While knocking down India’s GDP growth at 6.5% for 2022-23, the World Bank noted that this was largely due to a deterioration in the global scenario. But even at 6.5%, India will continue to post superior global growth this year.
An examination of GDP growth data from India and advanced countries over the past two decades leads to two conclusions. First, India’s growth cycles are in line with those of advanced economies. This implies that India cannot avoid the short-term pain of deceleration in developed countries. The increase in global interconnectivity only accentuates this effect. And second, the long-term trend rate of GDP growth of advanced economies and India is divergent. For India it has increased over time, while for advanced economies it is the opposite.
Thus, when assessing India’s growth prospects for this year and next, it is important to bear in mind the first conclusion – even if, in addition, the dynamics of domestic inflation and financial conditions will also influence growth outcomes. On the other hand, the long-term trend growth rate will be influenced by many factors, including efficiency-enhancing reforms.
This article focuses on the short-term outlook.
A complex interplay of geopolitical events, worrying inflation and sharp rate hikes has clouded the global environment – more for the 2023 calendar than for 2022. As economies moved beyond the pandemic at the start of 2022, risks geopolitics emerged and have only gotten worse since then. S&P Global recently cut global growth to 3.1% and 2.4% for 2022 and 2023 respectively. The main contributors to this are the United States and the Eurozone, which are expected to experience anemic growth of 0.2-0.3% in 2023, while China is expected to grow by 2.7%.
A slowing world will hurt India through lower exports. Worse still, it may not lower crude oil and commodity prices commensurately.
Typically, global downturns dampen crude and commodity prices, easing the burden on Indian imports. However, this time around, the lingering geopolitical stress should limit the drop in their prices. OPEC’s recent decision to cut oil production is an example of how geopolitics shapes oil prices.
Since the beginning of this financial year, geopolitical developments have had an outsized impact on inflation in India, particularly wholesale price inflation, which continues to be in the double digits and is impacting consumer prices. . The clash between Russia and Ukraine pushed up crude oil and commodity prices and created volatility for several agricultural commodities. Exporting countries then imposed trade restrictions. While commodity prices have moved off their highs, volatility and uncertainty about the price trajectory persist.
High inflation for four decades is forcing systemically important central banks such as the Fed and the European Central Bank (ECB) to raise interest rates faster and larger than previously expected. With each 75 basis point hike, the Fed has become more aggressive on its terminal rate forecasts. Such hikes in the US have raised the specter of currency depreciation and imported inflation for India. Although the Rupee’s depreciation has been quite orderly so far thanks to the deft interventions of the Reserve Bank of India, the downward pressure has intensified again with the Rupee crossing $82/$ last week.
A weaker rupee will only make imports more expensive. And although global food prices have fallen, domestic food inflation is rising. Domestic pressures on food inflation from extreme weather events and unbalanced monsoon keep inflation high
The slowdown in global growth is having an immediate impact on Indian exports, which have already started to contract. A 1% decline in global GDP is associated with a 2.3% reduction in exports. But every 1% depreciation of the real effective exchange rate leads to a 1% increase in exports. Thus, the impact of a slowdown in the global economy on exports will overshadow the slight positive impulse from the depreciation of the rupee. The World Trade Organization has already lowered its forecast for growth in the volume of world trade.
Consumer-related sectors such as textiles (ready-to-wear and home furnishings) and leather are already facing lower export orders. Engineering and electronics products are also affected. But as domestic growth momentum remains strong, imports are rigid and continue to grow. Between April and September of this year, while exports increased by 15.5%, imports increased by 37.8%. This widens the trade deficit and consequently the current account deficit (CAD). A rising CAD requires more capital flows to fund it. The availability of this in the current risk aversion scenario would be a challenge. Thus, the Rupee is likely to remain volatile with a short-term depreciation bias.
Domestically, the good news is that Covid-19 has stopped causing functional disruptions in the economy and activity indicators remain strong in the first half of the fiscal year. Contact-intensive services are recovering quickly, helped by a weak base. The index of purchasing managers for services and industry remains in the expansion zone. Bank credit growth is accelerating and central government investment is broadly on track. Large and medium enterprises benefit from sound financial profiles and the banking sector is well capitalized. Capacity utilization in the manufacturing sector has improved according to RBI surveys. This prepares the corporate sector to undertake investments, but continued uncertainty will hold them back.
Rising interest rates and slowing external demand will hold back growth for the foreseeable future. These risks will be more pronounced in the second half of this fiscal year and could intensify in the next fiscal year (when the maximum impact of rate hikes and the global slowdown will be felt). We see downside risks to our GDP growth forecasts of 7.3% and 6.5% for the current year and next year respectively.
With so many moving parts and geopolitical complexity, policymakers and market participants have the unenviable task of anticipating turnarounds and the speed of recovery or downturn. In general, growth forecasts are heavily influenced by the prevailing macroeconomic environment. In other words, in a recovery, growth is overestimated, while in a downturn, the reverse is true. Therefore, forecasts at this stage will have a short lifespan and a wider confidence interval (the range of values within which an estimate should lie). This has been amply demonstrated by the multitude of revisions over the past few months around the world.
The writer is Chief Economist, Crisil