Recent Dip in India’s Economic Growth – A Cause for Worry?

What’s the Point?

Recently, it was reported that India’s Real Gross Domestic Product (GDP) has grown by 5.4% year-over-year (y-o-y) in Q2FY25 – lower than the growth rate of 8.1% y-o-y in Q2FY24. This softening in growth was primarily driven by a deceleration in growth in the industrial sector, which grew by 3.6% y-o-y in Q2FY25 and 13.6% y-o-y in Q2FY24. In addition to this, Government capex has been slow in H1FY25, and bank credit growth has witnessed a sharp decline. This slowdown has come at a time when India’s inflation for October 2024 came above the upper tolerance level of 6%. Despite sluggish growth observed in the industrial sector and looming economic policy uncertainty in the global and local context, India’s structural growth story remains intact for the long term. In H2FY2025, India’s economic growth could see a recovery due to pick-up in Government spending (especially if tax devolution is used for capital spending), improvement in agricultural production growth, improvement in rural demand and other factors.

Numbers in Perspective

Source: Bloomberg, Ministry of Statistics and Programme Implementation (MoSPI). *PFCE: Private Final Consumption Expenditure, **GFCE: Government Final Consumption Expenditure, $Gross Fixed Capital Formation

Factors contributing to the recent dip in GDP Growth Rate

• By Sector: Compared to Q2FY24, the y-o-y growth in major sectors like manufacturing (unfavourable base of 14.3% y-o-y growth in Q2FY24), mining and quarrying, and electricity, gas, water supply and other utility services (impacted by heavy rains and base effects) witnessed a major fall in Q2FY25 (Refer to the chart below).

Source: MoSPI, *Public Administration, Defence & Other Services category includes the Other Services sector i.e. Education, Health, Recreation, and other personal services

• By Budgetary Item:

• Capital Expenditure: As per the data published by the Controller General of Accounts (Ministry of Finance), the expenditure of the Budgeted Estimates of capex for FY25 (FY25BE) stood at 42% (₹4.67 lakh crore out of the budgeted ₹11.11 lakh crore) in 7MFY25 versus the 54.7% during the same period last year. Its growth remained weak at 15% below 7MFY24, with the low pace of spending on loans to states for capex, defense, roads and highways, and other areas. As a matter of fact, investment growth (5.4% y-o-y) was behind private consumption growth (6% y-o-y) in Q2FY25 for the first time in 2 years, majorly due to weak public capex, but subdued residential and corporate capex.
• Revenue Expenditure: Revenue expenditure growth in 7MFY25 remained in line, with budget targets at 54% of FY2025BE, growing at 8.7% y-o-y above 7MFY24. Among the larger spending areas, revenue expenditure was relatively muted for transfers to states, education, and drinking water and sanitation, while healthy pace was seen in areas like agriculture, health, rural development, and subsidies.

• Slowdown in Credit Growth and Elevated Interest Rates slowing down urban consumption:

As per Reserve Bank of India’s (RBI) Scheduled Banks’ Statement of Position, the y-o-y growth rate of bank credit (excluding inter-bank advances) has dropped by ~8.5 percentage points since May 2024 to 11% as on November 15, 2024. Such a significant tightening on lending of bank credit has led to a weakening in consumption. Furthermore, during 2022 and 2023, inflationary pressures led RBI to hike its repo rate. While spending continued during that period, in the recent times, with interest rates reaching its peak levels, interest payments have increased, thus contributing to a lower surplus, especially in the hands of urban consumers, leading to a weakening in urban consumption.

What could be the Potential Bright Spots?

Despite weaker corporate profit growth potentially leading to lower-than-expected corporate tax collections, personal income tax receipts for 7MFY25 are already 22% higher compared to the same period in FY24. Additionally, Goods and Services Tax (GST) collections have grown by 8.5% y-o-y, reaching ₹1.82 lakh crore in November 2024, driven by strong festive demand. According to JP Morgan Research, government spending is expected to increase in the H2FY25. Agricultural growth is also forecasted to rise by 5.7% in FY25, as a result of a stronger monsoon. While weaker quarterly economic growth may impact fiscal targets, potential savings from lower subsidy growth in the coming quarters could help boost GDP and keep India’s fiscal deficit target of 4.9% for FY25 on track.

With inflation remaining high, predominantly due to rising food prices, and weaker quarterly GDP growth, it is uncertain whether the RBI will begin cutting its repo rate sooner than expected. However, India’s long-term economic outlook is likely to remain strong, supported by pro-growth government policies. As a result, India continues to be one of the fastest-growing major economies, maintaining a solid structural position for the future*.

Sources: Bloomberg, RBI, MoSPI, Kotak Institutional Equities, JP Morgan Research, *International Monetary Fund, and other publicly available information

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