Our country's economic outlook in 2022 and beyond - An analysis with a different angle

Our country's economic outlook in 2022 and beyond - An analysis with a different angle

? The state of the Indian economy

?The Indian economy grew at 13.5% on a year-on-year basis in the quarter ending June 2022 and the fastest rate since June 2021, it was meaningly lower than the 16.2% projection made by the Monetary Policy Committee (MPC) of the RBI. Most independent economists now expect the Indian economy to grow at a slower pace than the 7.2% forecast of the MPC.

?So, are the June 2022 GDP numbers good or bad? What do they mean for economic growth over the rest of the fiscal year? What is the current state of economic momentum in the Indian economy? What about the nature of economic recovery? For understanding the real picture, these GDP numbers should not be read without discounting the base effect.

Is it correct to see the June 2022 GDP growth as remarkably high, given the fact that GDP growth figures are rarely in double digits? The short answer is, it is not. The latest GDP numbers have a strong base effect which has artificially bloated the annual growth numbers. India’s GDP fell by 23.8% on an annual basis in the June 2020 quarter due to the 68-day lockdown which was imposed on March 25, 2020. While economic activity started recovering as restrictions were eased – the economy came out of contraction mode in the third and fourth quarter of 2020-21 – the second wave of the pandemic inflicted a huge disruption on the economy once again in the quarter ending June 2021. This meant that despite an annual growth of 20.1%, GDP was 8.5% lower than the pre-pandemic level during this period. This low base has given an artificial boost to the annual growth number for the June 2022 quarter. Quarterly growth projections by the MPC show that the headline growth number is expected to come down with moderation of the base effect in the successive period.

?We may endeavor to analyze the nature of economic momentum after the quarter ending June 2022. We are now in the last month of the second quarter of the fiscal year 2022-23. GDP numbers for the September 2022 quarter will only be released at the end of November. There is no method to ascertain correctly estimate GDP data, but we do have high-frequency indicators to give an idea about the state of the economy after June 2022. The picture is mixed. If one looks at the Purchasing Managers’ Indices (PMI), the situation looks good. PMI manufacturing came in at 56.4 and 56.2 in the months of July and August. Not only are these numbers comfortably above the psychological threshold of 50 which signifies expansion in economic activity over the previous month, but they are also higher than the monthly values in April, May, and June 2022. PMI services stood at 56.6 in July, lower than the individual monthly readings in the June 2022 quarters. ?The index of eight core sector industries, data available in this series till July, shows temperance in annual growth from 9.5%, 19.2%, and 13.2% readings in April, May, and June to just 4.5% in July. While the core sector numbers do show a sequential moderation in absolute terms, the decline in annual growth in July is also driven by the dispersion of base effect in the June quarter due to the second wave of the pandemic. Basically, there is nothing to propose that economic impetus was weakened suggestively. It is pertinent to know that high-frequency indicators generally capture formal sector activity.

? k-shaped recovery becoming deep-rooted?

?K-shaped recovery occurs when, following a recession, different parts of the economy recover at different rates, times, or magnitudes. This is in contrast to an even, uniform recovery across sectors, industries, or groups of people. A K-shaped recovery leads to changes in the structure of the economy or the broader society as economic outcomes and relations are fundamentally changed before and after the recession. This type of recovery is called K-shaped because the path of different parts of the economy when charted together may diverge, resembling the two arms of the Roman letter "K."

?This should be the biggest cause of concern. Because of deep inequality, the rich are insufficient contributors to economic growth in India. Has this disparity increased in the post-pandemic phase? Unfortunately, preliminary findings are proved right. Data from the Periodic Labor Force Survey shows that construction and trade, hotels, transport, storage, and communication sub-sectors of the economy employ around 30% of Indian workers. These two sub-sectors have shown the weakest recovery in terms of Gross Value Added from pre-pandemic levels in 2020-21 and 2021-22, and troublingly the trend continues even in the June 2022 quarter. Unless the economy finds a way to revive growth in the employment-intensive non-farm sectors or creates remunerative jobs for those employed here in other parts of the economy, the fruits of the post-pandemic recovery will continue to evade a large part of the population. This is bound to generate headwinds for medium to long-term growth, which can strengthen sooner rather than later given the global growth headwinds.

PERSPECTIVE-INDIAN ECONOMY: GROWTH PROSPECTS 2022 & BEYOND

The Indian economy is?expected to grow 6.5% in the current financial year?ending March 2022. This is according to the?United Nations ‘World Economic Situation and Prospects 2022’ report. India’s economic?recovery is on a “solid path”?amid rapid vaccination progress, less severe social restrictions, and still caring fiscal and monetary stances. Further, the?GDP is expected to expand by 6.7 percent in 2022 after a 9% expansion in 2021, as base effects decline. At the same time, the?report also restraints that while robust export growth and public investments underpin economic activity in the country, high oil prices and coal shortages could put the brakes on economic activity in the near term.

It will remain crucial to?encourage private investment to support inclusive growth?beyond the recovery. It added that while still vulnerable,?India is in a better position to navigate financial turbulence compared to its situation during the "taper tantrum" episode after the 2008-2009 global financial crisis.

This is due to a?robust external position and measures to minimize risks to bank balance sheets. In the medium-term, damaging effects from higher public and private debt or permanent impacts on labor markets could reduce potential growth and prospects for poverty reduction. In India,?inflation is expected to slow down throughout 2022, continuing a trend observed since the second half of 2021 when relatively restrained food prices compensated for higher oil prices. A sudden and renewed rise in food inflation, however, due to unpredictable weather, broader supply disruptions, and higher agricultural prices, could destabilize food security, reduce real incomes and increase hunger across the region.

?GLOBAL SCENARIO

The United Nations predicts a lower global economic growth for 2022 and 2023, saying the world is undergoing new waves of COVID-19 infections, determined labor market challenges, enduring supply chain issues, and rising inflationary pressures. The UN said that after expanding by 5.5 percent in 2021 -- the highest rate of global economic growth in more than four decades -- the?world economy is projected to grow by only 4 percent in 2022 and 3.5 percent in 2023.?

Last year's robust recovery was largely driven by consumer spending, some increase in investments, and trade in goods surpassing levels before COVID-19. But the momentum for growth slowed considerably by the end of 2021, including in big economies, like China, the European Union, and the United States as the impacts of monetary and financial stimuli from the pandemic began to recede and major supply chain interruptions developed. Without a coordinated and sustained global approach to contain COVID-19 that includes universal access to vaccines, the pandemic will continue to pose the greatest risk to an inclusive and sustainable recovery of the global economy. Labor shortages in developed economies?are adding to supply chain challenges and inflationary pressures. Growth in most developing countries and economies in transition has generally been weaker. While higher commodity prices have helped countries reliant on commodity exports,?rising food and energy prices have triggered rapid inflation,?particularly in the nine-member Commonwealth of Independent States and in Latin America and the Caribbean. Recovery has been especially sluggish in tourism-dependent economies, especially in the small island developing states. World bank downgraded its estimate of worldwide economic growth to 4.1 percent this year?from the 4.3 percent growth it was expecting last June. It's responsible for continuing outbursts of COVID-19, a reduction in government economic support, and ongoing blockages in global supply chains.

?A research group based in New York finds that India’s growth rate could touch 8.5%,?a striking rate amid the ruining Covid-19. The?World Bank data, oppositely proposes that India’s economy will grow by 8.3 percent in the fiscal year ending March 2022, unchanged from the June 2021 outlook. The forecast for FY2022/23 and FY2023/24 for India has been upgraded to 8.7 percent and 6.8 percent, respectively, shiny higher investment from the private sector and in setup, and dividends from ongoing reforms.

?TWO SCENARIOS OF ECONOMIC PROJECTION

Positive outlook

Accelerated rates of vaccination and substantially reduced mobility restrictions have improved consumer confidence. Once demand kicks in from one section of the population, it will likely result in a virtuous cycle as businesses will have to enhance spending. The?pandemic has increased the pace of digitization with businesses ramping up their online presence to survive. This trend is likely to continue even after the pandemic is over and will aid in improving the efficiency and productivity of labor and capital.

Telecommuting, e-commerce, hybrid workplaces, and digitization are expected to evolve rapidly, reshaping consumer preferences and, therefore, business operations. Further, the?impact of higher spending on infrastructure, government schemes (such as production-linked incentives and self-reliance), and digitization will start kicking in from 2023, leading to stronger outwardness, higher productivity, and greater efficacies—all leading to accelerated economic growth. High demand and supply, along with strong exports, will?give the government the space to gradually consolidate its position over the next few years. Asset monetization and stronger capital inflows will further aid the government in reducing its expenses and improving the fiscal deficit.

?Negative outlook

?Downside risks, such as?rapidly mutating virus and reduced effectiveness of vaccination leading to intermittent local lockdowns. Besides, muted demand, supply chain inefficiencies, and poor business confidence will cause sporadic and unsustainable growth spurts?over the next two years.

The recovery, nonetheless, is unlikely to be smooth and equal—some sectors and segments of the population will see a relatively gradual recovery than others. Several factors could potentially set back growth prospects, such as A surge in infections, Inflation—the biggest risk, Global supply chain disruptions, and travel restrictions, Crude oil prices have been steadily rising, Risks of capital outflows and Domestic investments in India have been low for over a year now, Job creation has been an Achilles’ heel for India, and the pandemic has created a highly fragmented job market, Nonperforming assets, and Inefficient utilization of demographic dividend.?

Future prospects

?In this fragile and uneven period of global recovery, the World Economic Situation and Prospects 2022 calls for?better targeted and coordinated policy and financial measures at the national and international levels. The time is now to?close the inequality gaps within and among countries. Without a?coordinated and sustained global approach to contain COVID-19?that includes universal access to vaccines, the pandemic will continue to pose the greatest risk to an inclusive and sustainable recovery of the world economy. The?government must focus its resources on capital investment, for example, on physical infrastructure, skill-building, and improving public health and other social infrastructure, as the country learns to live with the pandemic. These?expenses should be financed through sustained efforts toward monetization of assets and attracting investments. The other area of focus must be?enabling the ecosystem around job, income, and demand creation.?India is a domestic demand-driven economy and needs demand to sustainably pick up for a strong recovery. Since MSMEs are India’s largest job creators, the?government will have to identify their pain areas, and devise a solution that helps them become a part of “Aatmanirbhar Bharat.” Government must?focus on short- as well as long-term measures to boost exports and encourage foreign direct investment in sectors where India has a competitive benefit. Government must?be cautious of future variants and likely adopt a calibrated response through intermittent regionalized mobility restrictions.

?INDIAN ECONOMY: CLOUDY, WITH SOME SUNSHINE, TIGHTENING VIBES, WIDENING DEFICITS IN A SLOWDOWN, AND STATES OF AFTERMATH

Global Economy: Caught in the crosswind, and slippery slope

It is evident that Covid-19 made destruction the Indian economy severely. The economy contracted 6.6% in fiscal 2021 on account of the pandemic and then staged a mild recovery in fiscal 2022 when it grew 8.7%. However, the impact diverse across states, while some states were placed low by the virus, other states were able to endure mostly the shock. ?Bihar at one end of the band logged the fastest positive growth (2.5%); Kerala was at the other end, lessening 9.2%.?But after a deep dive into state-level data to analyze how the pandemic impacted the macroeconomic landscape, viz., growth, inflation, and fiscal health across states. The analysis is giving quite an incongruent picture.

?Highlights of the following trends are as under:

?Not all states saw their gross domestic product (GDP) shrink in fiscal 2021, leading to a differing permanent loss of GDP across states by fiscal 2022. In terms of growth (before Covid-19 and with the pandemic-induced hit), the better-placed states appear to be Bihar, Tamil Nadu, West Bengal, and Andhra Pradesh. Kerala, Maharashtra, Uttar Pradesh, Punjab, Rajasthan, Odisha, Jharkhand, and Madhya Pradesh are relatively worse off. Agriculture did cushion the pandemic’s impact on growth among states. This implies that generally states with a higher share in their GDP of agriculture contracted less in fiscal 2021. States with a relatively larger dependence on contact-intensive services, on the other hand, got hit more during the pandemic. Remarkably, the pandemic-induced hit to growth among states has not led to a divergence in that low-income states do not appear to have been harder hit. The sharp rise in inflation in the current fiscal has been mirrored in most states. So far, this fiscal, 13 large states recorded higher inflation than the national average, with Telangana, Maharashtra, and West Bengal recording the highest inflation. Most states facing maximum inflation are the richer states. Fiscal stress, as measured by debt-deficit levels, has increased across states during the past two years. Bihar, Kerala, Punjab, and Rajasthan are especially fiscally vulnerable, and their debt (as a percentage of gross state domestic product) is projected to be the highest among states in this fiscal as well. Finances of Andhra Pradesh, Bihar, Kerala, Madhya Pradesh, Punjab, Rajasthan, and West Bengal worsened, with debt/GDP crossing 35%

Services export prospects, domestic demand potential, and its emergence as an attractive investment destination will help India post strong economic growth this year. The end of 2021 making positivity. India was gearing up for a strong economic recovery—several forecasters such as the IMF expected growth to exceed 9% this fiscal. This optimism vanishes this year as a wave of omicron infections further swept, and in February 2022, Russia invaded Ukraine. These events aggravated the preexisting challenges such as surging inflation, supply shortages, and shifting geopolitical realities globally with no definite end in sight. And the subsequent confluence of headwinds such as surging commodity prices and disruption in trade and financial transactions fast declined economic essentials that were curving up a few months back. Consequently, this has obligated us to temper our growth expectations.

However, the risks are not strong enough to deny India an economic rebound given the domestic demand potential.?It is estimated that India to grow by 7.1%–7.6% in FY22–23 and 6%–6.7% in FY23–24.?This will ensure that India reigns as the world’s fastest-growing economy over the next few years, driving world growth even as several major economies brace themselves for a slowdown or possibly a recession.?

?Reasons for a positive outlook?

?India is primarily a domestic demand-driven economy with consumption and investments contributing to 70% of the economic activity. According to the RBI analysis of 10,000 listed companies, businesses have seen a steady net profit-to-sales growth over the past year and are sitting on piles of cash. Though investments are growing infrequently partly because of supply chain disruptions and global doubts, industry and service activities remain strong as indicated by the recent Purchasing Managers’ Index (PMI) numbers for India.

?Even Inflation, like in many other countries, has been hard on Indian consumers, with low-income households getting unduly impacted. That said, consumer confidence is improving with the easing of mobility restrictions. There is an appetite for spending among the top 10 income percentile of the population that has not spent for more than a year and thus is onto revenge buying and traveling. The number of flights taking off and hotel reservations have enthused travel industrialists. Revival in business travels and in-person client interactions have also helped the hospitality sector.?Besides, the number of foreign tourists visiting India almost doubled between January and April this year.?While demand for services is skyrocketing as is evident from the PMI numbers that were at an 11-year high in May 2022, the industry sector is also holding up well. ?Demand for electricity in the first six months of the year has been higher than in the past three years. The number of vehicles registered, meanwhile, has reached pre-pandemic levels. The other good news is that the government’s capital spending share is going up even as it is cutting down revenue expenses. ?India’s gross tax collection has beaten all expectations. The total tax collection reached INR 27.07 lakh crore (US$356.82 billion) in FY21–22, surpassing the government’s revised target by a substantial margin.?Improved economic activity and better compliance efforts in taxation have aided in better revenues. The tax buoyancy, which is a measure of growth in tax revenues compared to GDP growth, the simplified tax regime with low rates, comprehensive review and rationalization of the tariff structure, and digitization of tax filing is likely to support further capital spending in the future. Higher capital spending on infrastructure and asset-building projects is likely to boost growth multipliers in the medium term.

?Exports, in terms of their contribution to GDP, performed extremely well during the pandemic and reinforced recovery when all other growth engines were losing steam. The contribution of merchandise exports may waver as several of India’s trade partners witness an economic slowdown. The chance to lift services exports on the back of the global digitization wave is capable. Similarly, India’s manufacturing sector growth looks inspiring?as several global companies will look for resilience and cost-effectiveness in light of the China Plus One strategy. Moreover, if an expectation of a global economic slowdown results in a fall in commodity prices, which is what commodity indices currently indicate, Indian import bills will also come down. That may improve India’s current as well as fiscal accounts.?

?Global headwinds weigh on

Inflation which began after the pandemic led to supply chain disruptions, and then aggravated due to the war in Ukraine and the subsequent sanctions on Russia has emerged as the toughest challenge for economies around the world.?Inflation remained a persistent problem in India throughout the pandemic. A large part of it was earlier driven by high food prices, followed by fuel prices that started rising in 2021. Lately, a surge in demand for services has contributed to inflationary pressures. Most importantly, rising prices of commodities and raw materials globally have also seeped into the economy through imports. According to our estimates, the contribution of high import prices to domestic inflation remained significant throughout the pandemic.

The danger of persistent and prolonged inflation is that it reinforces inflation expectations. It then pushes up core prices (those excluding food and fuel prices, which are highly volatile) that often tend to be sticky down. Simply, what started as food and fuel inflation has become more broad-based. Till late 2021, a majority of the central banks believed inflation to be transitory. Cognizant of the fact that a tighter monetary policy cannot address supply-side issues but impact demand instead, banks globally hesitated in raising policy rates to anchor rapidly accelerating inflation. Finally, after reassessing the risks, several advanced nations decided to take the plunge; over the past six months, the central banks of the United States and the United Kingdom have been aggressively hiking policy rates, while the European Central Bank has recently hinted at similar actions. Moreover, many central banks are correcting their balance sheets. The possible consequences of such actions on global liquidity have unnerved investors, leading to capital flight, especially from emerging nations. These nations have seen their currency, external accounts, and borrowing cost conditions deteriorate, and to soften the blow, they have been forced to incur a higher fiscal deficit.

With banks globally tightening their monetary policy stance and domestic inflation remaining above the comfort zone (of 4%+2%) for several months, the RBI was left with very few policy choices. It sprang into action and raised the policy rates by 90 basis points within a month. It also has started reducing liquidity in the market, although it has kept the monetary-policy stance accommodative so far. The challenge is that the aggressive rate hikes may not result in taming inflation immediately. The rate hikes and liquidity squeeze are expected to raise borrowing costs and reduce demand, which, in turn, will ease price pressures. Therefore, the likely consequence of a tighter monetary policy everywhere will be a slowing down of economic activity. Concerns about a recession in the United States and the EU are imminent, and the questions being asked are “Not if, but when.” China’s outlook for the rest of the year, meanwhile, remains uncertain as it continues to rely on lockdowns and other restrictions to contain the spread of the virus. Activities in the property and auto sectors have also seen a moderation in the region. In short, the combination of geopolitical developments and global exigencies (such as the pandemic) are stressing supply chains, creating logistics bottlenecks, influencing trade relationships, and constantly changing the trade basket and competitive advantages.?

What lies ahead for India?

Economic fundamentals have deteriorated fast in the past two quarters, thanks to the uncertainties and risks to the global business environment. ?Consequently, we have revised our baseline projections compared to our outlook in March by over a percentage point. We expect two possibilities, with assumptions around the longevity and severity of the Russia-Ukraine conflict and the pandemic. Global economic growth and disruptions to the supply chain will be other critical determinants.

?We can foresee the situation under two scenarios

?Scenario 1?

?If the Russia-Ukraine crisis does not escalate but prolongs with a possibility of abating by the end of the year. Growth in the United States and the EU slows down but remains steady. The pandemic, meanwhile, has a marginal impact on the economy. With reduced uncertainties, businesses and investors focus on fundamentals and growth potential in the latter half of the year.?The Indian government and the RBI have a tough time balancing growth and inflation concerns, as well as containing capital flight as the US Fed raises policy rates. The RBI goes with six or seven hikes in FY22–23 and raises the policy rate to 6%.

?FY22–23 will likely witness the strongest rebound. Despite global risks, consumer and investment demand picks up. The buoyancy impact of government spending (infrastructure spending and production-linked incentive schemes) coincides with the economic recovery. Global economic slowdown, geopolitical conflicts, and rising global wages possibly enhance India’s status as a preferred alternate investment and outsourcing destination. We also expect several of the stressed economic indicators to likely improve as soon as global risks recede and recovery gains momentum. Our expectation inflation to remain inflexibly high despite rate hikes in FY22–23 unless the global slowdown causes oil and commodity prices to fall. The domestic currency recovers some lost ground against the US dollar, but not before early next year. India’s relatively strong recovery and global slowdown improve INR’s strength. The fiscal deficit deteriorates marginally because of higher subsidies (for fertilizers) and reduced excise duty revenues from oil. However, there are no long-term implications on the government’s consolidation targets as higher tax collections and returns from capital investments partially offset the expenses.?

?Scenario 2

?If the Russia–Ukraine crisis continues for a much longer duration, possibly spilling over into 2023. Advanced nations impose further sanctions on Russia, which provokes the latter to react (by reducing deliveries of natural gas to Europe during the winter months). Tensions escalated with several nations getting directly involved in the war. The United States and Europe enter a recession. The pandemic forces lockdowns and economic slowdown in several economies, including China. We do not associate much likelihood with this scenario. A prolonged crisis has second-order implications on financial stability and supply chains, especially in the semiconductor, food, and auto industries.?The Indian government absorbs the larger share of the price rise as inflation spirals up. The RBI goes with a hike or two but retracts later.

?Under the highly pessimistic assumptions, we expect the economy to experience a remarkable slowdown throughout our forecast period. Stagflation is a strong possibility under this scenario.

CONCLUSION

?It is true that doubts in the global business ecosystem will send debilitating headwinds toward India. Inflation and supply chain disruptions will remain rooted for some time. However, domestic demand and the desire of global businesses to look for more resilient and cost-effective investment and export destinations, among other factors, will help India ride this tide of headwinds. The optimism about India’s economic recovery, although slightly bruised, remains intact.

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