The budget for 2022-23 was saluted for its growth push despite the record gap in revenues and expenditures: Rs 15 trillion would be borrowed to fill these. This, however, did not hold back the stock market from touching the sky, nor commentary greeting the raised capex to draw in private investments, create jobs, and support demand. Days later, the euphoria subsided as fears set in over fiscal dominance in a riskier, inflationary environment within India and abroad. The 10-year bond, a benchmark for bank loan rates, rose by 30 basis points; the Reserve Bank of India rejected a sovereign debt auction in the budget week and cancelled another debt sale scheduled later to signal its discomfort with higher interest rates. The central bank then saved the day in an anti-climax last week by surprisingly not changing the monetary policy rate and an unexpectedly moderate inflation outlook, forecasting a progressive decline to 4.5% next year.
The policy moves come against a 9.2% GDP growth rebound in 2021-22 that marks India as the world’s ‘fastest-growing’ economy, a sobriquet repeated untiringly. A misleading distinction, as it were, given a -6.6% fall the previous year and, now, further proven by the desperation to grow through a borrowings-fuelled fiscal expansion and ‘looser-for-longer’ monetary policy.
Although the central bank didn’t spell out how the resources to fund budgeted spending will be managed, the benign inflation outlook moderated yields on government securities that are sold to borrow market funds. For now, market fears about interest rates rising have been allayed on account of inflation, deferring those due to the large-scale diversion of the economy’s savings to the government. Analysts have also pushed forward their rate hike expectations. But none is sure for how long.
The RBI’s inflation assessment is at variance with that of analysts who estimate it to be higher (in the 5-5.8% region) because of surging commodities’ prices, impending fuel price hikes to be passed on by the government since last November, higher ‘reopening’ inflation in services and so on. The central bank, on the other hand, foresees inflation peaking this quarter, averaging 5% in April-September, declining to 4% and 4.2% in the subsequent two quarters due to supply-side interventions by the government, a slower pace of selling price revisions by firms, and a benign trend in crude oil prices. Alongside, its growth trajectory estimates GDP to be growing 7.8% in 2022-23, with a 4.3% and 4.5% pace in the two quarters to March 2023. It remains to be seen how the disagreements on inflation — market beliefs and conviction about the RBI’s inflation narrative — evolve. Currently, most think there’s overoptimism on inflation; delaying monetary policy normalization could force bigger interest rate adjustments later.
The continual of this accommodative stance is also divergent with external settings. These are defined by sustained inflationary pressures, rising interest rates, and shrinking liquidity that altogether foreshadow tighter, volatile financial conditions. The global macro environment is uncertain and more hostile this year. The year, 2022, is not 2021, in which economies sprang back from recessions with record growth rates. Neither is it 2020 when fiscal and monetary policies were singularly devoted to combating the pandemic’s economic damages. World output growth is predicted to be slowing to 1.5 percentage points this year (4.9%) by the International Monetary Fund. Much of this is due to China and the United States of America, with the withdrawal of monetary accommodation driving the slowdown in the latter. Inflation touched 7.5% in the US last month, a forty-year high; its central bank is universally considered to have been mistaken in its reading and lagged in reaction; a steep catch-up of 5-7 interest rate hikes is anticipated this year. Most advanced and emerging market central banks have either increased interest rates or are poised to do so to prevent inflation from spiralling.
These trends have to be reckoned with. India’s consumer price inflation has been in the upper tolerance region of the 4% (+/-2%) target; its core element sticky at 6%. Higher costs are the main reason. Producer prices have risen on an average to 12.5% monthly this year; energy, commodities and other imported inputs being the biggest contributors. Demand pressures are visibly absent. However, unanticipated shocks, especially oil prices that are globally influenced, could upset the projected inflation dynamics, around which there’s wide uncertainty in the RBI’s forecasts for the October-March period.
It’s a moot point how much and for how long can India diverge from global interest rates. For one, there are implications for in-and-out movements of capital. This year, almost $6 billion has exited so far. Increasing oil prices and stronger import demand have widened the goods’ trade deficit, although the current account gap is limited. But economic strengthening and high oil prices could result in quicker expansion, export growth could be hurt with slowing world demand, while an escalation of uncertainty and risk-aversion could trigger financing difficulties. Despite large forex reserves’ stock, which do provide strength for crisis aversion or handling, the rupee could come under pressure. Two, the potential rise in US interest rates could mean dollar appreciation, which would import inflation into the country.
The internal imbalance, or fiscal risk, is more palpable and severe. Public debt is almost 90% of national income; the Central government’s interest payments have risen 54% over 2019-20, consuming almost half of its net tax revenues. A longer fiscal perspective or a medium-term strengthening plan, which would impart credibility, was not presented in the budget. The sustainability of public debt depends upon the interest rate trajectory; if the cost of servicing liabilities exceeds the pace of economic growth, it gets harder to lower debt in relation to GDP, the most-watched metric by investors and rating agencies. Therefore, debt burden needs to be kept low, including the use of the central bank’s monetary powers and/or its balance sheet to artificially repress interest rates. In addition to fiscal precarity, if macro balance worsens due to higher inflation and current account expansion, it could risk instability.
The success of the fiscal-monetary balancing in securing growth remains to be seen. While many consider the inflation outlook sanguine, there’s also the case that a strengthening economy rarely goes hand-in-hand with decreasing pace of price rise. If inflation surprises on the upside, higher interest rates may be inevitable even if a durable recovery eludes. The options are evidently limited and much is uncertain at present, particularly abroad.
Renu Kohli is a macroeconomist
