The year 2022 was a good ‘growth’ year for India. India’s economy was among the fastest growing large economies. This was commendable, especially in a year marred by war and extreme climate events, rising commodity and energy prices, tightening global monetary policy, and slower global economic growth. India is poised to grow at 6.9 per cent in 2023, as per the estimate by World Bank.

However, India’s Achilles heel is its burgeoning current account deficit (CAD), falling value of the Indian rupee, falling industrial growth and high domestic inflation numbers. Let’s first examine the negatives, and then the positives, as we go into the New Year.

During the second quarter of this fiscal, India’s CAD widened to $23.9 billion, the highest since 2012. Rupee touched a record low of 83.07 against the dollar in October 2022. Retail inflation hovered at over 7 per cent (against the upper tolerance limit of 6 per cent) for most part of this year. A bulk of India’s exports, for example, refined petroleum products, pearls, precious stones and chemicals are not picking up. Weak global demand implies a lower demand for these income-sensitive items.

A strong Indian economy demands more energy and fossil fuels, most of which are imported. As imports continued to grow, without a commensurate increase in exports, the rupee depreciated. A depreciating rupee also leads to domestic inflation, as the ‘imported’ commodity and energy prices become costly.

It will be difficult to sustain a GDP growth of 6.9 per cent without ensuring healthy domestic demand. India’s industrial production shrank 4 per cent from a year earlier in October 2022, the steepest contraction since August 2020. Real wage growth in the agriculture and construction sectors is stagnating.

This is a cause of concern as marginal propensity to consume for lower-income groups is higher in comparison to the upper 10th percentile of population. Most consumption by the rich and wealthy are on imported merchandise and services items, which do not contribute to domestic demand. Lack of domestic demand coupled with higher energy and input price will send a negative signal to the manufacturers against possible capacity expansion. Programmes such as MGNREGA can boost domestic demand.

However, the Centre and the Reserve Bank of India are making coordinated efforts to make exports competitive, lower domestic inflation, and arrest a fall in the rupee value.

Fiscal Measures

To reduce dependence on foreign imports and increase export competitiveness, the Centre launched programmes such as the National Manufacturing Policy in 2011. Additionally, several policy instruments were introduced; such as the Focus Market Scheme (FMS) and Production Linked Incentives (PLI). Under FMS, the government provides incentives on exports that can be used later to settle against future import duties on raw material to be used for exports. The PLI scheme was meant for increasing competitiveness of 14 items under manufacturing sectors such as pharmaceuticals, engineering, and electronics.

To lower trade and logistics costs related to the movement of goods, the Centre increased outlay on capital expenditure from ₹5.54 lakh crore in 2021-22, to ₹7.50 lakh crore in 2022-23. Such allocation of funds is expected to provide impetus to the Gati Shakti project, a plan to improve multimodal connectivity.

These moves have proved beneficial. In the case of high-value-added pharmaceutical exports such as formulation and vaccines, India is performing well because of FDI and government’s support in the form of FMS and PLI. The PLI scheme has seen foreign smartphone manufacturers showing interest in investing in India.

In the short run, policymakers undertook a few micro measures to reduce the widening CAD.

India continues to buy cheap oil from Russia. The share of Russian mineral fuel imports in India’s trade basket went up from 1 per cent in February 2022 to 22 per cent by November 2022. Additionally, on September 9, India banned export of 100 per cent broken rice which can be used for producing ethanol, an alternative source of fuel.

To reduce gold imports, another item responsible for increasing trade deficit, on July 1, 2022, India increased customs tariffs on gold imports from 7.5 per cent to 12.5 per cent.

Monetary Measures

The rupee has also fallen on account of monetary tightening in the US. Since March 2022, the Federal Reserve has raised interest rates by 350 basis points. The yield on two-year US treasury security increased from 1.56 per cent on August 1, 2020, to 4.50 per cent on December 9, 2022.

This has led to outflow of capital from the Indian economy, pulling down the rupee. Since March 2022, this year, RBI increased the policy rates by 225 basis points.

In addition to raising the repo rates, the RBI took a few other policy measures. For example, the RBI temporarily permitted commercial banks to open Foreign Currency Non-Resident (FCNR) accounts (held in foreign currency) and Non-Resident External (NRE) deposits from Indians residing outside India without any cap on the interest rate. This is likely to increase foreign currency deposits. Additionally, an attempt to include Indian government bonds listed in global indices can ease the inflow of foreign currency, improving foreign exchange reserves and curtailing a fall in the value of the rupee.

Silver Lining

The combination of fiscal and monetary policy initiatives has begun to show results. Foreign exchange reserves increased from $528.37 billion in October 2022, to $564.07 billion in December 2022.

Net foreign direct investment rose to $22.7 billion in April-October 2022 up from $21.3 billion during the corresponding period last year. Foreign portfolio investment contributed to inflow of $11.8 billion between June and early December, reversing negative trends. Although the rupee has depreciated up to 9.8 per cent this calendar year, it was less when compared to other developed countries in the EU regions, Japan, and South Korea, whose currencies depreciated in excess of 15 per cent.

Some caveats

Make in India, Atmanirbhar Bharat and PLI schemes will take time to make exports competitive. Meanwhile, Indian negotiators should find ways to deal with extra-trade provisions such as labour, environment, IPRs etc., which are increasingly hurting access to India’s exports in the developed markets.

The writer is Professor, School of Management, Mahindra University