Growth prospects appear sluggish

The resolution of Monetary Policy Committee (MPC) released on June 8 kept the policy repo rate (PRR) unchanged and resolved to continue with the withdrawal of accommodation in the monetary policy stance in sync with the monetary policy objective of ‘price stability keeping in mind growth.’ On account of ‘combined impact of monetary tightening and supply augmenting measures,’ the CPI inflation came down to 4.7 per cent in April 2023. However, due to uncertainties in the prospects for agricultural production and crude oil price outlook coupled with the hardening of input cost and output prices, the MPC projected CPI inflation at 5.1 per cent for 2023-24 would continue to remain above the target of 4 per cent.

The risk to growth outlook would emanate from weak external demand and prolonged geopolitical tensions. Accordingly, the MPC projected the real growth rate at 6.5 per cent in 2023-24 as compared with 7.2 per cent in 2022-23 and 9.1 per cent in 2021-22.

In the above context, it is important to mention that during the year gone by, the RBI assigned ‘primacy to price stability’ (controlling inflation and anchoring inflation expectations) as the headline inflation remained above the upper tolerance level of 6 per cent over 10 consecutive months during January-October 2022 with a peak at 7.8 per cent in April 2022.

As the RBI Annual Report 2022-23 has mentioned, domestic inflation was adversely impacted by global factors which included monetary tightening by major central banks on account of ‘multi decadal’ high level of global inflation (9.2 per cent in 2022) caused by food and energy prices (crude oil price reached a peak of $117 per barrel in June 2022). The elevated inflation remained a major threat in terms of anchoring inflation expectations, breaking the persistence of core inflation (which remained on an average 6.1 per cent in 2022-23 with peak of 7.1 per cent in April 2022) and strengthening medium term growth prospects. Therefore, the RBI took recourse to monetary tightening by increasing the PRR by 250 basis points (bps).

The monetary policy tightening both in the global and the Indian context resulted in disinflation. The disinflation glide path (inflation rate witnessed a reduction from 9.2 in 2021-22 to 5.6 in 2022-23) took a toll on growth in the global context as the growth rate slowed from 6.2 per cent in 2021 to 3.4 per cent in 2022 and 2.8 per cent in 2022-23, according to the IMF. The pace of global disinflation, as the RBI Annual Report has mentioned, ‘remains less than desirable’, implying that the inflation rate in many advanced economies and emerging market economies has remained more than the target rate for a number of inflation-targeting economies.

The RBI technical study (‘Recent inflation dynamics — role of supply vis-à-vis demand,’ RBI Annual Report, 2022-23 Box II.3.2) observed that the average contribution of demand side factors was 35.2 per cent in 2019 and came down to 24.6 per cent in 2020. However, it went up to 31.8 per cent in 2021 and 30.5 per cent in 2022. On an average, the supply side factors contributed around 55 per cent to CPI headline inflation from January 2014 to December 2022.

The deceleration in inflation rate was from a peak 7.8 per cent in April 2022 to 5.66 per cent in March 2023 and further to 4.70 per cent in April 2023. Furthermore, the inflation outlook set out by the MPC revealed that the inflation would be 5.1 per cent in 2023-24. Thus, the Indian economy would continue to move along the disinflation glide path. In this context, the RBI technical study (‘Monetary policy and disinflation’, RBI Annual Report, 2022-23, Box II.3.1) has observed that a 1 per cent rise in PRR leads to a peak impact of 30 bps fall in real GDP growth rate. The impact of inflation will operate with higher lag, with a peak reduction of 20 bps.

Disinflation path

The disinflation glide path as explained above resulted in downward movement in growth rate measured in terms of GDP at constant prices from 9.1 per cent in 2021-22 to 7.2 per cent in 2022-23. The deceleration in GDP growth representing the demand side or expenditure was due to decline in growth rate of private final consumption expenditure (7.53 per cent in 2022-23 as compared with 11.24 per cent in 2021-22); government final consumption expenditure (0.12 per cent as against and 6.56 per cent); gross fixed capital formation (11.39 per cent as compared with 14.64 per cent in 2021-22). The growth outlook by MPC moderated to 6.5 per cent in 2023-24 with the gradual decline from Q1 (8 per cent), Q2 (6.5 per cent), Q3 (6 per cent) and Q4 (5.7 per cent).

The MPC has resolved that the cumulative rate hike of 250 bps is transmitting through the economy and its ‘fuller impact should keep inflationary pressures contained in the coming months’. The RBI Annual Report 2022-23 has observed that banks raised their external benchmark-based lending rate (EBLR) upwards by the same magnitude, which strengthened the pace of transmission.

The RBI technical study (‘Monetary policy and disinflation’, Box II.3.1) observed that (a) if the PRR would have continued at 4 per cent (no change in PRR), inflation would have remained above 6 per cent with a peak rate of 7.3 per cent, (b) if PRR would have increased by 100 bps, inflation would have been lower at 25 bps, and (c) if PRR would have increased by 250 bps, inflation would have eased by more than 50 bps.

Thus, the technical study concludes that increasing PRR has a positive impact in the reduction of inflation rate. However, growth has been sacrificed. The efforts to control inflation by maintaining current policy stance might have sacrificed growth by about 65 bps.

This could be attributed to increase in higher interest rate which broadly moved in tandem with increase in PRR. For example, weighted average lending rate (WALR) increased to 6.52 per cent in March 2023 from 3.32 per cent in March 2022; three months treasury bill rate to 6.88 per cent (3.79 per cent); AAA corporate bonds to 7.85 (6.48 per cent); G-sec five-year bond to 7.28 per cent (6.38 per cent), and G-sec 10 years to 7.35 per cent ( 6.83 per cent).

The higher interest rate regime also impacted adversely credit uptake in the case of infrastructure sector (power, telecommunication and roads). For example the credit uptake for infrastructure declined to - 0.7 per cent in 2022-23 as against 9.1 per cent in 2021-22. Thus, the weak credit demand for infrastructure does not augur well for private investment and economic growth.

Thus, the picture is that the growth prospects remains sluggish with continued retail inflation pressure.

The writer is a Professor at the Gokhale Institute of Politics and Economics, Pune, and a former central banker. Views are personal Through the Billion Press

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