The economy must look beyond FY22 challenges
Intro: With a global stagflation-like condition, the economic ground work for a revival next year is underway.
While there is much market mayhem going on, the economic front is facing an uphill battle in showing good growth rates. There was a glimmer of a revival after the pandemic re-opening, but now there are a new set of challenges for the corporate, household and economy after the Russian-Ukraine conflict.
A recent RBI report on currency and finance titled ‘Revive and Reconstruct’ highlights the difficulties in shoring up economic growth rates. One important consideration summarises the economic picture is succinctly reflected in a paragraph from the report.
“Corporate balance sheets have coped with the pandemic by deleveraging and increasing liquid assets, but investment appetite that should motor a renewed capex cycle is still weak,” underscored the report. “Frail household balance sheets and labour displaced from contact-intensive activity have impacted consumption demand and quality of capital. As a result, the trend growth path of India may have shifted downwards, warranting urgency in putting in place a comprehensive range of measures for re-invigorating growth, while negotiating net-zero transition costs, de-globalisation and broken supply chains.”
In a slow gear
In short, the economic growth rates have to be calibrated downwards given the multiple global headwinds. The RBI has pointed out that a feasible range for the medium-term steady state GDP growth in India works out to 6.5-6.8%. For the Indian economy which needs a much higher growth to lift standards of living, this downshift from earlier expectations of upwards of 7.5% this re-calibration is not good enough. This does not reflect the potential of the economy.
A risk to economic growth comes from the fact that the government debt levels are high. In fact, the government needs to bring down its debt to below 66% of GDP over the next five years. One of the second-level outcomes of this will reflect in the release of available resources for the private sector to increase its capex activity.
However, it’s pertinent to note that the general government debt may not decline to below 75% of GDP over the next five years in the best possible outcomes. In adverse conditions, debt may even hover above 90% of GDP. With the debt-to-GDP hovering above the 88% mark, that could be a distinct possibility.
Another big challenge for the economy is to re-balance monetary and fiscal policies. One of the key considerations is to withdraw the large surplus liquidity overhang in the economy. Consider this, average inflation rises by 60 basis points with every percentage point increase in surplus liquidity above 1.5% of net demand and time liabilities (or deposits with the banking system). In other words, price-stability is now paramount.
Long term drivers
For longer and more sustained revival, there is plenty of ground that needs to be covered . The government has introduced several measures to boost economic activity, such as the PLI, tax reforms, increasing capex spends. However, reviving private investment will need access to cheaper land resources.
Further, the quality of labour has to be enhanced which means raising expenditures on education, health and Skill India initiatives. Private sector research and development activities also need to be stepped up considerably, which can be a driver of innovative growth. The government must encourage corporate investment in agriculture and create an enabling environment for start ups and unicorns in research and innovation.
Inflation control over growth
Nevertheless, for now the monetary policy committee (MPC) is prioritising inflation over growth at its April meeting. One of the first things, the RBI has done is increased interest rates in the economy by about 40 basis points. Even so, when there is an upward pressure on interest rates in the global economy, the Indian economy will find it difficult to isolate itself and keep interest rates low.
Global inflation is worrisome, particularly food and commodity inflation. US inflation is galloping and Fed watchers are forecasting sharp rate hikes to reign in inflation. China is battling a resurgent covid epidemic. Europe is going through its own set of challenges to stave off a recession due to food shortages and high oil and gas prices.
Against this backdrop, driving an economic expansion in India is not easy. The rupee also breached the Rs 77 mark to the dollar to touch Rs 77.46. The persistent FPI outflows and the Fed’s aggressive rate hike cycle are weighing on the rupee. So far, though the rupee has been holding on well, and the RBI is lending support to the rupee through direct interventions or swap auctions.
Globally central banks have to face the issue of high inflation and low growth. The RBI’s sudden rate hike and the pullback in the accommodative policy along with the hiking of CRR is a pointer to the upside risks in inflation. Hence, stagflation can be a major hindrance and one of the biggest challenges in the short run.
Groundwork in progress
The initial trends in consumption activity is patchy. However, monsoons are likely to be normal, and fertiliser sales showed an upward momentum. This will alleviate the stress in the rural economy. Farmers are also likely to get higher income given the increase in global food prices, hence that should see rural demand pick up over the second half.
The good thing is that India’s GDP growth of about 6.5-7% will still be one of the highest in the world. Foreign investors are bound to take cognisance of this fact once the carry trade position swapping begins to taper. Domestic investors continue to keep the faith, which will help capital formation.
For now, the economy will have to tide over the current global stagflation conditions. But post this consolidation phase, in FY23, India would be in a much better position to build on this consolidation phase.