Macroeconomic challenges revisited

Policies are moving in the right direction, but vulnerabilities remain

Four months ago, I wrote that India’s macroeconomic challenges deepened (Business Standard, April 14) as inflation rose sharply in the US and European countries, triggering tighter monetary policies, China’s lockdowns to combat the spreading Covid infections damaged economic activity, and the Ukraine war, then seven-weeks old, spawned unprecedented economic sanctions against Russia, leading to soaring prices for oil, gas, wheat and other commodities and to significant disruptions of supply chains. I went on to outline some macroeconomic consequences for India, including likely outturns in key macroeconomic indicators in fiscal 2022-23, and listed some desirable policy responses by the government and the Reserve Bank of India (RBI). Four months later, it may be timely to revisit these issues and take stock.
 

To state the obvious, the international economic and political environment remains fraught by conflict, economic disruptions and high uncertainties. The Ukraine war continues unabated, as do sporadic Chinese lockdowns of major urban centres and further tightening of monetary policies by major central banks. Last week’s avoidable flare-up of tensions in the Taiwan Straits doesn’t help. The negative impacts on global economic growth and inflation are increasingly apparent. In its fortnight-old July Update of the World Economic Outlook (WEO) the IMF projects global economic growth to slow sharply (from 6.1 per cent in 2021) to 3.2 per cent in 2022 and 2.9 per cent in 2023, with major slowdowns in the US, China and Europe. More ominously, the WEO states “the risks to the outlook are overwhelmingly tilted to the downside”, and presents an “alternative plausible scenario” that foresees global growth at 2.6 per cent in 2022 and just 2 per cent in 2023, which would put global expansion in the lowest decile of rates experienced since 1970. Inflation has increased markedly in nearly all countries and external financing pressures have mounted in many developing countries.

Back in April, I had suggested some policy actions by the government and RBI (together referred to as “the authorities” in standard IMF parlance) to minimise the damage to the Indian economy. These included: Steps to hold the fiscal deficit to the budgeted target; an immediate increase in the policy repo rate and swifter normalisation of exceptionally accommodative monetary policy; a willingness to allow rupee depreciation “with brakes on” to contain volatility; sustained execution of public investment plans; upgrading of our observer status to membership in the proximate, mega-regional free trade agreement, the Regional Comprehensive Economic Partnership (RCEP), to enhance our future trading prospects and restore sustainable dynamism to our exports and associated investment and productivity; and measures to promote expansion of low-skill employment.

Illustration: Ajay Mohanty

It’s heartening to note that substantial progress has been made during the past few months in several of these areas. Despite the unavoidable increase in the fertiliser subsidy and certain other expenditure commitments, the government has acted to raise revenue resources to maintain the credibility of the budgeted fiscal target. The measures include the recent taxes on windfall profits and exports in the oil sector (since reduced in step with some easing of international oil prices), the reduction of exemptions and other rate rationalisations in the goods and services tax (GST) by the GST Council and continuing efforts to improve the administration of this major tax. In the monetary domain, the RBI and its Monetary Policy Committee at last acted decisively in early May to raise the policy repo rate by 40 basis points and followed up with further increases of 50 bps in June and another 50 bps last week (for a cumulative 1.4 per cent point increase). Increasingly, the RBI has accelerated the withdrawal of its accommodative policy and made that a focus of its attention, going forward, in its most recent policy announcement.

The authorities have allowed the rupee to depreciate to some extent against a sharply strengthening US dollar, although keeping “some brakes on” through RBI dollar sales has entailed a fall in our forex reserves of over $50 billion. Such high market intervention has also meant that the rupee has appreciated against the British pound, the euro, the Japanese yen and some other significant currencies. In overall trade-weighted real effective exchange rate (REER) terms (allowing for differential changes in nominal exchange rates and inflation across a currency basket) the rupee’s value has held roughly constant. Against the background of sharply rising deficits in foreign trade and the current account of the balance of payments (now widely expected to exceed an uncomfortable 3 per cent of GDP in the present fiscal year), it would be better to “ease the brakes” and allow some depreciation in REER terms to ensure medium-term viability of our external payments situation.

There has been no progress with RCEP; nor does any look likely in the near-term. Our weak engagement with regional preferential trading arrangements and our relatively high customs tariffs (relative to both East Asian nations and even our own position in 2015) continue to impede the growth of exports, output and employment. So does our unenviable legacy of an unprecedented three successive years of 10 per cent plus consolidated (centre and states) fiscal deficits and government debt-to-GDP ratios near 90 per cent.

Somewhat intriguingly, the RBI’s latest monetary policy statement’s projections for growth and inflation remain unchanged from those in May, despite all that has happened in the world in the last three months. Notably, economic growth is expected to average only 4.8 per cent in the latter three quarters of the current fiscal year, after a 16 per cent “statistical” bounce in the first quarter from the previous year’s Delta-hit first quarter low GDP base. The latest WEO update projects India’s growth at a higher 6.1 per cent in 2023-24. This is possible, but growth could easily be closer to 5 per cent if the expansion of world output and trade is closer to the WEO’s gloomier scenario or our own policies weaken significantly.

Finally, anyone suffering from complacency about India’ s macroeconomic resilience should note that the latest June quarter estimate (from CMIE’s rolling surveys) shows India’s employment rate (total employment divided by working age population) languishing at a very low 36.6 per cent, by far the lowest among “all large economies”. It means that less than two-fifths of the working age population in India today is actually able to find any work! And let us remember that employment was the central focus of John Maynard Keynes, the acknowledged parent of macroeconomics.

The writer is Honorary Professor at ICRIER, former chief economic adviser to the Government of India and author of An Economist at Home and Abroad. Views are personal