Home / Opinion / Views /  Stable shores in India only after 2023’s global storm

Central bank governors have a lot in common with ship captains. Both need to assess the winds to forecast if a storm is on the way, and draw up the sails accordingly. In both cases, there is a perceptible lag between turning the wheel and the ship starting to change direction. And if you find yourself staring at an iceberg, then it’s probably too late!

So, at the Reserve Bank of India’s December meeting, markets were arguably more interested in RBI’s forward guidance than its rate hike. On this front, the signals were pointedly hawkish. Markets picked up RBI’s repeated mention of elevated core inflation, comment that the policy rate adjusted for inflation is still accommodative, and its “withdrawal of accommodation" stance, which signals more policy normalization to come.

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Yet, between the lines, RBI’s communication was actually far more nuanced. Governor Shaktikanta Das mentioned that future policy actions will take into account the 225 basis points of rate hikes already delivered and will be data-dependent, suggesting that policy is not on a preset path. In an uncertain environment, firm guidance by central banks can indeed be counterproductive, in our view, and data-dependence is wise: committing to a pause can prematurely ease financial conditions, but continuing to hike rates could risk overtightening, as monetary policy works with long lags and the full impact of this year’s hikes will materialize only in 2023-24.

So, what does the growth-inflation outlook indicate about the monetary policy direction? Our estimates suggest dark clouds gathering over growth and gradual disinflation.

The global growth outlook looks grim. Developed markets (DMs) are sliding into recession, in our view, and to slay the inflation beast, central banks globally will likely keep policy rates higher for most of 2023, meaning that the recession may be less deep than those during the pandemic or global financial crisis, but is likely to last long. In the US, EU and UK, we expect six straight quarters of negative growth: 2023 real GDP growth of -0.5%, -1.4%, and -1.5% respectively.

Its spillovers on India’s domestic growth will be large. During the US recessions of 2000-01 and 2008-09, the average downswing in US GDP growth by 4.6 percentage points, peak-to-trough, was accompanied by an average 6 percentage-point drop in India’s GDP growth. A primal hit to exports transmits a shock to the manufacturing sector and employment. Investments are sensitive to demand uncertainty and financial conditions, both of which take a hit during global recessions, delaying capex plans. Consumption should offer a relative buffer, but will also moderate, owing to the lagged effects of policy tightening. With the consensus forecasting India’s growth in 2023-24 in the 6.0-6.5% range, we believe the downside risks are significantly under-appreciated. We expect GDP growth in 2023-24 to average 5.1%, down from 6.6% in 2022-23.

Inflation remains elevated, but should moderate gradually. Recent November CPI inflation data surprised by falling below RBI’s upper tolerance bound of 6%, primarily driven by a sharp fall in vegetable prices, while core inflation remains sticky around 6%, reflecting the pass-through of higher input costs to consumers and price pressures due to service-sector reopenings. However, this is unlikely to continue indefinitely.

A slowdown in domestic growth and capped global commodity prices should moderate core inflation in 2023-24. Easing supply-chain bottlenecks should also help, resulting in sharper goods’ disinflation, relative to more sticky services inflation. With second-round effects in check and fading cyclical forces, we expect inflation to average around 6.8% this fiscal year and 5.0% the next, close to RBI’s projections (of 6.7% and 5.2% respectively).

What does this macro backdrop mean for RBI? With the current policy rate at 6.25% and RBI’s one-year-ahead inflation projection at 5.4%, the real policy rate is about 0.8%, still below the 1% psychological level that monetary policy committee (MPC) members have cited in the past. However, the softening of both inflation and growth, and lagged effects of monetary policy, mean that RBI could hang its boots on rate hikes soon. A 25 basis points rate hike at the February meeting is a close call, but even if it materializes, it is likely to be the final hike in this cycle. Beyond that, a long pause is likely, but we believe policy could turn towards easing in the latter part of 2023-24, especially as lower growth is likely to bring disinflationary pressures. We believe global monetary policy is also likely to pivot by the third quarter of 2023, with the US Federal Reserve likely to deliver its first cut in policy rates around September.

India will face a challenging growth backdrop in 2023, but this is largely due to global spillovers, while India’s medium-term fundamentals look better. Better balance sheets, a young population, prudent policymaking and supply chains diversifying away from China mean that as global headwinds fade, the economy could be ripe for a V-shaped recovery in 2024-25, when we expect a rebound in GDP growth to 6.8%. India thus holds the promise of stable shores, which should attract more investors in the second half of 2023. For now, a tumultuous global storm is brewing and policymakers will need to stay vigilant.

Sonal Varma is the Chief Economist for India and Asia ex-Japan at Nomura, and Aurodeep Nandi is the India economist at Nomura.

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Sonal Varma & Aurodeep Nandi are, respectively, chief economist for India and Asia ex-Japan, and India economist, at Nomura.

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