Reforms can immunise Indian economy against shocks in 2022

Since the onset of the Covid pandemic, the economy has entered a VUCA phase. VUCA describes an environment that is Volatile, Uncertain, Complex and Ambiguous. World GDP growth went from 2.8 percent in 2019 to -3.1 percent in 2020 and the IMF’s projected growth for 2021 is 5.9 percent.

The Indian economy has followed a similar trajectory. We can borrow three terms from the lexicon of risk management to understand what lies ahead for the economy in 2022.  These are the known knowns (facts), the known unknowns (possibilities) and the unknown unknowns (black swans).

Known knowns

The US Fed has doubled the pace of tapering. It will now reduce its monthly purchase of bonds by $30 billion. The Fed’s bond buying will end by March 2022 and interest rates will be raised from June. While a short-term negative reaction is expected from emerging stock markets, due to fears of flight of capital, the taper should be read as a sign that the US economy does not need a monetary stimulus anymore.

A recovery in the world’s largest economy can be nothing but good news for the rest of the world. Among emerging economies, India’s macros are looking good. The economy clocked growth rates of 20.1 percent in Q1 (helped by the base effect) and 8.2 percent in Q2 of FY2021-22. Forecasts for the full year range from 9.5 percent (IMF) to 10.5 percent (Morgan Stanley). The festival season bump to economic activity has lifted economic sentiments since last month as shown by a number of high-frequency indicators and business optimism indices.

There are two causes of concern. First, vehicle sales. Struggling two-wheeler and tractor sales indicate muted rural demand, but rising sales of luxury cars show buying power among the affluent. Such a K-shaped recovery is hardly surprising because economic growth driven by monetary stimulus tends to widen inequality as the liquidity ends up in the hands of the wealthy. Second, the 3-month average of wholesale price inflation is 12.5 percent while it is 4.6 percent for retail inflation. This means cost push factors (supply bottlenecks and input prices) are dominating demand driven inflation. The worry is that producers will soon pass on the higher costs to consumers and the cost of living will rise. For both reasons it is timely that the RBI has started normalising its policy by increasing the scale of liquidity absorption through variable reverse repo auctions. It is a matter of time before it hikes the reverse repo rate and restores the symmetry of the policy rate corridor.

Known unknowns

The union budget is the first major event of 2022. A recovery in tax collections offers hope that the finance minister may meet the fiscal deficit target of 6.8 percent of GDP. However, fiscal expansion will possibly continue. With the RBI stepping back and state polls coming up, the government cannot afford to take its foot off the stimulus pedal. But election time caution and the recent farm bills debacle also mean that while there is room for fiscal sops like reduction in fuel taxes or an urban jobs programme, major structural reforms are unlikely in the budget speech.

Once the elections are over in March, the government may look towards the stock markets to raise money. The success of the Air India sale may encourage it to complete the unfinished agenda of privatising banks, insurance companies and other PSUs as promised in the last budget. Of course, street politics could delay or derail these reforms.

Then there is the uncertainty stemming from Covid variant Omicron . OPEC has recently increased its demand forecast for crude in 2022 (from 28.6 to 28.8 million barrels per day) expecting the Omicron impact to be negligible. But global supply chains may falter if producer countries impose lockdowns once again. Businesses have started diversifying their supply chains to reduce the risk of overdependence on certain locations for their critical supplies.

Semiconductor chips are one such area, where the reliance on China and Taiwan has proven to be costly for the global automobile and computer industries. The Indian government has stepped in at the right time with a Rs. 760 billion incentive scheme for this industry, hoping to attract investments in semiconductor design, manufacturing and fabrication. The success of the production linked incentives scheme may encourage the government to expand it to many more sectors, heralding a revival of manufacturing.

The RBI may also choose to launch the digital rupee in 2022. While this could reduce transaction costs and increase financial inclusion, there are unknown challenges in regulation, privacy and security.

Unknown unknowns

In theory, everything could go wrong. Risk factors range from a deadly variant of the Covid virus, geo-political crises (Russia-Ukraine, China-Taiwan, China-India), cyber-attacks or natural disasters. But our policymakers have gained experience from navigating the uncertainty of the last one-and-a-half years. There is no substitute for unrelenting efforts towards GDP growth. It is the antidote that will reduce inequality and raise living standards.

If the government can successfully implement the new education policy and labour reforms while continuing the good work on health and infrastructure, we should be able to immunise the economy against future shocks.

Rudra Sensarma is Professor of Economics, Indian Institute of Management – Kozhikode. Twitter: @RudraSensarma. Views are personal and do not represent the stand of this publication.