As global economy faces headwinds, India must tread cautiously

Policy choices made to deal with COVID-19 resulted in India’s growth plummeting to about 1 percent per annum. (Image source: Reuters)

Macro-economic policy for growth, inflation, and exchange rate always face challenges. After battling COVID-19 challenges in the last two years, 2022 is witnessing massive disruptions caused by Russia’s invasion of Ukraine, strengthening of the US dollar, and tightening of fiscal and monetary policies in advanced countries.

Policy choices made to deal with COVID-19 — most stringent lockdown, restrained fiscal stimulus, and large-scale liquidity infusion — resulted in India’s growth plummeting to about 1 percent per annum, and GDP deflator inflation crossing double digit in FY-2022, while the exchange rate depreciated in an orderly manner by only about 2 percent.

India’s performance in 2022 has been more concerning. While the GDP growth might come at a nominally respectable 7 percent, the GDP deflator inflation remains stuck in double digits. The exchange rate has depreciated quite sharply to Rs 80, despite the Reserve Bank of India (RBI) spending more than $60 billion in last six months.

Has India done better than others? Could India have done better?

No Reasons For Feeling Smug

The government has opted for expanding subsidies (fertiliser, food, petroleum, and interest subsidies). With reduced petroleum taxes and commodities facing downward pressures, the government’s tax revenues are also likely to suffer. With taxes minus subsidies contributing much less, the government might be unwittingly contributing to depressing GDP. As the government is running large fiscal deficits, the debt-funded expenditures are likely to cause significant economic harm for many years.

Global growth is indeed suffering significantly this year. India should, however, not be deriving any false sense of achieving a high growth as the annual GDP growth over pre-pandemic FY2020 would still average only 2.5 percent.

Unprecedented inflation in advanced economies such as the United States and the United Kingdom was caused by their governments splurging on subsidies and central banks opening liquidity taps. With these reversing these policies, they are likely to see inflation tamed soon. India’s high inflation — on account of high imported prices and the government’s debt-funded expenditures — might not see any sharp containment.

The rupee crossing 80 to a dollar has been the biggest macro-economic story of the month. Policy-makers have sought to comfort businesses and people by constantly messaging that the rupee’s depreciation has been smaller than others.

The claim is plausibly true in the context of dollar index, which has appreciated 12 percent this year whereas the rupee has depreciated by about 7 percent. Our smaller nominal depreciation has, however, come at the expense of spending a whopping $62 billion in last six months.

Globally exchange rate movements have taken place more in line with the fundamentals of respective countries, and the policy choices they make. The Euro has depreciated heavily because Europe is facing the double whammy of dollar appreciation and acute oil and gas supply shocks. Japan is willingly depreciating by injecting money supply at near zero rate. Currencies of oil and other commodity exporters have actually appreciated. The Rubble is the best performing currency despite sanctions. The US dollar has appreciated massively despite very high inflation on account of global confidence in its inherent strength.

Instead of drawing false comfort from any relative performance, we must focus on doing what works best for us.

Deep Fundamental Vulnerabilities

We have quite a few deep-seated fundamental vulnerabilities.

Our $250 billion goods trade and $150-160 billion goods and services trade deficit is on account of three fundamental vulnerabilities — massive dependence on oil and gas imports (further accentuated by increased coal imports), big dependence on electronics imports, and inability to eliminate gold imports. We have failed to find any solutions for these.

We have built a huge net negative global investment position. Our liabilities (both equity and debt) exceed $1,300 billion, whereas our assets (excluding foreign exchange reserves) are practically nothing. This costs us annual interest/dividend payments of over $30 billion. Short-term debt component of these liabilities create big anxiety as refinance becomes costlier, and difficult.

We have big opportunities as well. Renewable energy can be expanded, exploiting our natural advantages, to substitute fossil fuels. We can expand other services exports to repeat our IT services story. Exporting our talented and skilled manpower can further grow the remittances pipeline.

Agreed that these are long-term solutions, but we have to make serious beginning.

We Live Dangerously

There are two policy options in the short-term for managing our rupee vulnerability. Either resume capital account inflows, or run-down reserves.

The first option requires creating an attractive interest rate/yields differential for NRI deposits/ECBs/and portfolio investments to flow-in again. The RBI has been reluctant to undertake credible policy steps in this respect.

The RBI has opted for supplying dollars. The RBI has the fire-power to do it. However, if the imbalance spills over to next year, the central bank will find it difficult to stave-off sharper rupee depreciation.

The global economy seems headed towards recession/major slowdown this year which will bring down inflation in India as well. Slumping global growth will, however, make our growth more vulnerable.

The pressure on the rupee is likely to continue in and beyond 2022. We can continue to live dangerously.