LOOMING EXTERNAL MACROECONOMIC UNCERTAINTIES & ITS IMPLICATIONS FOR INDIA - Sarthak Desai

 

After looking at the latest GDP growth figures (4.1% for Q4 FY22 and 8.7% for FY22) revealed by the NSO last week, one may wonder whether the Indian economy is out of woods or not? The answer is Yes. However, India still hasn’t been able to cross its pre-pandemic growth trajectory (without any Covid). Many external shocks seem to shadow the growth targets the Indian government had set in when the budget was announced on Feb 22.

The shocks that the Indian economy faces are inflation, capital outflows, depreciated currency, slowing European economy, and sudden oil price hikes. All of these have both direct and indirect relationships with the Russia-Ukraine war. Due to sanctions imposed on Russia, many western countries are reluctant to buy oil from Russia. It has put demand-side pressure on oil prices. As Russia is a major oil supplier in the global market, higher oil production by OPEC countries won’t help. Thus, oil prices are expected to remain in this range for the next many months.

This sudden oil price hike ($70 to $ 110) has caused supply-side shocks to every sector in India’s economy causing inflation to move out of the targeted 4% (with 2% relaxation) level set by the government and RBI. Thus, the RBI has increased interest rates for moderating aggregate demand with plans for more hikes in future MPC meets. The government has also reduced excise duty on fuels to curb inflation.

Here, comes the dilemma of curbing inflation and maintaining the growth at the same time. This oil price hike is going to cut at least 1.2% out of GDP through higher current account deficit. Thus, the question arises. Who is going to pay for it? If the people continue to pay more for fuel (no excise duty cut), the government would get the intended revenue and spend everything (Marginal Propensity to Consume = 1), resulting in higher nominal GDP. However, inflation would keep rising. If the govt pays the price through excise duty cuts, which is the current scenario, people would save some money, but they wouldn’t spend everything (Marginal Propensity to Consume = 0.7), resulting in less GDP compared to the earlier case. However, inflation could be possibly tamed in the latter case. An in-between path should be looked upon.

Due to this sudden oil price hike, the rupee has also depreciated a lot. This is because oil comprises a major chunk of our imports, which are mostly paid in dollars. The RBI has tried to mitigate this sudden depreciation shock by using its war chest of forex reserves (about $ 600 bn). Also, due to the availability of higher interest rates and tighter monetary policies followed in western countries, Foreign Institutional Inflows (FIIs) have remained negative in the past few months. This would thus result in a possibly negative balance of payments situation for India this year forcing RBI to further increase rates (to match interest rates globally).

So, how should the government and the RBI try to maintain GDP growth along with these global shocks? One should look at the components of GDP calculation to answer this. Private Consumption (C) as % of GDP hasn’t shown much growth during the past 26 months of GDP due to reduced MPC of people. Private Investments (I) of corporates haven’t picked up despite deleveraged balance sheets as Private Consumption hasn’t shown much growth. Exports (NX) have been record-breaking ($ 400 bn in FY22) but can’t be relied on due to demand-side and supply-side shocks that can arise if the Russia-Ukraine war worsens. Thus, the government and RBI should work together to increase government expenditure through higher spending on the CAPEX side. It would help generate more employment for people which would effectively result in more private consumption. This strategy would help the govt maintain India’s GDP growth along with external uncertainties.