The Indian economy is in facing some unprecedented challenges. A protracted war in Europe has introduced new strains even before the impact of Covid-19 has fully waned. Together, these two significantly weaken the backbone of the world economy, impacting both the advanced and emerging markets. Contemporaneously, the Indian economy is also impacted.
Inflation has turned alarming and is generalised. There are fears that in the current fiscal, the inflation rate will be above the upper tolerance limit of 6 per cent as mandated in the flexible inflation target (FIT) system for three consecutive quarters. This will imply a failure of the RBI to adhere to the FIT mandate, a first since the inception of FIT in 2016.
Economic growth has slowed as evident in Q4 data of 2021-22 (Q-o-Q, around 4 per cent). Even though the Monetary Policy Committee (MPC) has kept unchanged the rate of economic growth at 7.2 per cent for 2022-23, the Q3 and Q4 data at 4.1 per cent and 4 per cent, respectively, are pointers to a marked slowdown. Against this backdrop, the RBI Governor’s remark (in his statement of June 6) that the “Indian economy has remained resilient supported by strong fundamentals and buffers” needs a relook.
With inflation out of control and growth under pressure, what does resilience really mean?
If the upside risks to inflation continue, the upside risks to economic growth will also continue as the higher interest rate will be transmitted to a higher lending rate which, in turn, will discourage both private consumption and private investment. The RBI has released credit offtake data as on May 22. The non-food credit data in general as on this date was 9.7 per cent (Y-o-Y) and industrial credit data in specific in the same period was 7.1 per cent.
For an economy of India’s size, this is not very encouraging. The 90 basis points (bps) hike in interest rate (policy repo rate, announced in the May and June policy statements) will result in an increase in the bank lending rate as the MPC rate action transmits to the credit channel. The higher bank lending rate will further discourage private consumption/investment.
The Governor’s statement also noted that “optimism on exports, both goods and services, and remittances, should help contain the current account deficit (CAD) at a sustainable level which can be financed by normal capital flows”. The slowdown in economic growth both in advanced and emerging market economies will affect India’s exports as the global demand will be weak. Furthermore, the external demand for our commodity exports are inelastic. Thus, our exports will be affected both by inelastic demand and the weak economic growth worldwide.
Even though the remittances and software services are to some extent pro-cyclical, the prolonged war in Europe could hurt trade in goods, services and remittances.
In view of the above, optimism on exports is misplaced at this stage. There is also pressure on imports in terms of crude oil, edible oil and pulses. Therefore, CAD could well be higher than that is anticipated currently. Past evidence suggests that higher crude prices make CAD unsustainable. Further, on account of the global slowdown and large-scale uncertainty, “normal capital flows” in terms of foreign direct investment (FDI) may take a pause for some time.
In the context of a forex “buffer”, as mentioned in the Governor’s statement, a large component of forex reserves of $601.1 billion is debt flows. According to the International Investment Position (IIP), which measures external assets and liabilities, India is a net liability country. For example, as per the latest IIP data released by the RBI on March 31, 2022, for December 2021, our external debt liabilities comprised 48.5 per cent of the total external liabilities.
These debt liabilities mostly consist of External Commercial Borrowing (ECB) and NRI deposits. Furthermore, our assets-to-liabilities ratio as on end-December 2021 is 72.1 per cent. To the extent the “safe haven demand for US has increased”, as mentioned in the Governor’s statement dated June 8, the pressure on capital outflows from India continues.
Given the uncertainty in global demand for our exports and the rising oil import bill, the CAD position could remain fluid and the capital outflows may add pressure on volatility of our exchange rate vis-a-vis the dollar. Thus, the present 2.5 per cent rupee depreciation as against the dollar may not be a comfortable phenomenon, given the potential pressure on the CAD and normal capital flows.
Another important issue is the fiscal situation. The fiscal deficit, as a proportion of GDP, stood at 6.7 per cent in the provisional account of 2021-22 as against 6.9 per cent recorded in the revised estimates. This was on account of higher revenues but also a cutback in capital expenditure. Thus, growth-augmenting expenditure was reduced.
Furthermore, the revenue deficit-to-GDP ratio was 4.37 per cent. Revenue deficit conceptually is dis-savings of the government and is, therefore, a drag on growth. Thus, the fiscal trend for 2021-22 is not growth augmenting. If a similar trend continues in 2022-23, economic growth will further slow down and will be lower than the MPC-RBI estimate.
Let us now turn to the forward-looking surveys released by the RBI on June 8. The consumer confidence survey remained negative in respect of the economic situation, employment and price level.
The inflation expectation survey indicated that both, three months ahead and one year ahead, inflation will remain high. The survey of professional forecasters on macroeconomic indicators indicated largely a slowdown in growth rate (6.5 per cent), higher inflation rate (7 per cent) in 2022-23 against 7.2 per cent economic growth rate and 6.7 per cent for inflation estimated by MPC-RBI.
Also, the professional forecasters have estimated that CAD relative to GDP will be 3 per cent, which is higher than the CAD-GDP ratio of around 2 per cent historically.
In sum, growth is slowing and will slow further because of the higher lending rate, resulting in potential deceleration in credit offtake. Inflation has moved to a higher trajectory, mostly supply driven, and will cause hardship. CAD will be higher and normal capital flows may not be forthcoming. In this light, claims that the Indian economy is resilient offers an encouraging and optimistic reading but it is based less on ground realities and more on hope.
The writer is a former central banker and a faculty member at SPJIMR. Views are personal (Through The Billion Press)
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