Q. Do you think India is on the brink of stagflation?
Aditi Nayar: Inflation is set to be uncomfortably high in FY23—at 5.6 per cent on average, as per our forecast. We have raised our projection substantially after the Russia-Ukraine conflict which has inflamed commodity prices. Some items will see a relatively faster transmission to the CPI (consumer price index) inflation, such as fuels and edible oils. For other items, an uncertain demand outlook may make transmission less rapid. The extension of free food grains under the PMGKAY will soften the blow somewhat by protecting household food budgets for six months.
On the growth side, we had cut our FY23 projection to 7.2 per cent last month. We believe that higher prices of fuels and items like edible oils are likely to compress disposable incomes in the low- to middle-income segments, constraining the demand revival. In the mid- to upper-income segments, normalisation of behaviours after the third wave is set to result in a pivot of consumption towards the contact-intensive services that were avoided during the pandemic. Overall, inflation is set to be uncomfortably high, and growth lower than what we were hoping for. However, it is hard to categorise a 7.2 per cent growth as a stagflationary situation.
Jahangir Aziz: The term stagflation is overused, and mostly incorrectly. It refers to a long period of below potential growth and high inflation. India, and the world, is far from that situation. Even the more cautious estimates of growth in FY23, such as ours, have growth over 7 per cent and inflation for the year below 6 per cent—hardly a sign of stagflation. Nonetheless, we should worry because despite the strong growth in FY22 and FY23, the GDP level by the end of FY23 will be significantly below the pre-pandemic path, indicating that there has been permanent loss to incomes. In addition, both employment and labour market participation will still be below pre-pandemic levels. So, clearly, there has been permanent scarring from the pandemic that India’s policy response has not managed to mitigate.
Neelkanth Mishra: We don’t think so. The underlying economic momentum is very strong and enough to counteract the large macroeconomic adjustments ahead of us. The job market has improved meaningfully over the past few months as schools and offices have restarted, tourism has opened further and governments are able to execute projects that were stuck due to lockdowns. The dwelling construction cycle is turning after nearly a decade-long lull, Indian firms are gaining global share in manufacturing exports, and services exports are quite robust—India, for instance, remains a major provider of software developers. The rise in energy prices is a headwind though, putting upward pressure on inflation, and forcing a downward reset of the rupee to bridge the balance of payments deficit. However, this only needs a reset, and sustained pressure on prices is unlikely. While we believe FY23 GDP growth will be meaningfully higher than the downward-revised 7.2 per cent forecast of the MPC [monetary policy committee], even the latter forecasts 4 per cent growth in the second half.
Pronab Sen: Yes. Due to periodic lockdowns, there has been a serious reduction in the productive capacity of the Indian economy, especially in the MSME sector. As a consequence, the economy has very little surplus capacity despite the numbers appearing on corporate balance sheets.
“Inflation is set to be uncomfortably high and growth lower than we hoped…but it is hard to categorise a 7.2% growth as a stagflationary situation”
– Aditi Nayar
Ajit Ranade: It is true that economic growth is slowing down, and inflation is inching up, but I don’t think India is on the brink of stagflation. There are recession-like conditions in some sectors, but in some other sectors, there is a boom, like in anything related to digital, healthcare, pharma, metals; even travel and tourism is picking up. But if growth continues to slow down, then even a positive growth rate of 3-4 per cent will feel like a recession. This will put pressure on both the Centre and state governments to pursue anti-slowdown measures, which will call for fiscal spending. As such, the government has already extended the free food grain scheme under the National Food Security Act to all till the end of September 2022.
Q. Will India’s growth be slower than expected? How will it impact jobs and incomes?
Aditi Nayar: We have cut our growth forecast to 7.2 per cent from 8 per cent. A gradual improvement in capacity utilisation levels may lead to a potential modest delay in the awaited broad-basing of capacity expansion by the private sector, which is somewhat negative for jobs and incomes. However, we expect the contact-intensive services to revive, which will make related jobs reappear.
Simultaneously, this could entail a reduction in the availability of agricultural labour, affecting acreage in some states, which was the key driver of agri output during FY21 and FY22. This may constrain agricultural GVA growth below 3 per cent in FY23.
Neelkanth Mishra: The rise in energy prices is a headwind to growth, especially since India imports 36 per cent of its energy needs and nearly half of its dense-energy needs. As India runs a current account deficit, it is weaker compared to other energy importers in adjusting to a reset in prices. To close the balance of payments deficit, the best course of action in the near term may be to let the rupee depreciate and curtail imports. This will have an impact on overall price levels and, as energy consumption drops, it will also slow the economy, hurting job creation and income growth. That said, we believe growth can still be meaningfully above current consensus forecasts.
The RBI has revised the estimate of growth rate for FY23 downward. It could be around 7%, which means slower growth in job creation…”
– Ajit Ranade
That depends on what one expects. There is general consensus among economists that the potential growth rate has dropped from around 7.5 per cent to 6 per cent. The actual growth may be lower still. This will lead to a slow growth of employment, even taking into account that agriculture has recorded an increase in employment, reversing a 30-year trend.
Ajit Ranade: The RBI and other agencies have revised the estimate of growth rate for FY23 downward. It could be around 7 per cent, meaning slower growth in job creation and incomes. In March, the unemployment rate actually fell, but not because more people found jobs. Actually, there has been a fall in the aggregate workforce to 428 million as per a CMIE [Centre for Monitoring Indian Exonomy] report. This means the labour force participation rate is at 39.5 per cent, the lowest in a long time. The worrying trend is that people are choosing to leave the workforce. Job creation remains our greatest challenge.
Q. Economic activity is back in full swing, yet industrial production and private investment are sluggish. Do you see this trend continuing?
Aditi Nayar: Elevated inflation and a pivot to services consumption away from goods is expected to constrain the growth in the demand for goods in FY23. Even though exports of some items from India will rise to meet global demand amid the supply crunch, we expect a very gradual improvement in capacity utilisation levels to approximately 74-75 per cent in Q3 FY23 from approximately 72.4 per cent in Q3 FY22.
Jahangir Aziz: We don’t think the recovery is back in full swing. Apart from IP and investment, consumption is way below its pre-pandemic path too. Even in nominal terms, it is about Rs 7-8 lakh crore lower despite the surge in prices. The same goes for private sector non-farm credit. For India, it will be very hard to recover the loss from the pandemic. For example, even if FY22 growth is 8.5 per cent, the level of GDP will be about 7 per cent lower than the pre-pandemic path. If we take the government’s trend growth rate of 7 per cent, India will need to grow at an astounding 14 per cent to cover this loss in FY23, which is unlikely. We think that the permanent scarring to the labour market and balance sheets of households and SMEs has lowered India’s potential growth over the medium term.
Apart from IP and investment, consumption too is running way below its prepandemic path”
– Jahangir Azaz
Neelkanth Mishra: Economic activity is only now coming back fully. We have to remember that one in four Indians is a student, and most students were not going to schools/ colleges. Not only did this mean that many teachers in private schools lost their jobs, but the transportation to and from education institutions, a business worth over Rs 1.6 lakh crore, was mostly shut. Similarly, inbound international tourism was 1 per cent of GDP before Covid, and is only now restarting. As offices and schools have reopened, demand for personal services has picked up: domestic help, drivers, receptionists, etc. Similarly, with the opening up, spending by the central and state governments has picked up. There were also supply-related disruptions in production in some sectors. We should see a pick-up in industrial production in the coming months. Private investments were expected to be healthy, but given the rise in global uncertainty and the necessity of some major macroeconomic adjustments in the Indian economy, the acceleration may be postponed by six to 12 months.
Pronab Sen: Only a part of the economy is back in full swing—the corporate sector. The MSME sector continues to limp seriously. This is likely to continue for the next couple of years until capacities in this sector are rebuilt.
Ajit Ranade: Private investment spending is indeed still sluggish. Investors are in wait and watch mode. The Ukraine war, global geopolitics and stagflation fears have made investors wary. Some sectors are definitely booming, like infotech, metals and mining, healthcare and pharma. The hiring in the infotech sector is supposed to be three times what we saw in the past couple of years. Anything that has a digital asp
(Photo: Chandradeep Kumar)
ect (be it crypto assets, cloud computing or AI) will see good times. Other sectors that are likely to see better times are green initiatives (including renewables) and the ones that benefit from the government’s infra spending.
Q. Do you think the RBI should have raised key rates to check inflation?
Aditi Nayar: We were expecting a change in tone to signal an upcoming stance change, which is what the MPC has provided. With inflation being imported and supply side in nature and not demand-led as of now in India, we foresee a shallow rate hike cycle of 50 basis points (bps) in Q2 FY23.
Neelkanth Mishra: The RBI has already meaningfully tightened financial conditions in the past six months. When the banking system is depositing surplus funds back at the RBI every night, the effective rate is the reverse repo rate and not the repo rate. That is the cost at which the RBI takes in the surplus funds with banks. As the governor explained in February, the weighted average cost of absorption rose by 50 bps, from 3.37 per cent in September 2021 to 3.87 per cent in the fortnight ending February 6, 2022. They did so not by raising the reverse repo rate, but by conducting VRRR (variable rate reverse repo) auctions at nearly 4 per cent. These auctions though were still at the RBI’s discretion, and the introduction of the SDF [standing deposit facility] at 3.75 per cent firms up the RBI’s stance on normalising the rate corridor. The rise in deposit rates and sovereign bond yields means that financial conditions have already tightened materially. Raising the repo rate till there are overnight surpluses in the banking system is unlikely to be very effective other than for some bank loans that may be linked to the repo rate.
Pronab Sen: The fact is that the RBI has already raised the key rates while holding down the repo and reverse repo rates. The variable reverse repo (and SDF) rates have now become the operative rates rather than the reverse repo. This is showing up in the sharp increase in yields on government bonds.
Ajit Ranade: The RBI is between a rock and a hard place. This is because, on the one hand, due to the threat of a serious slowdown, the RBI cannot make interest rates go higher, but, on the other hand, to fight inflation, it cannot keep interest rates too low. It has managed the monetary policy quite deftly and also taken care of financial stability so far. Since it has several levers to control, such as the repo rate, the reverse repo rate, the SDF and other macro-prudential measures, it will have to really stretch itself to find that optimal balance of monetary policy that promotes growth vs. fighting inflation. It must also now worry about causing worsening inequality due to stock markets. Much of the liquidity has gone into stocks and housing, causing those prices to soar, but that tends to benefit people in the higher income bracket which means wealth inequality is worsening.
Q. What key measures should the Centre take to boost growth and provide more jobs?
Aditi Nayar: Accelerating capex both at the central and state levels with an early kick-off of the Rs 1 trillion interest-free loan could quickly boost growth and jobs.
Jahangir Aziz: There are many things that the government should have done and can still do. For example, overhauling India’s health system. This is an area that can create far more jobs than manufacturing, which has become capital-heavy and largely automated. More importantly, the biggest source of employment in India remains its SMEs. So far, the only programme the government seems to have focused on is providing contingent credit guarantees to SME bank loans. That’s just a roundabout way to extend regulatory forbearance to banks. There needs to be direct cash transfers to SMEs for reopening, expansion and new investment. Why not extend the production-linked incentives (PLI) to SMEs? Without such help, it is hard for SMEs to recover and start generating jobs.
Neelkanth Mishra: The Centre has kept its focus on overall macroeconomic growth: this is important not only for good fiscal health but also job creation. The Centre does not have the granular execution system that states have. Working through the latter, therefore, is the most prudent way forward. Ease of doing business should also remain a focus area, as India has a long way to go in expanding its share of global manufacturing. The government can also consider government-to-government contracts to streamline labour flow to economies like Europe and Japan, that are seeing demographic pressures and shrinking workforces.
“The Centre has kept its focus on overall macroeconomic growth; this is important not only for good fiscal health, but also job creation”
– Neelkanth Mishra
Pronab Sen: The focus must be on reconstructing the MSME sector quickly. Some steps have already been taken, but the pace has to be accelerated.
Ajit Ranade: Since Ukraine and the pandemic are external factors, there is limited scope on how to tackle the impact. Oil and other supply chain whiplash effects are causing high inflation. If India can maintain its fantastic performance of exports for the next few years, it would be a big boost to industrial growth and SMEs. India has to try harder to capture the lost ground in labour-intensive exports, plus participate aggressively in supply chains. The proactive approach to signing an FTA with Australia and soon perhaps, with the UK and EU, is a good sign. India must remain an open economy even as it pursues Aatmanirbhar Bharat.