The world is passing through a complex and painful period. While most economies were already suffering from slow growth and high inflation driven by the pandemic, the recent Russo-Ukraine war has increased the challenges. Global commodity prices have remained buoyant despite supply constraints for some important food items and raw materials. While growth remains a challenge, major central banks have no option but to tighten monetary policy to counter high inflation. The Indian economy, which was yet to retreat from the pandemic and other domestic concerns, has also been embroiled in this.
India’s economic growth forecast for 2022-23 has been lowered as a result of recent challenges. With an estimated Gross Domestic Product (GDP) growth level of over 7% for the year, India is still in a better position than many others. This is not to deny the challenges emerging from several quarters which, if not properly addressed, could lead to further slowdown. Most importantly, consumer sentiment and consumption spending, impacted by the pandemic, are still weak. Private consumption, contributing 55% to GDP, is a major pillar of the economy. So it is very important to improve it. Consumption GDP has improved only marginally in 2021-22 compared to 2020-21 (pre-pandemic levels), while high frequency indicators such as IIP consumer goods data remain weak. On the investment front, the private sector has so far been the bastion of the public sector, despite the caution. We can expect a positive change in this as the level of capacity utilization increases. Private intention to invest has increased, as reflected by a jump in data on new investment announcements tracked by the Center for Monitoring Indian Economy. However, a meaningful improvement in the private capital expenditure cycle will depend on continued improvement in capacity utilization and a stable macroeconomic environment.
The employment landscape presents a sharp dichotomy. On one hand, there is a huge demand for value-added jobs in the IT and financial sectors, which are struggling for talent. On the other hand, job losses in the lower value-added spectrum are increasing as many urban workers have lost their jobs.
Rising inflation due to high global commodity prices is another challenge. While inflation is primarily due to supply-side factors, prices have risen in most categories. This is weakening consumer sentiment and putting pressure on producers’ margins. The increase in WPI inflation is faster than CPI inflation, which suggests that retail prices may still be higher.
Challenges on the global front have also created vulnerabilities for India’s external sector. As exports feel global growth is slowing and import bills are driven by higher commodity prices, India’s current account deficit is expected to widen in 2022-23. Unfortunately, the economy is also seeing an outflow of foreign portfolio investment as the US Federal Reserve prepares for further rate hikes. While foreign direct investment inflows remain healthy, India’s balance of payments will see a shortfall. This has already led to a fall in foreign exchange reserves and weakening of the rupee. A weaker rupee may worsen imported inflation.
In short, there are many challenges for the Indian economy at the moment. However, the country is still in a better position than many other economies in this period of global unrest. While inflation is on the rise in India, growth is still not as rapid as it is in many major economies. Abundant liquidity still hasn’t happened because of the warming of the economy. For example, in economies such as the US, UK and Australia, the real estate market has heated up. Abundant liquidity has led to a sharp rise in asset prices, which requires immediate attention from policy makers. With this not happening in India, the Reserve Bank of India has the comfort of being slow in the return of monetary accommodation. However, with inflationary pressures to remain so persistent, it is now needed to start raising policy interest rates and infuse liquidity in the system to make rate hikes more effective. Since inflation is mainly caused by supply-side factors, monetary policy action will have its limits. But at this point in time, stabilizing inflation expectations is crucial to halting the wage-price spiral.
As far as fiscal stimulus is concerned, the limits exist, as India’s fiscal deficit is put upward pressure by the rising subsidy bill. The government will immediately be wary of any further incentives as the current challenges may be long lasting. In such a situation, the government will have to keep some ammunition ready for use. However, it should consider cutting fuel taxes, as higher fuel inflation has a major impact in the second round and could heavily impact domestic inflation expectations. What is comforting on the fiscal front is that tax revenue collections have recently strengthened, giving the Indian government a cushion to go ahead with its capital expenditure plans. It is much needed at this point, as private players may still be indecisive on their capital expenditure plans due to economic uncertainties. It will also lay the groundwork for the long-term sustainability of the country’s economic growth story as the prevailing adverse conditions are easing.
Rajni Sinha is the Chief Economist, CareEdge, CARE Ratings Ltd.