Near term challenges for Indian economy and how is India resilient enough

In this article, we discuss some of the major challenges Indian economy is facing currently and also despite these both the government and the Reserve Bank of India (RBI) is hopeful that Indian economy remains resilient and be on course to becoming fastest growing economy in the world. Read more….

Near term challenges for Indian economy and how is India resilient enough

Indian economy witnessed a sharp recovery after the covid-19 blow thanks to stimulus measures by the government, central bank’s easy monetary policy stance in 2020 and vaccination rollout in 2021. However, just when the economy tried to gradually get back on track; beginning 2022 the Russia-Ukraine war, sharp spike in the global crude oil prices, rising inflation and US Federal Reserve’s aggressive stance posed a huge shock. The Indian economy could not remain unscathed by all these discouraging global developments and impacted its domestic economic state.  In this article, we discuss some of the major challenges Indian economy is facing currently and also despite these both the government and the Reserve Bank of India (RBI) is hopeful that Indian economy remains resilient and be on course to becoming fastest growing economy in the world. Read more….

Rising inflation 

The retail inflation rate, as measured by the Consumer Price Index (CPI), stayed largely unchanged at a high of 7.01% in June 2022 compared to 7.04% in May 2022. CPI inflation continued to greater than the 2-6% tolerance band for three consecutive quarters. The elevated commodity prices globally, supply constraints which were the after effects of pandemic and rising demand after economy’s resurgence in a post-Covid era pushed inflation higher across the globe including India. The inflationary scenario aggravated further with the higher oil prices after the Russia-Ukraine war. Global economies too have been reeling under the pressure of higher inflation. The inflation rate in US surged to 9.1% - the highest in 41 years. To ease the inflationary pressure, the global central banks and the RBI back home hiked the interest rates in the first half of 2022.

Slowdown in the economic growth

The monetary tightening impacts the macroeconomic picture. The interest rate hikes and gradual unwinding of the stimulus measures have raised the fears of the recession in the developed economies like US and Europe. The less favourable global economic scenario impacts Indian economy as well. Although, Indian economy is resilient but still the economic growth has been downgraded by several international agencies. (See below chart) IMF has cut its gross domestic product (GDP) growth forecast for India for the fiscal 2023 by 80 basis points to 7.4% while a similar downgrade is made to growth forecast for fiscal 2024, which now stands at .1% as against 6.9% earlier.  The RBI growth projection remains at 7.2% for fiscal 2023 as per the last monetary policy.

Emerging twin deficit problem

Two major concern emerging in the recent times has been twin deficit worries. Fiscal deficit which is difference between government’s total expenditure and revenue stood at 6.7% in fiscal 2022 mainly on account of higher tax realisation. The fiscal deficit target is projected to be at 6.4% of the GDP in fiscal 2023; but the government revenues have taken a hit following cuts in excise duties on diesel and petrol, posing risk to budget level of gross fiscal deficit. Rationalizing of the non-capex expenditure is crucial to avoid fiscal slippages. Capex expenditure is crucial and has a much bigger multiplier effect on the overall GDP growth.

Spike in the oil prices after Russia-Ukraine war (See chart) and higher gold imports has resulted in widening of the India’s trade deficit. The trade deficit ballooned to a record of $26.18 billion in June 2022 (See chart below) and during the first three months of this fiscal widened to $70.80 billion from $31.42 billion in the year-ago period. This has raised concerns about ballooning of the current account deficit (CAD) adding more pressure on the rupee which fell to record low against the US dollar.  Heavy foreign portfolio outflow following interest rate hikes by the US Fed, rising US Treasury yields, rising commodity prices and geopolitical tensions also weakened rupee against the dollar.    

Decline in India’s forex reserves

To prevent the rupee from tumbling past 80 a dollar, the RBI has stepped up its intervention wherein it is using reserves. As a result, India’s forex reserves fell to their lowest in over 20 months. The reserves fell $7.5 billion to $572.7 billion as of July 15 – lowest reading since November 6, 2020

Rising unemployment

One of the biggest blows of the pandemic has been on the state of employment as many people from the organised and unorganised sector lost jobs. The unorganised sector was impacted severely prior to pandemic due to demonetisation in 2016 and Goods and Services Tax execution in 2017 with situation get worst from the Covid-19 lockdowns. Several businesses opened up after lockdown relaxation but they are struggling to survive due to lack of demand and lack of available workforce. Start-ups facing the fund crunch were forced to layoffs many youths. The unemployment rate rose to 7.80% in June with the loss of 13 million jobs, mainly in the agriculture sector according to Centre for Monitoring Indian Economy (CMIE).  The labor force participation rate - meaning people who are working or looking for work - has dropped to just 40% of the 900 million Indians of legal age, from 46% six years ago, according to the CMIE.

The way ahead:

The above macroeconomic challenges look scary but note that we are living turbulent times.  Indian economy cannot remain unharmed by rising global economic uncertainty. However, just like post pandemic, the central banks and policymakers across the globe are working hard to revive the economic state.

Back home, the finance minister Nirmala Sitharaman said that the economic growth will continue to be supported by fiscal spending along with an investment push and remains confident that India will continue to achieve a high growth rate at 8.9% in the current fiscal year. The central bank back home – RBI strongly believes that the Indian economy remains relatively better placed. In its recent speeches, the RBI Governor Shaktikanta Das stated that the financial system is well-capitalised, asset quality indicators have improved, balance sheets are stronger, and banks have returned to profitability. The credit demand looks healthy and the external sector is well-buffered to withstand the ongoing terms of trade shocks and the portfolio outflows.  The central bank is cautious about headwinds and shall be proactive in taking measures as necessary to ensure financial stability. The RBI has zero tolerance for volatile and bumpy movements in the value of rupee. The central bank is actively involved in the forex market and will ensure that the rupee finds its level in line with its fundamentals.

While we saw foreign outflows from the financial markets in the last few months, the strong presence of retail and domestic institutional investors (DIIs) has also augured well for the domestic equities. Since the India growth story remains intact; the foreign money will return back to India soon. Equity market benchmark – S&P BSE Sensex rebounded sharpy in July 2022. The surged 9% in July 2022 compared to 4% decline recorded in June 2022. Hence, as an investor don’t be fearful of the short-term blips but have faith and remain focus on the long-term wealth creation.