India’s next FM may lean on macro economy cushion

Easing of inflationary pressure may bring comforts to macro-economic management

By Pradeep Kumar Panda

Bhubaneswar, June 3: The Reserve Bank of India (RBI) has projected seven per cent growth rate of the Indian economy in the current fiscal. The global economy is exhibiting resilience and fortitude.

There are, however, multiple challenges emanating from still elevated inflation, tight monetary and financial conditions, escalating geopolitical tensions, rising geoeconomic fragmentation, disruptions in key global shipping routes, high public debt burdens and financial stability risks.

Amidst heightened uncertainty, global growth is likely to weaken below its historical average in 2024, with divergent and uneven pathways across geographies and sectors. Global financial markets are on edge, with recurrent bouts of volatility as every incoming data increases uncertainty around monetary policy trajectories of major central banks.

Inflation is easing but rules above target in major systemic economies. The outlook for further disinflation is impeded by sticky core and services inflation and tight labour markets. While major advanced economy (AE) central banks are expected to pivot towards rate cuts in 2024, the fuzzy inflation trajectory is leading to sharp gyrations in market expectations of the pace and timing of monetary policy easing.

In this milieu, several emerging market economies (EMEs) have started rate cutting cycle and major AEs are undertaking regime shifts including exits from negative policy rates.

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According to the International Monetary Fund (IMF) , global growth decelerated to 3.2 per cent during 2023 from 3.5 per cent during 2022. The pace of economic activity was dragged down, inter alia, by restrictive monetary policy stances to tame inflation, protracted geopolitical tensions and sluggish recovery in China.

The potential impact of climate change became increasingly evident, with economic losses due to extreme weather events. Global inflation fell to 6.8 per cent in 2023 from 8.7 per cent in 2022 on the back of easing commodity prices, favourable supply conditions and monetary tightening across major economies, but still remained at its highest level in over two decades.

Inflation in respect of core items and services remained elevated, exhibiting persistence in major economies amidst tight labour market conditions.

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Global merchandise trade volume contracted by 1.2 per cent in 2023 in contrast to an increase of 3.0 per cent in the preceding year as demand rotated back from goods towards services with the ebbing of the pandemic.

Apart from geopolitical tensions and geoeconomic fragmentation, the multi-decadal high inflation in 2023 depressed consumption of manufactured goods, which also dampened external trade. On the other hand, services trade exhibited resilience due to continued recovery in spending on travel from the COVID-19 pandemic lows and sustained demand for digitally delivered services.

Global financial conditions tightened amidst heightened volatility in response to synchronised monetary policy tightening as well as aggravating geopolitical conflicts. Sovereign bond yields hardened to multi-year highs in the first half of 2023-24, driven up by monetary tightening and exhibited large two- way fluctuations in the subsequent period over growing haziness surrounding monetary policy trajectories of major central banks.

The US dollar remained strong, with large swings in response to changing monetary policy expectations. This exerted downward pressures on a number of EME currencies. Global equity markets inched up higher on prospects of soft landing, with sharp gains registered in technology and artificial intelligence (AI) related stocks.

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Against the backdrop of subdued global economic activity and multiple headwinds, the Indian economy expanded at a robust pace in 2023-24, with real GDP growth accelerating to 7.6 per cent from 7.0 per cent in the previous year – the third successive year of 7 per cent or above growth.

With gross fixed capital formation (GFCF) accelerating to 10.2 per cent in 2023-24 from 6.6 per cent in 2022-23, investment was the major driver of domestic demand, buoyed by government spending on infrastructure. Growth in private consumption demand, on the other hand, stood at 3.0 per cent as against 6.8 per cent a year ago.

Government consumption demand was also subdued tracking fiscal consolidation. Net exports dragged down growth due to the moderation in exports as a result of contraction in global trade volumes. Import demand was relatively buoyant on robust domestic demand.

On the supply side, growth in gross value added (GVA) in the agriculture and allied sector in 2023-24 stood at 0.7 per cent as against 4.7 per cent a year earlier as foodgrains production declined due to the deficient and uneven southwest monsoon rainfall. The government undertook a number of supply measures throughout the year to maintain domestic supply-demand balance in food items and mitigate inflationary pressures.

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They included release of public foodgrains stocks through open market sales; application of stock limits in cereals and pulses; export restrictions on cereals and onions; and easing of access to import pulses and edible oils. The declaration of 2023 as the international year of millets by the United Nations (UN) provided a renewed thrust to diversification of crops from rice and wheat towards nutritional, environmentally sustainable and traditional crops across the country.

In the industrial sector, manufacturing GVA accelerated, benefitting from the boost to corporate profitability provided by easing of input costs. Industrial activity was also supported by the sustained momentum in mining and electricity generation. Infrastructure and capital goods production gained from the government’s push to capital expenditure.

The production of consumer goods recovered, led by the consumer non-durables segment. The recovery in consumer goods was volume driven, with growth in rural demand catching up with the urban segment. The government continued with initiatives to promote the industrial sector, especially in emerging areas.

Investment amounting to ₹1.3 trillion was approved for the establishment of three semi-conductor manufacturing units as part of the development of the full production line for semi-conductors. In order to support the renewable energy initiative, royalty rates for the extraction of three vital and strategic minerals [viz., lithium, niobium, and rare earth elements (REEs)] were specified to attract bidders in the auction process.

The government also endorsed a viability gap funding (VGF) scheme to develop battery energy storage systems (BESS) by lowering storage costs for both distribution companies and consumers. The ‘Pradhan Mantri Surya Ghar: Muft Bijli Yojana’ 5 marks a significant push towards sustainable energy solutions.

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The services sector, with a share of over 63 per cent in GVA, remained the mainstay of aggregate supply, with growth of 7.9 per cent in 2023-24. Construction activity accelerated to register double digit growth, benefitting from rising demand in the housing sector and the government’s thrust on infrastructure. The sustained ebullience in bank credit growth propelled financial services, while there was a slowdown in IT services during 2023-24 on subdued global demand.

Employment conditions improved, with the unemployment rate falling to its lowest level during 2023 (January-December) – 3.1 per cent in the usual status and 5.0 per cent in the current weekly status – in the periodic labour force survey (PLFS) series for which data are available from 2017-18 (July-June). Both urban and rural regions recorded a decline in the unemployment rate.

The labour force participation rate (LFPR) and worker population ratio (usual status) increased to 59.8 per cent and 58.0 per cent, respectively, in 2023, the highest since the survey’s inception, along with a steep rise in the female LFPR.

According to the Climate Change Performance Index (CCPI) Report 2024, India’s climate action performance improved, making India the fourth best performing nation among 63 countries analysed. Strong progress was made towards nationally determined contributions in terms of key indicators like reduction in the emission intensity of GDP and an increase in the installed capacity of non-fossil fuel-based energy resources. Among major climate initiatives, India notified the carbon credit trading scheme (CCTS) while also launching the National Green Hydrogen Mission.

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Inflationary pressures moderated albeit unevenly during 2023-24, reflecting the combined impact of calibrated monetary tightening, easing of input cost pressures and supply management measures. Headline inflation softened to 5.4 per cent during 2023-24 from 6.7 per cent in the previous year, driven by the fall in core inflation (CPI excluding food and fuel) to 4.3 per cent from 6.1 per cent.

Fuel inflation also eased sharply, moving into deflation since September 2023, with the reduction in the domestic prices of liquefied petroleum gas (LPG) and kerosene on the back of correction in global energy prices. Food inflation, on the other hand, hardened amidst high volatility.

Sustained pressures from prices of cereals, pulses, spices and vegetables due to overlapping supply shocks pushed up food inflation to 7.0 per cent in 2023-24 from 6.7 per cent a year ago, thereby keeping headline inflation above the target.

Considering the growth-inflation dynamics, the Monetary Policy Committee (MPC) kept the policy repo rate unchanged at 6.50 per cent during 2023-24 and continued with a stance of withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.

The MPC noted that monetary policy has to remain disinflationary to ensure fuller transmission and better anchoring of inflation expectations. Liquidity conditions tightened during 2023-24 in sync with the monetary policy stance. The liquidity surplus as reflected in average daily net absorption under the liquidity adjustment facility (LAF) moderated to ₹485 crore during 2023-24 from ₹1.87 lakh crore in the previous year.

The Reserve Bank conducted two-way operations, both main and fine-tuning auctions, to ensure availability of adequate liquidity in the banking system. The weighted average call rate (WACR) traded, on an average, 13 basis points (bps) above the policy repo rate during 2023-24.

Domestic financial markets remained stable during 2023-24, with orderly movements in the bond and foreign exchange markets and exuberant equity markets. G-sec yields softened on favourable inflation prints, reports of inclusion of Indian bonds in major global bond indices and lower than expected market borrowings by the Union Government in the interim Union Budget 2024-25.

Corporate bond yields moderated tracking the G-sec yields, and corporate bond issuances increased. The Indian Rupee (INR) displayed stability on the back of improving external sector and macroeconomic fundamentals, including a significant moderation in the CAD and resurgent capital inflows, that offset persistent headwinds from volatile global financial markets, the strong US dollar and persisting geopolitical tensions.

The INR depreciated by 1.4 per cent during 2023-24 (7.8 per cent in the previous year) and was amongst the best performing major EME currencies during the year. Equity prices recorded solid gains on robust corporate earnings and strong domestic GDP growth. There were, however, intermittent corrections due to geopolitical concerns and uncertain monetary policy trajectories in the systemic economies.

The domestic equity market capitalisation crossed the US$ 4 trillion mark in H2:2023-24, making the Indian stock market the fifth largest in the world.

The transmission of the repo rate increases undertaken in 2022-23 to banks’ lending and deposit rates continued in 2023- 24 amidst moderation in surplus liquidity in the banking system and credit growth persistently outpacing deposit growth.

The share of external benchmark linked loans in total outstanding floating loans rose further, with a concomitant fall in the marginal cost of funds-based lending rate (MCLR) linked loans. The expansion of currency in circulation moderated while deposit growth accelerated with the return of ₹2000 banknotes (following their withdrawal from circulation in May 2023) to the banking system, mostly in the form of deposits.

The central government delivered on its fiscal consolidation commitments. The gross fiscal deficit (GFD) declined to 5.9 per cent of GDP in 2023-24 (RE) from 6.4 per cent of GDP in 2022-23. Revenue spending growth was contained at 2.5 per cent while capital expenditure grew in double digits for the fourth consecutive year.

Fiscal adjustment was also supported by buoyant revenues – gross tax revenues increased to 11.7 per cent of GDP in 2023-24 (RE), their highest level since 2008-09, driven by income tax collections. States budgeted a GFD of 3.1 per cent of GDP in 2023-24, within the limit of 3.5 per cent prescribed by the Centre.

Capital expenditure by states rose by 19.4 per cent during 2023-24. The general government deficit moved lower in 2023-24 (BE), even as general government capital outlay increased from 5.0 per cent of GDP in 2022-23 (RE) to 5.6 per cent of GDP in 2023-24 (BE).

During H2:2023-24, the Reserve Bank issued an ultra-long security of 50-year tenor aggregating ₹30,000 crore to cater to the growing needs of long-term institutional players. The central government’s borrowing in H2 also included the issuance of new sovereign green bonds (SGrBs) of 30 years. The weighted average yield (WAY) on G-secs issued during the year moderated to 7.24 per cent in 2023-24 from 7.32 per cent in the previous year.

India’s merchandise exports fell in 2023- 24, driven by the declines in global trade volume and commodity prices. In 2023-24, merchandise exports contracted by 3.1 per cent in US dollar terms, while imports fell by 5.7 per cent.

Consequently, India’s merchandise trade deficit narrowed to US$ 238.3 billion during 2023-24 from US$ 264.9 billion a year ago. With robust services exports and a steady flow of inward remittances, the CAD moderated to 1.2 per cent of GDP during April-December 2023 from 2.6 per cent in the corresponding period a year ago.

Capital flows were robust during 2023- 24, attracted by buoyant economic growth and improving domestic macroeconomic fundamentals. Net foreign portfolio investment (FPI) flows recorded a significant turnaround to US$ 41.6 billion in 2023-24, the second highest after 2014-15 (US$ 45.1 billion).

India received the highest net FPI inflows amongst EME peers during the year. Gross foreign direct investment (FDI) flows were resilient at US$ 71.0 billion in 2023-24, broadly comparable to US$ 71.4 billion a year ago. Net foreign direct investment (FDI) flows, however, moderated to US$ 10.6 billion from US$ 28.0 billion primarily owing to higher repatriation.

Other major capital flows – external commercial borrowings (ECBs) and non-resident deposits – were higher during the year. With overall net capital inflows outpacing the CAD, there was an accretion to the foreign exchange reserves to the tune of US$ 32.9 billion (on a balance of payments basis, i.e., excluding valuation effects) during April-December 2023. India’s foreign exchange reserves rose to an all-time high of US$ 648.7 billion as on May 17, 2024, covering 11.4 months of imports and strengthening buffers against external sector risks and adverse spillovers.

To sum up, the Indian economy is navigating the drag from an adverse global macroeconomic and financial environment. Real GDP growth is robust on the back of solid investment demand which is supported by healthy balance sheets of banks and corporates, the government’s focus on capital expenditure and prudent monetary, regulatory and fiscal policies.

As headline inflation eases towards the target, it will spur consumption demand especially in rural areas. The external sector’s strength and buffers in the form of foreign exchange reserves will insulate domestic economic activity from global spillovers. Geopolitical tensions, geoeconomic fragmentation, global financial market volatility, international commodity price movements and erratic weather developments pose downside risks to the growth outlook and upside risks to the inflation outlook.

The Indian economy would also have to navigate the medium-term challenges posed by rapid adoption of AI/ML technologies and recurrent climate shocks. Even so, it is well placed to step-up its growth trajectory over the next decade in an environment of macroeconomic and financial stability so as to achieve its developmental aspirations by reaping its demographic dividend and exploiting its competitive advantages that have placed it as the fastest growing major economy of the world.

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