India’s economy is on a strong wicket

Updated on Sep 12, 2022 07:41 PM IST

It is possible to maintain average real GDP growth of about 6.5% for the next three years. However, it is important to recognise the limitations on how fiscal or monetary policy can be used to mitigate global shocks, whether in energy prices or capital outflows

The economy’s resilience was supported by a counter-cyclical fiscal policy, which bore the brunt of rising fertiliser and fuel costs, but the monetary and exchange rate policy provided ‘covering fire’ (Shutterstock) PREMIUM
The economy’s resilience was supported by a counter-cyclical fiscal policy, which bore the brunt of rising fertiliser and fuel costs, but the monetary and exchange rate policy provided ‘covering fire’ (Shutterstock)
ByRahul Bajoria

The global economy has taken a turn for the worse in the last three months. There are signs of an imminent slowdown in Europe, which has been hamstrung by gas shortages and poor consumption. China’s recovery has been weak, and risks of growth slipping below 3% appear high amid new supply shocks caused by droughts and energy shortages. While the United States (US)’s economy appears resilient, it is still experiencing a rapid tightening in monetary conditions, which will ultimately result in weaker demand. Whether the US experiences a hard or a soft landing remains to be seen.

With the world’s major economies experiencing a sharp pullback in activities and simultaneous monetary tightening, the outlook for the rest of the world cannot hold up, at least for an extended period. Almost on cue, export growth has started to weaken globally, including in India.

A key differentiating feature of this development has been the divergence between the anticipated growth slowdown and commodity prices, which remain somewhat high despite rising risks to growth.

For India, the latest Gross Domestic Product (GDP) rate fuelled the debate on whether growth was strong or weak. In the face of a very sharp increase in inflationary pressures, growth appears to have held up. The economy’s resilience was supported by a counter-cyclical fiscal policy, which bore the brunt of rising fertiliser and fuel costs, but the monetary and exchange rate policy provided “covering fire”. As the summer fades and the northern hemisphere inches towards winter, India appears relatively better placed than its regional and global peers, in terms of sustaining growth and managing inflation. This relative advantage is a function of three factors.

First, India’s food security has been enhanced dramatically in the past decade, as the country transitioned from being a food importer to a food exporter. This small but subtle shift has been significant for domestic inflation management, as the absence of supply-driven shortages and the build-up of buffer stocks have prevented any significant spikes in food inflation (though the impact of climate-driven factors is slowly becoming more significant). This represents a break from the past, when rising global food prices spilled over and materially raised India’s inflation profile.

Second, India’s lack of connection to the global manufacturing cycle is now a virtue. India’s external trade’s lack of synchronisation with global cycles, especially compared with north Asian economies that focus on electronics production, is helping to shield its economy from the slowdown in the West. This dynamic becomes especially telling given India’s weak reliance on China as a driver of economic growth, since India imports from, rather than exports to, China.

Finally, the biggest tailwind for India relative to the other economies is its clean balance sheet. Policymakers in India chose not to extend fiscal or monetary help indiscriminately during the pandemic, which means there is now room to implement some targeted counter-cyclical support measures. Furthermore, the balance sheets of financial institutions, households, and non-financial corporates appear relatively deleveraged. If income growth remains generally high, as it has for the past 18 months, we expect more room for top-line growth, even if profits remain under pressure due to elevated commodity prices.

These factors should be enough to ensure that India’s growth is better than that of its peer economies. Indeed, we believe average real GDP growth of about 6.5% for the next three years is possible. This should allow India’s economy to expand in a way that will not create overheating pressures.

However, a word of caution is warranted. Through the cycle, fiscal and monetary policies have helped manage prices. The fact that India did not allow the pass-through of lower oil prices in 2020 to feed through to consumers has helped to offset upward price pressures in 2022. Through fiscal tools (e.g. excise duties), price pressures have been pointing downwards, which has helped anchor inflation expectations. This relative success has also allowed India to lean against inflationary pressures during the Russia-Ukraine conflict and is also visible in exchange rate management. Foreign exchange has been utilised from reserves accumulated over the last three years to stabilise the rupee and avoid sharp adjustments.

Since this policy of counter-cyclical price management appears to be working, the temptation may be to retain to the same approach — “if it isn’t broken, don’t fix it”. However, we need to recognise that there are limitations to how fiscal or monetary policy can be used to mitigate global shocks, whether in energy prices or capital outflows. Indeed, subsidies, windfall profit taxes and foreign exchange reserves are creating distortions. They can have unintended consequences if maintained for too long. Ultimately, relative prices, in the form of inflation, exchange rates and interest rates must adjust to align with global realities to ensure the longer-term sustainability of growth without distorting the incentives of domestic economic agents.

Rahul Bajoria is managing director and head, EM Asia (ex-China) Economics at Barclays The views expressed are personal.

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