India’s chance to shed pandemic scars and reach out for the stars
5 min read 18 Dec 2022, 09:33 PM ISTWe must focus more on macro stability and reforms instead of obsessing about precise levels of growth amid global volatility
PremiumMany of us are stepping into 2023 with some trepidation. We’ve just experienced another year fraught with shocks and volatility and many of those challenges look set to stay.
But rather than worrying about all the problems in store for 2023, a more constructive strategy is to strengthen the country’s economic foundations so as to achieve the best possible economic outcome no matter what happens in the rest of the world. We believe two things must go right for India to achieve ‘stronger-for-longer’ growth: macro stability and a continuation of reforms. Let us explain.
There are some new high-growth sectors which could raise India’s potential growth in the medium term. Look no further than the production of Apple’s iPhones in Chennai. India is also gaining global market share in other high-skill exports like IT services, drugs, auto parts and specialized machinery, all of which were snapped up during the pandemic. The rise of digital startups has attracted substantial capital into the economy, and are providing digital solutions to real-economy problems. And we see India’s green-transition ambitions as an opportunity, spurring investment in emerging sectors like green hydrogen, electric vehicles (EVs) and solar panels.
But what many miss is that these new sectors, while exciting, may not be sufficient to bolster growth. The one thing needed to support higher levels of growth is macro stability. Think government borrowing at rates which do not crowd out private investment, inflation that doesn’t spiral out of control, and a sustainable trade deficit that keeps the exchange rate stable. In fact, we would argue that softer growth at a time of global volatility is fine if the macro environment is stable.
The recovery so far has been more gradual than rapid. India’s GDP in September 2022 was just 7.6% higher than in September 2019 (a pre-pandemic quarter). This is not too impressive for a country with an annual potential growth of about 6%. And the economy is set to slow in 2023 as the key drivers of growth are now softening.
High-tech export volumes have slowed since August amid a global slowdown. After a period of pent-up demand, household savings have dipped below pre-pandemic levels, leaving limited firepower to spend. And our analysis suggests that investment spending so far seems to be driven more by replacement capex, and could eventually run its course too.
Then there’s the fiscal angle. The Centre’s interest bill on past debt makes up 50% of net tax revenues, leaving little to spend on infrastructure, health and education. The only solution is to lower the fiscal deficit. And a positive is the government does aim to lower its fiscal deficit from a budgeted 6.4% of GDP in 2022-23 to under 4.5% in 2025-26. But fiscal consolidation so far has been led by large corporates paying more tax as they gained market share from small and informal firms. Now with the informal firms stabilizing gradually, this tax bounty may not continue. Fiscal consolidation from here on may have to come more from expenditure cuts. But this will inevitably end up being a drag on growth in the short-run, and a price that needs to be paid for a stronger medium-term outlook.
Then there is inflation. It has peaked and will likely soften meaningfully in the next year. Much of the moderation will likely be driven by falling food prices as the government ramps up supply-side management in the run-up to the next general election in 2024.
And while slowing inflation is good news, there are a few issues we need to be mindful of. One, depending only on food price declines makes the inflation trajectory vulnerable to climate change-related events like heatwaves and patchy monsoon rains. Two, core inflation (a part of inflation that the Reserve Bank of India actually has control over via rate hikes), remains elevated at over 6% in the last year. One big reason is because large firms grew in the pandemic, they gained pricing power, and are now keeping prices higher than where they should be. Hence, despite a series of rate hikes, we don’t think headline inflation will fall to the 4% target easily. Even if RBI were to hike rates further by 25-50 basis points, we expect inflation to print in the 5-5.5% range over the next few years.
We believe India’s main vulnerability is on the external front. The current account deficit is likely to be elevated at around 3.4% of GDP in 2022-23. If oil prices fall by $10 per barrel, the deficit could narrow to 3% in 2023-24, but still remain higher than the 2.5% level considered sustainable. The problem here is the large non-oil trade deficit, as, simply put, India imports more than it exports. This, we believe, has been the key driver of the rupee’s underperformance in the region lately. The optimal policy response is to let the rupee gradually weaken (which will encourage exports) and to raise rates (which will discourage spending and imports). Again a seeming trade-off between macro stability and growth, but paving the way for a more stable tomorrow.
And before we end, one word on the ever-so-important ‘hand of reforms’. Several important reforms are maturing, adding to efficiencies and growth. These include public digital infrastructure, the Goods and Services Tax (GST) reform, the Insolvency and Bankruptcy Code, the RERA Act to make the real-estate sector more transparent, and higher public capex.
The risk is that there may be a pause on reforms and a sense of complacency that a lot has been done and so it’s time to take it easy. As per the bicycle theory of reforms, one needs to keep pedalling, else the cycle will fall. We need more and new reforms, ranging from the power-sector clean-up and a new direct tax code for the government to upskilling the workforce to make people job-ready and further improving the country’s business climate by lowering regulatory cholesterol.
Macro stability and continued reforms will ensure that once the ongoing global storm passes, India will be raring to go.
Pranjul Bhandari is chief India and Indonesia economist at HSBC
