reserve Bank is indispensable for safeguarding the integrity of the financial system, in turn a necessary condition for economic security.
Financial inclusion as policy
The good news story is that financial inclusion as a policy has worked. Rapid adaptation to the Unified Payments Interface and Direct Benefit Transfer, two signature policies of the current Indian government, may have brought more small savings that would otherwise be tucked under the pillow into the financial system. The bad news story, perhaps, is one of greater income inequality, implying in turn that most savings happen in the higher earning groups, which have a natural tendency to take the financial form.
Which of these is closer to reality is a point that can only be resolved with a clearer understanding of savings behaviour across income groups, and this remains a distant prospect with currently available data.
What can be said with some clarity is that the growing importance of capital in the financial form—rather than as physical assets—has created new policy priorities. Production flows were at one time the main determinant of economic fortunes. Earnings from the production process were once where income distribution and economic well-being were decided. Today, the state of asset markets is a factor that cannot be ignored since much of newly created wealth depends on it.
Asset ownership, as a number of studies have shown, notably the French economist Thomas Piketty’s 2013 work Capital in the Twenty-First Century, is as a rule more unequal than incomes earned through the production process. And a major transformation effected over the last three decades, more particularly since the global financial meltdown of 2008, is the hard-wiring of asset markets in most economies as the ultimate destination of all liquidity.
A sense of this is available from the COVID-19 pandemic and all the stresses it generated in economies around the world. With the normal cash flows that sustain life being disrupted, a semblance of order was restored by massive cash payouts, or what could be called injections of liquidity. It went by various names—quantitative easing is the currently utilised term of art—but what it all meant was the creation of money.
In economic orthodoxy, this would have meant intolerable pressures of inflation, destroying economic well-being across all strata. Yet, what was remarkable about the creation of liquidity at the time was the ease with which newly created money flowed into asset markets. Rather than the generalised inflation that economists believed would be the outcome of the huge liquidity injection, an assets price boom resulted.
The inflation of asset prices creates a sense of extravagantly high returns on investment, cheapening the cost of capital. Shares that are quoting at massive premiums in the markets make the task of raising capital for fresh investment much easier.
Anybody who has followed how the valuation game has played out in global capital markets, enabling fortunes in eye-popping numbers built around new tech start-ups, will know how that system operates.
Rise in unicorns
The claims of a new growth momentum in India come alongside the celebration of a surge of so-called “unicorns”, newly incorporated firms, typically in the IT space, that achieve market valuations in excess of a billion dollars. Increasingly, the national pool of savings is being ploughed into these enterprises in the obsessive pursuit of short-term gain. What is most notable about these unicorns is that very few, if any, among them have ever earned a profit in terms of conventional revenues and costs. But merely because global finance capital cannot possibly find a way out of this conundrum, except by putting in new money after old, the valuation bubble for these companies keeps growing.
Alongside this element of risk, the real estate sector has resisted every effort at moderation of the speculative frenzy it has been in. Household savings, flowing through the financial system, find their way into this form of assets inflation despite growing evidence that buyers at the other end of the chain may be diminishing in number. The RBI as the final custodian of financial sector integrity has issued warnings every so often, though its ability to intervene to restore stability may have waned with the transfer of larger shares of its capital to the government exchequer.
In 2018, the economist Viral Acharya,3 who was then Deputy Governor of the RBI, spoke of the autonomy of the central bank as indispensable for safeguarding the integrity of the financial system, in turn a necessary condition for economic security. The cautionary tale he invoked then was from Argentina, where a government had in 2010 demanded that the central bank transfer virtually its entire capital to meet a situation of budgetary stringency. The story did not end well, as a US court soon afterwards ordered the impoundment of the Argentinian central bank’s deposits in the US banking system for its allegedly illegal seizure of assets.
Argentina has just elected a fanatical right-wing populist as President, who ran a campaign promising, among other things, to “blow up” its central bank, abolish its currency, and make the US dollar its official medium of exchange.
No such eventuality threatens India. But Acharya spoke at a juncture of escalating conflict between the RBI and the government in 2018. The RBI thought it best to retain a corpus as a hedge against instabilities in the financial system. The government, asserting ownership rights, insisted the money was best redeployed in its Budget. The confrontation caused the departure of two RBI Governors and a few deputies, which did not quite dispel the spectre of financial instability. It leaves unsettled the question of how any future contingency can be handled when global turbulence is an imminent prospect.
Sukumar Muralidharan is an independent writer and researcher based in the Delhi region.