Where does India’s economy stand, and where is it headed? Two recent reports on Indian economy provide an ample measure. Amid heightening global uncertainties, India is showing remarkable economic resilience but it can’t afford to lower its guard. This sentiment is reflected by the two commentaries on India’s economy: the article on the state of the economy published in the Reserve Bank of India’s (RBI) December Bulletin, and a report by the International Monetary Fund (IMF) based on the Article IV consultation conducted by its Executive Board with the Indian government.
The IMF Executive Board came up with a ringing endorsement of India’s growth story, commending India’s robust economic growth, resilient financial sector, and notable progress in formalisation and digital infrastructure. The RBI paper, written by a team of researchers led by Deputy Governor Michael Debabrata Patra, highlighted the scope of sustained economic growth but also cautioned on inflation which can stymie growth. However, both the reports also underlined various possible risks to growth.
Economic growth
India’s GDP growth of 7.7 per cent in the first half of this fiscal has “left sceptics gasping and woefully behind the curve”, the RBI article said. It also stressed the buildup in the growth momentum is likely to be sustained. In India, the broad-based strengthening of economic activity that is underway will likely be sustained by easing input costs and corporate profitability, said the article.
The article also said as inflation eases, a revival of topline growth will support the manufacturing expansion. Among services, construction activity remains robust, boosted by housing demand. Other categories of services are normalizing from the post-pandemic revenge spending, but underlying momentum remains resilient. The authors said the main risk to the outlook stems from the evolution of inflation in the months ahead.
“If inflation is not brought back to the target and tethered there, there is a strong likelihood that growth may falter,” the researchers said.
IMF’s growth projection is much lower than the Reserve Bank of India’s Monetary Policy Committee growth forecast of 7% for FY24. The MPC revised its growth numbers in December owing to a strong performance in the first half.
The Indian economy averaged 7.7% growth in the first two-quarters of the fiscal due to strong consumption demand and rising investment. “Stronger than expected consumer demand and private investment would raise growth. Further liberalization of foreign investment could increase India’s role in global value chains, boosting exports. Implementation of labour market reforms could raise employment and growth,” the IMF said.
The IMF said a robust public capex agenda, which will support India’s wide-ranging infrastructure needs, is expected to boost growth while crowding-in private investment. It has commended the Indian authorities for their macroeconomic policies and reforms that resulted in the economy’s strong performance, resilience, and financial stability. It said India is on track to be one of the fastest-growing major economies in the world this year.
The IMF said risks to India’s economic outlook are considered balanced. Global factors such as a sharp growth slowdown or supply disruptions could impact India through trade and financial channels. Domestically, weather shocks pose a potential threat to inflation, even as strong consumer demand and private investment could positively influence growth.
Inflation
The article said CPI-based retail inflation is expected to ease to 4.6 per cent in the first three quarters of 2024-25 from 5.6 per cent in November. “The recurrence of food price spikes in November has punctured a brief respite in September and October. It is expected that these pressures will linger on into December before the usual winter softening sets in and dispels these adversities,” the authors said.
The article noted that the repetitive nature of food imbalances impinging on prices reinforces the view that for India, it is the food category that is the true ‘core’ of inflation, with second-order effects that delay the policy goal of aligning headline inflation with the target. Consequently, a lasting solution to these sporadic flares is the “only panacea”, it said. “Supply augmenting measures and adjustments have the lead role here, but monetary policy shall have to respond if food inflation as a whole becomes lastingly elevated and sends secondary impulses across other prices,” it said. On the other hand, core inflation has been steadily disinflating, attesting to the efficacy of monetary policy actions and stance.
“Projections indicate that inflation will go up further from the September-October average of 4.9% before it can come down. The objective of aligning inflation with the target on a durable basis is far from assured,” the researchers said. The paper said that the real-time inflation is adversely impacting discretionary consumer spending which is impeding the overall growth of manufacturing companies, including their capital expenditure.
IMF expects inflation to decline to 5.4% in FY24 from 6.7% in the previous year. It is further expected to fall to 4.6% in FY25. It has praised the RBI’s “proactive monetary policy actions” and strong commitment to price stability. The current neutral monetary policy stance, anchored on a data dependent approach, is appropriate and should gradually bring inflation back to the target, the IMF report said.
Rate cuts
By underlining the need to watch inflation, the RBI has scotched the exuberance based on the hope of rate cuts coming next year. The paper termed current hopes of coming rate cuts as “hypermetropia”, a tendency to expect inflation going down in future coupled with an inability to comprehend near-term risks of inflation going up.
“The softer inflation prints for September and October 2023 and the prolonged pause in the stance of monetary policy has engendered a certain hypermetropia among some stakeholders – an irrational long-sightedness whereby inflation forecasts gravitating towards the 4 per cent target sometime in the distant future are sighted clearly whereas high near-term risks of spikes in inflation outcomes on the back of food volatility are blurred. Under these conditions, a clamour rises for rate cuts or at least that the central bank commits to a path of moderation in the level of the policy rate. Such views imperil the conduct of monetary policy in the pursuit of its goal of durably aligning inflation with the target,” the paper said.
It said inflation would likely remain elevated relative to targets unless recessions set in and take their toll. Hence many central banks will not declare
victory prematurely – this is already evident in their reluctance to commit to time-stamping future interest rate cuts, although it is more certain now that they
may not raise rates further. The paper said that the hopes of rate cuts coming in future are reflected in exuberant financial markets which are already pricing in rate cuts in early 2024 and loosening financial conditions. Rejuvenated risk appetite is being mirrored in corporate debt markets.
The researchers said that stubbornly high inflation is holding back consumer discretionary spending and corporate investments as well, hence the expectations of lower interest rates may be unrealistic.
Fiscal management
Another article published in the RBI Bulletin on ‘ Government Finances 2023-24: A Half-Yearly Review’ said the combined finances of the Centre and the States remained robust in the April-September period of the year. The Centre recorded robust tax collections, both direct and indirect taxes reflecting sustained recovery of the economy, enhanced tax governance and administration as well as improved profitability of the corporate sector, it said.
Lower disinvestment receipts are likely to be offset by sharp gains in non-tax revenues, mainly attributable to higher dividends from the Reserve Bank and other financial institutions. By reiterating its gross fiscal deficit target of 4.5 per cent of GDP by 2025-26, the Centre has exhibited its firm commitment to fiscal consolidation while at the same time prioritising capital expenditure to drive the recovery in growth and create a virtuous cycle to crowd in private investment.
The Centre achieved more than half of its budgeted revenue in H1:2023-24 while containing its expenditure to less than half of what it had projected for the entire financial year. This would augur well for the Centre to meet its GFD target of 5.9 per cent of GDP for 2023-24.
The states too have witnessed strengthening of their fiscal parameters as is evident from their continued buoyancy in tax revenues. However, it said the states grapple with several challenges in sustaining the momentum of their capital expenditure, on both the expenditure and revenue fronts. The reversion to the old pension scheme (OPS) by a few states and reports of some other states moving in the same direction would exert a huge burden on state finances and restrict their capacity to undertake growth enhancing capital expenditures.
The IMF has welcomed the government’s efforts to ramp up capital spending while tightening the fiscal stance. “Improving revenue mobilization and spending efficiency would allow for continued improvements in digital and physical infrastructure and targeted social support,” the directors pointed out. They also highlighted the need to establish a sound medium-term fiscal framework.
The government plans to reduce the fiscal deficit to 4.5% of GDP by FY26. The IMF projects the government to achieve its fiscal deficit target of 5.9% in FY24 but a marginal decline to 5.6% in FY25.
(With inputs from TOI and agencies)
