Mumbai: High interest rates, part of a tight monetary policy, caused India’s economic growth to slow at a time when the world economy had embarked on a synchronous recovery, said the Economic Survey.
According to the survey, until early 2016, India’s growth had been accelerating when other countries were in the midst of a slowdown. This dynamic later changed with Indian growth “decoupling" from global growth.
The survey, authored by chief economic adviser Arvind Subramanian, outlined five factors for the divergence: a tight monetary policy, the 8 November 2016 invalidation of high-value banknotes, the goods and services tax, the so-called twin balance sheet problem, and higher oil prices.
The survey said that until the middle of 2016, real policy interest rates (those adjusted for inflation) had dipped following a global trend. Most countries continued to see that trend with rates in the US falling on an average by 1 percentage point between July and December 2016. However, average real interest rates increased by about 2.5 percentage points during the same period in India.
GDP growth slowed to 7.1% in 2016-17 from 8% in the previous year as interest rates and demonetization slowed activity in cash-dependent sectors. In fiscal 2018, the economy is likely to grow 6.75%, the survey said, against 6.5% estimated by the Central Statistics Office.
“This tightening of monetary conditions contributed to the divergence in economic activity in two ways. First, it depressed consumption and investment compared to that in other countries. Second, it attracted capital inflows, especially into debt instruments, which caused the rupee to strengthen, dampening both net services exports and the manufacturing trade balance," the survey said.
According to Gaurav Kapur, chief economist at IndusInd Bank, higher interest rates do impact consumption demand, and thereby growth.
“But it can’t be the primary reason. The bigger issues were of the twin balance sheet problem, demonetisation and GST, which disrupted supply chains," he said.
In the previous monetary policy in December, the Reserve Bank of India’s (RBI) monetary policy committee (MPC) kept key interest rates unchanged, noting risks to inflation, but expressed optimism that the slowdown in economic growth had bottomed out.
Inflation measured by the Consumer Price Index (CPI) accelerated to 17-month high of 5.21% in December from 4.88% a month ago. This was sharply higher than the 4% medium-target for MPC.
“The policy rates can be expected to remain fairly stable if the inflation rate does not deviate much from its current levels," the survey said.
However, it also said that persistently high oil prices, at current levels, remain a key risk and would affect inflation, the current account, the fiscal position and growth, and “force macroeconomic policies to be tighter than otherwise."
Based on the current indications, oil prices can be expected to increase by about 10-15% over and above the likely average price of around $ 56-57 per barrel (for the Indian basket) in fiscal 2018, the survey said.
According to the report, a $10 per barrel increase in the price of oil reduces growth by 0.2-0.3 percentage points.
“At this point of time, oil prices are a big worry. On the domestic front, the MPC is aware of the possibility of a fiscal slippage. But they would closely look for efforts taken towards fiscal consolidation and the quality of spending. Any hints that budget would look to boost consumption will be seen with caution especially at a time when growth is picking up and output gap is likely to close," Kapur said.
The MPC will meet next week to decide on policy rates.