India will be lucky if GDP grows by 6% in FY23, says Pronab Sen

The RBI currently sees India's GDP growth cooling to 7.2 percent in FY23 from 8.7 percent in FY22. However, economists have lowered their forecasts in recent weeks due to the impact of the Russia-Ukraine war and the tightening of financial conditions by the RBI to lower inflation.

Last week, Nomura cut its growth forecast for India for 2023 to 4.7 percent from 5.4 percent.

According to Sen, India’s potential growth rate has fallen to around 5.5 percent.

Fiscal support needed

In a scenario where the monetary authority is applying brakes to curb red hot inflation, Sen feels the government must ensure fiscal support to make sure the economy does not tip over into a slowdown.

“Once you start having monetary tightening, the dangers of growth retraction go up. You don’t want growth to go down too fast because if it does, there is always a tipping point after which the contractions start getting a momentum of its own and it just gets worse after that,” Sen said.

“It becomes incumbent on the fiscal policy to make sure that the economy doesn’t go over that tipping point.”

The RBI has raised the policy repo rate by 90 basis points so far in FY23 to 4.9 percent to combat elevated inflation levels, with another rate hike expected next month in August.

One basis point is one-hundredth of a percentage point.

The latest Consumer Price Index (CPI) inflation print for June, at 7.01 percent, met market expectations. However, it was the 33rd month in a row that it came in above the medium-term target of 4 percent.

Sen expects the repo rate to be raised to as much as 5.5-6 percent from 4.9 percent currently as the RBI continues its fight against high inflation.

“The repo rate should be marginally above where you want the inflation to be… getting inflation down to 4 percent is not going to happen in the near future, but getting it down to 5.5 percent can happen. So, you just take it there and leave it there and wait for inflation to come down,” he said.

Asia’s third-largest economy, faced with a cost-of-living crisis, is barely above its pre-pandemic level and faces headwinds from elevated commodity prices, a widening current account deficit (CAD), and a likely recession in the West as central banks world-over quicken monetary tightening to combat multi-decade high inflation.

“Some of the (slowdown) is bound to happen, and should happen, otherwise monetary policy might be ineffective. So, the responsibility now should be of fiscal policy to make sure that doesn’t happen because the RBI has no choices left,” Sen added.

How much support the Centre can offer is questionable. Pandemic-related costs, loss of revenue, and cleaning up of the government’s books saw the central government fiscal deficit jump to 9.2 percent of GDP in FY21, before easing to 6.7 percent in FY22.

The Budget has targeted a fiscal deficit of 6.4 percent for FY23. But Finance Minister Nirmala Sitharaman has a tough task on her hands as expenditure on food subsidy has been raised, while earnings have been hit by excise duty cuts and a lower dividend from the RBI.

Investment question

Key to the Indian recovery is investments.

The pandemic has led to the Indian corporate sector garnering a larger share of the economy as the so-called micro, small, and medium enterprises (MSMEs) were battered by the second wave of the pandemic.

“If you look at corporate data, there is fantastic recovery, better than anywhere else in the world. But if you look at it as a whole, the MSMEs are still in very, very bad shape,” Sen said.

According to Sen, the spurt in investments seen in the second half of FY22 is not sustainable as that reflected a rush to finish projects, with the past lockdowns leading to a bunching of investments.

“These were projects that were already on the ground, the finances were tied up, everything was in place. So, there was a huge rush to complete that, which is why you saw a bulge in capex in the second half of the last fiscal year,” Sen said.

“Will the corporates want to invest more now? Do they have the confidence, particularly when you are looking at a global recession staring you in the face by the end of this year and next year?”

Sen’s doubts are reflected in data. While the government has highlighted that private sector project announcements are high, not all of the money is finding its way out of companies’ pockets. According to the RBI’s latest Financial Stability Report, released in late June, companies have been sitting on increasingly large piles of cash.

Let rupee ease

Meanwhile, Sen is not too worried about the rupee, which has plummeted to new lows recently.

According to Sen, the rupee probably needs to continue depreciating as it continues to be overvalued when seen against currencies other than just the US dollar.

As per latest data, the rupee’s real effective exchange rate (REER) against a basket of 40 other currencies stood at 104.18 in June.

A REER of more than 100 is indicative of overvaluation of the currency.

“The thing is, do you actively manage the deprecation, that is, do you force the rupee down or do you just allow it to happen? My opinion is to just let it happen if it happens. Just manage the volatility,” Sen said.

On the CAD likely hitting 3 percent of GDP in FY23, Sen said that didn’t warrant an overreaction given the overall “unusual situation”.