By Dipti Deshpande
This month has been packed with big macro releases — the interim union budget on February 1, the monetary policy review on February 8, the consumer price inflation and industrial production data on February 12 and the external trade data on February 15.
As we look back at these releases, what do they tell us about the economy in totality?
One, the centre’s budget deficit is getting slimmer, which is good for bringing down the country’s debt burden over time. The states now need to follow suit too and tighten their fiscal belts. S&P Global estimates (December 2023) government debt to GDP for the country (centre plus states) at ~85% in fiscal 2024, up from ~67% a decade ago.
Support to counter shocks as well as measures to drive growth have pushed this ratio up overtime. But a much bigger challenge now is to bring this ratio down without crimping growth. And that is not an easy task.
The 2024 central budget tried to check both boxes to some extent. The budget deficit is lower at 5.1% of GDP for fiscal 2025, from 5.8% in fiscal 2024 and hinges on curtailed revenue spends and improving tax collections. There is some moderation in capital expenditure, but the support to growth continues.
A lower deficit makes way for reduced market borrowings and takes off pressure from the 10-year government bond yield – currently hovering in the range of 7.1-7.2%. CRISIL expects the yield to soften further to 6.8% by next March supported by policy rate cuts, lower inflation, benign oil prices and steady foreign capital inflow into India’s debt markets.
The budget is also non-inflationary since a large part of the spending remains tuned towards asset creation rather than cash handouts. To that extent it coordinates with the monetary policy objective of taming inflation.
The monetary policy review released a week after the budget announcement, not only took comfort from the fiscal stance, but also from the softening of inflation off late. Policy rates were held steady for the sixth straight time and the stance remained unchanged at ‘withdrawal of accommodation’. The monetary policy is steadfastly pursuing two goals; (i) complete transmission of its 250 basis points (bps) rate hike in this cycle; and (ii) aligning headline inflation to its target of 4% on a durable basis.
Fiscal 2024 saw no movement on the policy rate and no alteration in the stance. Yet, interest rates in the market rose. This fiscal, the central bank leaned on liquidity management to improve the transmission of its rate hikes to lending rates.
So far, money market interest rates have reacted, responding to tighter liquidity and the Reserve Bank of India’s regulatory actions to tame unsecured lending via non-bank financial corporations (NBFCs). But bank lending rates are yet to completely pass-on the 250-bps repo rate hike so far in the cycle and the RBI will continue to lean on liquidity management to do this job.
Slowing inflation, a smaller fiscal deficit and an imminent turn in the US Federal Reserve’s policy rates will create the ground for the Monetary Policy Committee (MPC) to start cutting rates. However, more clarity on the path of disinflation could push this decision at least to June 2024, if not later. While CPI inflation has remained in the RBI’s tolerance band of 2-6% since August, it is still shy of the 4% target and that keeps the MPC on watch.
This fiscal, if not for the repeated spikes across food categories, headline CPI inflation would have stayed well within the RBI’s comfort zone and closer to its target. The January data on CPI inflation provides relief but also highlights the pressure that remains on the food inflation front. Headline inflation slowed to 5.1% from 5.7% in December. This was led by food inflation which inched down but stays elevated at 8.3%.
Meanwhile it is the drop in core inflation (headline excluding food and fuel) at a 50-month low of 3.5% that clearly steals the limelight. The steep and broad-based disinflation in core inflation is both comforting and intriguing. Though low input costs have contributed, softer domestic demand too has kept core inflation under control.
We expect CPI inflation to average 4.5% in fiscal 2025, down from an estimated 5.5% this fiscal. Cooling domestic demand, assumption of a normal monsoon along with a high base for food inflation should help moderate inflation next fiscal. A non-inflationary budget also bodes well for core inflation.
The RBI’s forecast on inflation is also 4.5% but that on growth is a tad brighter. The Indian economy’s post-pandemic recovery created a growth spurt averaging 7.8% over fiscals 2022 to 2024, and from there the growth rate we believe, will retreat towards trend. The growth moderation is expected to be spread throughout the year as a variety of factors play out – high interest rates since an easier monetary policy will work with a lag, softer economic growth in key export destinations, and economic uncertainty given the geopolitical flare-ups.
To be sure, the 6.4% growth that we forecast for fiscal 2025 displays healthy growth supported in part by government spending and by a gradual increase in private sector capex. The latest data on industrial production shows that economic activity in industry held up. Trade data for January too showed healthy numbers, but not the impact of the Red Sea disruption. Full year estimates by the National Statistical Organisation already show that industrial growth was broad-based and at 7.9% in fiscal 2024, up from 4.4% in the previous year.
The highlight of fiscal 2024 was the better-than-expected growth performance of the Indian economy despite numerous global headwinds and an uneven rainfall pattern.
As we step into fiscal 2025, three factors will guide the twists and turns down the growth path.
First, gains from the dramatic drop in input costs in fiscal 2024, which is a huge support to the industry, will somewhat diminish. Oil prices fell more than 13% during April 2023 and January 2024, while the metals index fell more than 7%. Hereon, there is a little further downside to these prices. Moreover, the recent developments in the Red Sea and a fading low base effect for commodity prices could put some upside pressure on input cost inflation.
Second, global growth is forecast to be steady but there is unevenness in regional growth. This keeps the uncertainty quotient high. Plus, another factor that can create swings in expectations and sentiments is the election season in many significant parts of the world. Roughly about 60-70 countries comprising 40-45% of global GDP will see general elections this year.
The election impact could be varied – ranging from possible populist measures (that possibly cushion any impending growth slowdown) or policy uncertainty that encourages the private sector to delay investments. In India, while pre-election anxiety cannot be ruled out, as elections draw closer in April/May, the expectation of populist measures have been put to rest by the announcements in the union budget.
Expenditures have in fact been pruned to cut the deficit ratio, and a study of past budgets reveals very little variation in the interim and final budget estimates.
Finally, for the Indian economy the number one unknown risk – that of an unexpected adverse weather event – looms. An unusual weather event, if at all, can reverse the gains across growth, inflation, and monetary policy.
(The author is Principal Economist at CRISIL Limited. Views are personal)
