Tuesday July 26, 2022

India Macroeconomic Update: Growth and Policy Outlook

India Macroeconomic Update: Growth And Policy Outlook

A host of negative developments in the global environment have driven down growth projections and India is no exception. There are, additionally, local factors weighing on the economy, including inflation and rising interest rates, supply-side issues and continued challenges in the financial sector. The government has made efforts to boost domestic manufacturing, employment, credit growth and entrepreneurship but the results may not be immediately visible. At a recent session of the India CEO Forum in Bangalore, Adit Jain, IMA’s Chairman and Editorial Director, discussed some of the looming risks ahead for businesses and the medium-term prospects for the Indian economy.

A Crumbling Global Economy…

The Russia-Ukraine war has impacted two specific areas of the commodity market: agriculture and energy. Hundreds of tonnes of wheat are rotting in silos in Ukraine as a blockade of Odessa prevents shipments. Sanctions on Russian oil and gas exports have doubled consumer bills in the West. Inflation in the US has jumped from 5% a year ago to 8.5% currently, and inflationary expectations have spiked. The Federal Reserve Bank mistook the early warning signs, assuming that rising prices were transient. However, inflation has now become deeply entrenched and US interest rates are expected to rise to as much as 3-3.5% in the coming year. Bond markets have adjusted to this reality, with the spread between treasury and corporate bonds going from miniscule a few months ago to 400-450 basis points today.

War has disrupted global supply chains; sanctions have pushed up energy prices

Currently, investors are worried about the ability of firms to continue delivering growth and profitability in the medium term. With borrowing costs rising, emerging markets will face headwinds, including large capital outflows. In 2022, global growth is likely to slow to 3.6%, from a previous forecast of 5%. Growth will be 3.5%in Europe and 2.8% in the Eurozone – both figures are 150 bps lower than the earlier estimates. China is likely to grow by 4% while Ukraine’s GDP may contract by 45%. Oil prices are expected to average USD 107 in 2022 and USD 93 in 2023. Inflation is projected at 5.7% in the advanced economies and 9% in emerging markets – a 300 bps increase in both cases from the previous year.

Investors are worried about long-term growth and profitability

Consumer demand will soften, causing an abrupt fall in industrial output in the midst of a post-Covid economic recovery. The US dollar has risen by 8% against a basket of currencies and stock markets across the world have adjusted by 15-25%. When asset prices fall, whether in India or the advanced economies, it generates a negative wealth effect, and this is evident today.

Demand is weakening and stock markets have corrected

…And A Collapsing Liberal World Order

The US-China rivalry is at the heart of an increasingly polarised world. The rivalry is driven less by military competition than by a desire to dominate technologies such as batteries, solar energy and microchips. Long a monopoly of America’s, China has made rapid strides forward in these areas, seizing the baton of ‘technology hegemon’. Complicating matters is that the ruling establishment in both countries has lost some of its legitimacy. Having botched up the response to Covid and failed (so far) to reunite Taiwan with the mainland, Xi Jinping’s position is weaker than he would hope in the lead-up to Presidential elections. He is, however, very likely to secure an unprecedented third term.

The US-China rivalry is reshaping the world order

Notwithstanding the deep partisanship that marks US politics, the two major parties agree on one thing: China is a threat and its power needs to be curbed. The Middle East and Africa are no longer as important to America and its sole focus is now on the Indo-Pacific, which it regards as strategically vital. With the liberal world order being challenged, America is losing interest in policing the world on its own. It has realised that it will struggle to compete with China and is therefore relying on strategic alliances like the Quad (which includes India, Australia and Japan), and with countries like South Korea, Vietnam and New Zealand. These countries have established active working groups, with strict guidelines to translate policies into action, particularly in areas where China seeks global domination.

…and strategic alliances are being re-designed

The Pentagon believes that China will invade Taiwan within this decade, destroying Asia’s existing security framework. This will have a massive impact on countries reliant on the Chinese market, such as Malaysia, Singapore and the Philippines. They will have to choose between the two poles: China, which rules their markets and supply chains; and America, which has provided them with a security umbrella while staying out of their domestic politics.

Asia’s tiger economies can no longer be fence sitters

India: The Geopolitical View…

Unlike India, which enjoys political and economic stability, the rest of South Asia is in the grip of turbulence. The fall of Pakistan’s government, the Taliban’s ascent in Afghanistan and Sri Lanka’s economic collapse could all have a bearing on India. So far, the government has done a good job of managing these difficult situations, acting as a good Samaritan by extending aid to Sri Lanka even as China has backed away. It has also exported 50,000 tonnes of wheat to Afghanistan, and indications are that the two sides are engaged in back-channel communications.

India ‘lives’ in a tough neighbourhood

On the strategic front, India has refused to participate in multilateral groups or treaties, such as RCEP, that include China. It has, however, built new economic partnerships with UAE and Australia. India’s ties with the US have deepened under the Biden administration, and on the European front, India enjoys close relations with the UK, France and Germany. All of these countries have made the Indo-Pacific core to their foreign policy and have consequently moved closer to India.

It has done a good job of strengthening relations with a host of countries

…And An Economic Outlook

India has overtaken China as the world’s fastest-growing large economy. In the last 8 years, some 100 unicorns have emerged and India has become a lucrative environment in which to start new businesses. The Jan Aadhar Mobile (JAM) programme covers over 100 million farmers and has transferred some Rs 1.8 trillion to their bank accounts. 50% of households are covered under the Jal Jeevan Mission, which aims to provide all rural households access to drinking water by 2024. The UPI interface and initiatives like the ONDC (Open Network for Digital Commerce) have helped India strengthen its position in the digital economy. Indigenous vaccine production and its supply to the world, has helped India grow its global stature.

The world’s fastest-growing major economy, India has many ‘positives’ in its favour

GDP grew by 8.7% in FY22 but is likely to slow to ~7% this year owing to rising inflation, reduced global liquidity and falling consumer demand. The Rupee is likely to fall further, to 80-82/USD, by March 2023 due to FII outflows. CPI inflation will remain elevated until year-end while the WPI may start to ease from June onwards due to a high base effect. The RBI has raised its policy rate by 90 bps, to 4.9%, and interest rates could go up by another 1-1.5% by the end of FY23. However, short-term indicators look positive, with e-Way bill issuances and GST collections rising strongly and domestic aviation recovering.

Still, consumer demand has begun to moderate in both urban and rural India, and margins are under pressure as input costs (both people-related and in terms of raw materials) have risen. India’s national debt recently touched 90% of GDP – and empirically, growth tends to slow at levels of debt beyond that point. India need not worry, for now, about its balance of payments situation, as FDI flows have remained strong, but it will need to keep a tab on inflation. There is also the possibility of a ratings downgrade, given that India is already at the negative end of investment grade.

Growth is likely to slow this year, with inflation rising and consumer demand weakening