Explained | Is the economy driving with the brakes on?
The story so far:
At this time last December, India’s economy was on the cusp of a fledgling recovery from the COVID-19 pandemic, though the Omicron variant posed fresh speed bumps for the rebound. With oil prices escalating, commodity prices volatile and shipping disruptions hitting supply chains, the U.S. had recorded a 40-year high inflation rate in November 2021 and ripple effects were expected to flare up around the world. That Russia’s brewing tensions with Ukraine could come to a head, was a worry too. Broadly, however, economists and the government were hopeful that Indian households’ consumption spending would return to pre-pandemic normalcy in 2022 and help fuel a virtuous private investment revival spurring job creation.
Why did 2022 turn out to be a rougher storm than most anticipated?
While the Omicron wave was less fatal than the pandemic’s preceding waves, it also didn’t take as much of a toll on the economy in 2022 as the previous two years. However, some of the other fear factors at the turn of the year did materialise and ended up manifesting themselves into more shocks across the globe. Finance Minister Nirmala Sitharaman summed up the biggest dampener when she explained to the Rajya Sabha on Wednesday why the government had sought over ₹3.25 lakh crore more for this year than it had budgeted for. “As we were preparing for the 2022-23 Budget (presented on February 1), there was a clear understanding across the globe that the pandemic is waning and recovery measures by different countries were all probably taking us to a good road to recovery. The IMF projected that the Indian economy will grow at a high rate of 9%… But then came in late February, the Russia-Ukraine war and the complete disruption in supply chains, particularly for food and energy,” she said. Amounting to 8% over the Budget expenditure estimates, the supplementary funds were sought largely for food subsidies for the poor that were initiated in the pandemic and recently extended till December 31, and an escalation in the fertilizer subsidy bill due to higher global prices.
As JP Morgan managing director and India chief economist Sajjid Chinoy explained at a CII economic policy summit last week, 2022 was expected to see a pick-up in growth as well as inflation, but by the middle of the year, there was a real concern that the global economy would slip and slide into recession thanks to supply shocks. “I would venture to say that we are ending the year with another R word, which is resilience for the global economy. Just think of what’s happened in the last 12 months — we’ve had the strongest global inflation in 50 years around the world, we’ve had the most aggressive and synchronised monetary tightening cycle in 40 years, we’ve had the strongest U.S. dollar in 20 years for much of this year. And we’ve had what’s less appreciated — the weakest Chinese growth in about 46 years barring the pandemic. Now, in a normal year, two of these shocks would have been enough to tip the global economy into recession, we’ve had four such shocks, and we are still standing.” One key reason for this resilience that helped ride out an almost perfect storm is that large corporate balance sheets have become stronger on the back of record profits in the last couple of years and were able to absorb these multiple shocks better, Mr. Chinoy said.
What hogged Indian policy makers’ attention?
While a slowdown in manufacturing and exports in recent months is a cause of worry, inflation was undoubtedly India’s bugbear of the year. With Russia being a key energy supplier and Ukraine a dominant player in the world market for food items like wheat and sunflower oil, fuel and food inflation translated into consumer price rise levels not seen in decades across several countries. India’s retail inflation which flared up to the 6% upper tolerance threshold set for the central bank in January 2022, stayed over that mark through 10 of the 11 months for which data is now available. This included some months of 7%-plus inflation, with April recording a near eight-year peak of 7.8%. The surge in inflation compelled central banks, including the U.S. Federal Reserve, to hasten unwinding of easy money policies deployed to prop up economic activity through the pandemic.
In a bid to rein in inflation pressures, India’s central bank has also hiked rates through the year to take the key policy rate from 4.9% in April to 6.25% by December. While the latest hike announced earlier this month was a less aggressive 35 basis points compared to 50 basis points in the previous monetary policy iterations, there is still no sign we are at the end of this tether yet. On its part, the central government unveiled a slew of measures to cool prices, including a ban on wheat exports and curbs on a few other food items’ exports, with a few measures to rein in high raw material costs for industry owing to runaway commodity prices. Petrol and diesel prices have been frozen through most of this year, but that has also meant consumers have not gained from price resets when global crude prices fall, as they have in recent weeks. Vegetable prices fell dramatically in November to bring inflation below 6% for the first time this year, but cereals and pulses’ price rise continue to accelerate. The government expects steps to check cereals and pulses prices to be ‘felt more significantly’ in coming months, while the Reserve Bank of India, which had to recently explain to the Centre its failure to meet the inflation target range for three quarters in a row, expects inflation to average 5.9% in the January to March quarter. National Council for Applied Economic Research director-general Poonam Gupta believes inflation will be lower in the coming year, partly due to base effects and partly due to the rate hikes.
Are we out of the woods yet and what’s the outlook for 2023?
Growth expectations have fluctuated through the year as have growth rates skewed by pandemic base effects (real GDP grew 4.1% in the January to March quarter, followed by 13.5% in April to June, before halving to 6.3% between July and September). However, the Indian economy has displayed a broad resilience amid strong external headwinds thanks to a consistently growing farm sector and consumers catching up on pent-up demand for contact-intensive services that have now recovered to pre-COVID levels. The World Bank recently scaled up its 2022-23 growth estimate to 6.9%. By all accounts, however, growth is expected to be slower in the coming year (2023-24) at around 6% or slightly under.
Most developed nations are expected to enter a recession, which will dent demand for India’s exports. With the Ukraine conflict far from over, fresh fears of a new COVID-19 variant spreading its wings, little hope of an immediate pause in global monetary tightening, and the RBI’s warning of the next financial crisis emerging from private cryptocurrencies, the risks ahead remain as heady as they were last year.
Maintaining macro-economic stability and building buffers to steer the economy through these external shocks while pursuing reforms to make India a reliable alternative investment venue, should keep policy makers’ hands full. The immediate challenge for the government, though, will be to balance this economic tip-toeing with appropriate political messaging in what could be its last full Budget before the 2024 Lok Sabha polls, to be presented in about five weeks.