There are still reasons to be hopeful on India

Published April 9 2021

The second COVID wave in India is threatening the near-term recovery. Case numbers are at the highest on record and activity is understandably deteriorating. Various high frequency indicators, including manufacturing, have stagnated, suggesting some let-up in the growth momentum seen in January and February.

Lacklustre credit growth, though improving at the margin, is a pre-existing risk if it starts to impede a recovery in investment. These risks do not present much upside to ANZ Research’s full-year 2021 GDP forecast of a 7 per cent decline.

That said, ANZ Research is hesitant to extrapolate these impediments to growth into fiscal 2022. Several developments are encouraging, such as the steady progress in the vaccination drive, improving exports and most of all solid corporate confidence in capacity utilisation, employment and overall business prospects.

It is also encouraging that in February, the unemployment rate retreated to its pre-pandemic level of around 7 per cent. ANZ Research also notes households’ financial savings are much higher than historical levels and should be progressively unwound in the coming months.

Fiscal policy is also more pro-growth, with a focus on capital spending. Based on these developments, ANZ Research has upgraded it full-year 2022 Indian GDP forecast to 10 per cent, from 8 per cent previously. The upgraded forecast remains on the conservative side of the market, allowing for fewer adjustments if the second wave is not contained in time.

In 2023, expect growth to reach 6.7 per cent which should in turn allow for a complete closure of the output gap.

Inflation risks

The main thorn in this otherwise hopeful narrative is persistently high inflation which has been aggravated by higher crude oil prices off-late.

ANZ Research forecasts full-year 2020 headline CPI at 5.1 per cent, in the upper half of the official target range of 2 per cent to 6 per cent. Inflation is also likely to remain volatile in the near term and its core component sticky at an elevated level.

Apart from varying base effects, the behaviour of many components of the CPI basket suggest higher costs arising from the pandemic are being passed on to consumers.

Some of these components include costs of air travel and casual labour, including watchmen and domestic help. However, ANZ Research notes a reduction in excise duties on retail gasoline prices could help alleviate inflation.

While there is growing public pressure to reduce excise duties, policymakers have yet to respond. Accordingly, ANZ Research has not factored in any cut in excise duties in its inflation forecast for now.

Higher crude oil prices are also expected to weigh on the current account balance, which is expected to turn into a deficit of 0.4 per cent of GDP from a surplus of 0.9 per cent in fiscal 2021. On balance, however, a deficit of this order is not a concern for overall macro stability.

Moreover, financial account flows are expected to stay robust, including longer-term FDI flows. Portfolio flows into Indian assets, especially equities, will continue to keep the overall balance of payments in a comfortable surplus in 2022. ANZ Research forecasts this to come in at $US61.4 billion, or 1.9 per cent of total Indian of GDP.

Pro-growth fiscal policy

Fiscal policy is likely to remain pro-growth as underscored by the 2022 budget announcement. The budget incorporates a 26 per cent step-up in capital spending, which should have a strong multiplier on overall GDP growth.

The flipside of this increase is that the commitment to medium-term fiscal consolidation has slipped, and the fiscal 2022 budget deficit at 6.8 per cent of GDP will remain high by historical standards.

However, ANZ Research takes comfort from the fact the underlying macro assumptions, including that on tax buoyancy, are conservative. Therefore, the actual fiscal outturn may be lower than projected. ANZ Research expects the 2022 fiscal deficit to come in at 6.5 per cent of GDP.

However, monetary policy will be challenged in several areas. Increased volatility in inflation and sticky core prices will not only force the RBI to maintain a long pause on the policy repo rate in 2022 but will also narrow the policy corridor by raising the reverse repo rate.

It will also need to drain excess liquidity, part of which has arisen from its intervention in the FX market but at the same time, ensure yields on longer -tenor bonds do not rise aggressively. Overall, ensuring an orderly evolution of the yield curve could be a complicated task for the RBI even though it has committed to do so.

Rini Sen is an Economist, India at ANZ