The global economy has deteriorated over the past three months. There are signs of an impending downturn in Europe, which has been crippled by gas shortages and poor consumption. The recovery in China has been weak and the risks of growth falling below 3% appear high amid further supply shocks caused by droughts and energy shortages. Although the United States (US) economy appears resilient, it is still experiencing a rapid tightening of monetary conditions, which will eventually lead to weaker demand. Whether the United States will experience a hard or soft landing remains to be seen.
With major global economies experiencing a sharp decline in activity and simultaneous monetary tightening, the outlook for the rest of the world cannot be sustained, at least for an extended period. Almost at the right time, export growth began to falter globally, including in India.
The gap between the anticipated slowdown in growth and commodity prices, which remain somewhat elevated despite rising risks to growth, has been one of the main differentiators of this development.
For India, the latest gross domestic product (GDP) rate has fueled the debate over strong or weak growth. Faced with a very sharp rise in inflationary pressures, growth seems to have resisted. The economy’s resilience was supported by countercyclical fiscal policy, which bore the brunt of higher fertilizer and fuel prices, but monetary and exchange rate policy provided a “covering fire”. As summer fades and the northern hemisphere moves closer to winter, India looks relatively better placed than its regional and global counterparts, in terms of sustaining growth and managing inflation. This relative advantage is a function of three factors.
First, India’s food security has improved dramatically over the past decade as the country has evolved from a food importer to a food exporter. This small but subtle change was important for the management of domestic inflation, as the absence of supply-driven shortages and the build-up of buffer stocks prevented any significant spike in food inflation (although the impact climate-related factors is slowly becoming more important). important). This represents a break from the past, when rising global food prices reverberated and significantly raised India’s inflation profile.
Second, India’s lack of connection to the global manufacturing cycle is now a virtue. India’s foreign trade is out of sync with global cycles, especially compared to electronics-driven North Asian economies, helping to insulate its economy from the West’s downturn. This dynamic becomes particularly telling given India’s low reliance on China as an engine of economic growth, as India imports from China rather than exports to it. .
Finally, the biggest tailwind for India relative to other economies is its healthy balance sheet. Indian policymakers have opted not to extend fiscal or monetary assistance indiscriminately during the pandemic, which means that it is now possible to implement some targeted countercyclical support measures. In addition, the balance sheets of financial institutions, households and non-financial companies appear relatively deleveraged. If revenue growth remains generally strong, as it has been for the past 18 months, we expect more scope for revenue growth, although earnings remain under pressure due to high prices raw material.
These factors should be sufficient to ensure that India’s growth is better than that of comparable economies. In fact, we believe that average real GDP growth of about 6.5% for the next three years is possible. This should allow India’s economy to grow in a way that will not create overheating pressures.
However, a caveat is in order. Throughout the cycle, fiscal and monetary policies have helped manage prices. India’s failure to allow lower oil prices in 2020 to pass through to consumers helped offset upward pressures on prices in 2022. Through fiscal tools (e.g. excise duties), price pressures turned downwards, helping to anchor inflation expectations. This relative success has also enabled India to fight inflationary pressures during the Russian-Ukrainian conflict and is also evident in the management of the exchange rate. Foreign exchange was used from reserves accumulated over the past three years to stabilize the rupee and avoid abrupt adjustments.
Since this counter-cyclical price management policy seems to be working, the temptation may be to stick with the same approach – “if it ain’t broke, don’t fix it”. However, we must recognize that there are limits to how fiscal or monetary policy can be used to mitigate global shocks, whether to energy prices or capital outflows. Indeed, subsidies, taxes on windfall profits and foreign exchange reserves create distortions. They can have unintended consequences if held on too long. Ultimately, relative prices, in the form of inflation, exchange rates and interest rates, must adjust to align with global realities to ensure long-term sustainability of growth. without distorting the incentives of national economic agents.
Rahul Bajoria is Managing Director and Head, EM Asia (ex-China) Economics at Barclays The views expressed are personal.