India’s economy in 2023: Hope, challenges, and a lot of uncertainty

India may not be decoupled from all of this, even though it was bracketed with the better performing economies in 2022. Its relatively strong growth notwithstanding, the Indian economy is yet to recover a lot of ground lost due to Covid-19.

Unlike most developed and emerging market economies that saw an extended run of high economic growth and subdued inflation before the pandemic hit, India entered the pandemic after eight successive quarters of declining growth and a flare-up in the inflation trajectory. So, the return to normal for India involves traversing a longer uphill trajectory, more so as the statistical base effect is now beginning to ebb.

Growth forecasts

In its December ‘State of the Economy’ update, the Reserve Bank of India struck a sombre note, noting that the balance of risks is increasingly tilted towards “a darkening global outlook”, and emerging market economies (EMEs) appear to be “more vulnerable”, even though incoming data suggest that global inflation may have peaked.

In that backdrop, the expectation that global growth could average around 3% in 2022 seems to be a commendable achievement, given that the decks were almost fully stacked against this. The year witnessed the highest global inflation in 50 years, the most aggressive monetary tightening cycle in nearly 40 years, the strongest US dollar in 20 years, and the weakest Chinese growth in over 45 years.

According to Sajjid Chinoy, JP Morgan’s Chief India Economist and Part-Time Member in the Prime Minister’s Economic Advisory Council, even two of these shocks would have been enough to tip the global economy into recession. Forecasts by the IMF suggest that global growth is projected to slow from 6% in 2021 to 3.2% in 2022 and 2.7% in 2023 — the weakest growth profile since 2001, except for the global financial crisis and the acute phase of the pandemic.

External situation

Global food, energy and other commodity prices may have eased moderately over the past few months, but inflation continues to stay high and broad-based. Global inflation, according to the IMF, is forecast to decline from 8.8% in 2022 to 6.5% in 2023 to 4.1% by 2024 — still high by most yardsticks.

The problem going into 2023 is the implications of stubbornly high inflation for the US Federal Reserve, especially the fact that the American labour market remains red hot, defying the impact of the Fed’s monetary tightening. A high wage growth of well over 6% is simply not compatible with the Fed’s 2% inflation target — which means that the American central bank is going to have to continue raising policy rates well beyond expected timelines.

An extended phase of rate hikes in the US could have a three-pronged impact:

• the difference between interest rates in the US and countries such as India widens every time the Fed raises policy rates, thus making the latter less attractive for the currency carry trade;
• higher returns in US debt markets could trigger a churn in emerging market equities, tempering foreign investor enthusiasm;
• currency markets would be potentially impacted by the outflow of funds to the US; sustained rate hikes by the Fed would also mean a lower impetus to growth in the US, which could be bad news for global growth, especially when China is facing a new Covid outbreak.

Which then means that a central bank-engineered recession is a looming possibility in 2023. Emerging markets such as India will have to continue grappling with the paradoxical situation of a strong dollar and elevated commodity prices — typically, they move in opposite directions and offer a hedge of sorts to net importers such as India, but they have moved in tandem in 2022, and could do so in 2023 as well.

Prognosis: the positives

• The near-term growth outlook for the Indian economy is supported by domestic drivers, some of which are reflected in the buoyant trends in high-frequency indicators. In November, equity markets touched new highs, buoyed by a rebound in portfolio flows to India.
• Headline consumer-level inflation moderated by nearly a percentage point to 5.9% in November, driven by a fall in vegetables prices.
• The twin balance sheet problem — of corporates having high levels of debt and banks saddled with bad loans on their books — looks to be on the mend. There has been significant deleveraging over the last five years, with the corporate debt-to-GDP at its lowest in nearly a decade and a half, and bank books have shed much of the legacy bad loans.
• Waning input cost pressures, surging corporate sales, and a turn-up in investments in fixed assets seem to be heralding the beginning of an upturn in the capex cycle, which could potentially contribute to a reboot of India’s growth momentum. The PLI scheme is offering an impetus to manufacturing, although the gains are skewed in favour of larger companies. Fresh investments are expected in renewables, electric vehicles, and battery tech.
• Bank credit has been growing in double digits for eight months now, reflecting in part an uptick in investment appetite.
• The China-plus-one strategy being adopted by most multinational companies could be an opportunity, given that Beijing is vacating large amounts of space in low-skilled, unskilled labour intensive manufacturing such as textiles, shoes, leather, and ceramics, and India has a chance to fill part of this vacuum.
• On a disaggregated basis, RBI data suggest that after a long gap of over two years, term-lending to non-corporates is seeing an uptick — a positive sign that seems to imply that smaller firms may be seeking funds beyond their immediate working capital needs.
• The Centre had recorded robust collections in both direct taxes and GST, reflecting sustained recovery of the corporate sector; states too have shown some decline in their consolidated deficits and net market borrowings.
• Agriculture has been a sustained driver for overall GDP growth, with the rabi outlook showing good prospects for wheat production with higher support prices, adequate reservoir levels, and climatic factors supporting higher acreage, according to the RBI.

Prognosis: the negatives

• The external environment continues to be fraught with risks. The Ukraine war drags on, threatening an energy-linked downturn in the European Union, India’s biggest export market. The US continues to grapple with cooling inflation pressure, and a let-up in the Fed’s rate hikes is unlikely until well into the second half of the year. The World Bank has slashed its growth forecast for China to 2.7% this year from the 4.3% estimated in June, and has nearly halved the projection of 8.1% next year. With the world’s second-largest economy going into a sustained slump, there is mounting evidence that the global economy will slow sharply next year.
• 2023 will see higher protectionism worldwide, greater fervour for de-globalisation, and more economic balkanisation: a worrying prospect for countries such as India that are keen to tap exports as a driver for growth. Given that no country in the world has grown at over 7% for a decade without strong export growth, the protectionist mood around the world is a major dampener for emerging economies.
• In India, manufacturing continues to be wobbly. Factory output, as measured by the Index of Industrial Production (IIP), slumped to a 26-month low in the festive month of October. Core sector growth for October was just 0.1%, the lowest for 20 months. That has led to a rapid downward revision of India’s growth projections by analysts for the next fiscal.
• The anomaly of private consumption growing at over 9% even as manufacturing has shrunk by over 4% is worrying. Part of this can be explained by falling exports, the other plausible reasoning is that the consumption growth is being driven by the upper-income groups whose consumption is far more important than it is dependent upon domestic products, according to former Chief Statistician of India, Pronab Sen. This ties in with the sharp increase in imports during the last six months.
• Capacity utilisation — the ratio of actual output to the potential output that can be produced under normal conditions — has shown a minor uptick but continues to hover around the 75% mark. Unless this goes up on a sustained basis, private investments are unlikely to pick up perceptibly.
• There is continuing distress among the Micro, Small and Medium Enterprises (MSME) firms, reflecting the deep cleavages in industrial recovery where the bigger companies are doing far better than the smaller firms. Evidence of this distress: one in every six loans disbursed under the Emergency Credit Line Guarantee Scheme launched as part of the Covid-19 relief package in May 2020 has turned bad in just 27 months, with the defaults mainly in the lower end of the loan bands (up to Rs 20 lakh). Given that MSMEs employ a sizable section of the labour force, their continuing financial stress points to the distress in the labour market, and a cascading impact on demand recovery.
• Capital expenditure of the states has remained weak. Investments by states typically tend to have a higher multiplier effect.
• Managing inflation expectations could be a challenge going forward, given that the RBI has been behind the curve on tackling prices, despite having hiked its benchmark lending rate by 225 basis points since May this year.
• An analysis of the inflation trajectory post-February 2022 by an RBI team led by Deputy Governor Michael Patra has concluded that while the initial inflationary pressure was delivered by successive supply shocks, as their impact waned, “a revenge rebound in spending and especially a swing from goods to contact-intensive services is generalising price pressures and making them persistent”. This could be a concern going into 2023.
• India’s significant dependence on imported energy, at 4% of the country’s GDP, is a challenge that shows up on the balance of payments side. A current account deficit of well over 3% is projected for FY23. Also, even though the trade weighted dollar has depreciated in the last couple of weeks, according to Neelkanth Mishra, Co-head of Asia Pacific Strategy, India Equity Strategist with Credit Suisse and part-time member of the PM’s Economic Advisory Council, it might be too early to declare that this phase of dollar strength is over.
• The buoyancy in farm output notwithstanding, rural wages contracted for the ninth consecutive month in September, pointing to continuing distress in the hinterland. This points to a continued labour oversupply in rural areas, and could have an impact on the labour supply dynamics and in depressing aggregate household consumption. The relatively higher inflation in rural areas is further muting spending in those regions.