National Council of Applied Economic Research
Opinion: Poonam Gupta and Ayesha Ahmed
The global environment seems to have turned less hostile as inflation rates have peaked in advanced economies and oil prices have stabilised at lower levels. So capital flows have started returning to India, the exchange rate is bouncing back and foreign reserves are being rebuilt.
Year 2022 turned out to be a rocky one for most economies. While many countries managed to put the worst of Covid-19 behind them, they entered another challenging space, characterised by unmanageably high rates of inflation, unruly monetary policy tightening by advanced economies and continued supply chain disruptions. The situation was compounded by the Russia-Ukraine war, which upended any remaining hopes of a holistic recovery in a post-Covid world.
India faced its own share of challenges in the form of reversal of capital flows coupled with sharp rise in oil prices and elevated domestic inflation. In the end, it rode through them by skilfully deploying a policy tool kit comprising tight monetary policy, exchange rate depreciation, use of forex reserves and specific fiscal actions. Overcoming these challenges, the Indian economy grew at 9.7% cumulatively in the first half of the fiscal year. And it seems well on its way to registering a growth rate of about 6.8-7% during the year.
The global environment seems to have turned less hostile as inflation rates have peaked in advanced economies and oil prices have stabilised at lower levels. So capital flows have started returning to India, the exchange rate is bouncing back and foreign reserves are being rebuilt.
When such recurring shocks occur, the most that policymakers can do is firefight. An appropriate time to devise policies to insulate the economy from them is when the situation is calmer — like now. This is just the right time to build resilience to capital account volatility and put in place policy frameworks to mitigate the impact of oil price shocks and tame vegetable price inflation.
Within the mix of the international capital that we attract, FDI is the most stable form of capital, and portfolio flows are the most volatile. To reduce capital account volatility, it will be advisable to change the mix of capital inflows towards more stable forms of capital, particularly FDI.
With the declining intensity of oil in GDP, the relevance of oil prices in the Indian economy has diminished, but has not disappeared. It will be useful to prepare an “oil price mitigation strategy”, comprising an oil price stabilisation fund, replenishment of strategic reserves, hedging against large price increases and locking in of oil supply at low prices.
Food inflation, especially vegetable price inflation, has been particularly volatile in India. Monetary policy is a blunt instrument for addressing it. Instead, better demand-supply management is needed to tame it. It will be a win-win for all: it will stabilise farmer incomes, liberate monetary policy from responding to food inflation and provide a useful political narrative.
Meanwhile, policymakers need to keep a watch on the evolving global economic outlook. Global growth is slated to slow down, as the effects of monetary policy tightening will set in. The IMF has lowered the growth forecast for 2023 — from 3.8% in January 2022 to 2.7 %in October 2022.
Global growth affects India in two ways. The first is through demand for India’s exports. With the elasticity of growth of Indian merchandise exports to global demand being close to 1, a slowdown in global demand has a direct bearing on Indian exports. Second, a pessimistic global investment sentiment has a proportional impact on domestic sentiment.
Thus, the latest projections suggest a lower growth rate of 6-6.5% and a lower inflation rate of 5-5.5% for India. IMF has projected the real growth rate at 6.1%, inflation at 5.1% and thus a nominal growth rate of 11.2%. The corresponding figures in the Survey of Professional Forecasters by RBI are 6%, 5.2% and 11.2%, respectively. RBI’s own projections for the first half of 2023 suggest an average annual growth rate of 6.5% and inflation at 5.2%.
These prognoses have implications for the forthcoming budget. The 2023 Budget should be prepared, assuming a modest level of nominal growth; and it should keep provision to support specific sectors that would likely be impacted by the repercussions of a global slowdown.
On the broader policy front, the budget should retain the focus on growth with macroeconomic stability and fiscal prudence, complemented by efforts to attract higher FDI and more globally competitive and integrated production capabilities. Overall, while we should hope for the best, we should be prepared to tackle another difficult year.
Gupta is Director-General, National Council of Applied Economic Research (NCAER); Ahmed is a Research Associate at NCAER