India’s economic outlook: watch out for turbulence ahead

Central banks around the world are planning to raise interest rates significantly to keep inflation in check. A rate hike could push the global economy into recession as supplies are cut by the war between Russia and Ukraine and a slowdown in China. Rising interest rates will encourage continued capital outflows, threaten financial stability in developing countries that borrow too much in dollars, and cause exchange rate problems.

All of this will affect our growth prospects. A global recession will certainly restrain exports and thus growth. With limited exposure to foreign borrowing, financial instability is less dangerous, but exchange rate management can be problematic. Reserve Bank of India (RBI) faces a tough choice between intervening strongly to ‘manage volatility’ at the risk of losing reserves or letting the currency ‘find its own level’ .

Some grounds for building the alternatives we face can be gleaned from the World Bank report “Is a Global Recession Imminent,” released last week. Using a global model of the economy, he details his three alternative scenarios for emerging market economies (EMDEs).

Baseline scenario: EMDE moderately accelerates to 4.1% in 2023 and 4.3% in 2024, almost returning to pre-pandemic growth by 2024.

Sharp Deceleration Scenario: EMDEs will slow to 3.3% in 2023 and rise to just 4.1% in 2024.

Global Recession Scenario: In this scenario, EMDE slows sharply to 1.8% in 2023 and recovers to just 3.4% by 2024!

Where does India stand in this framework? The RBI’s original forecast of 7.2% may be revised down to less than 7%, but remains solid. Growth was 13.5% in the first quarter, reflecting last year’s low base, but the RBI forecast a sharper slowdown in subsequent quarters, averaging just 5% over the past three quarters. I did.

The World Bank report does not include forecasts for India, but the International Monetary Fund forecast India’s growth of 6.1% in April and has since lowered its forecasts. All of this suggests that next year’s budget should be framed for real gross domestic product (GDP) growth of 6 or 6% or more. In the medium term, we can aim for higher growth. For example, the goal of a $10 trillion economy by 2030 requires an average growth rate of around 8%, and we don’t have to give up on that. But the 2023-24 budget should be based on realistic targets. Given a growth rate of 6% or higher and an inflation rate of 4%, nominal GDP growth of around 10.5% is realistic. Tax revenue should be projected on this basis. Optimistic assumptions about tax buoyancy should be tied to specific tax reforms, such as the implementation of the much-talked-about GST reform.

Budgetable spending growth depends on the size of the budget deficit. This is clearly a weakness, as the central government budget deficit is well off the target set several years ago. The pandemic was a valid excuse for this deviation, but now that it’s gone, budget watchers will look to steps to bring the deficit under credible control.

Significant financial adjustments are always achieved over time. In this context, he could aim to bring down the central government’s deficit to, say, his 3.5% of GDP in three years. This could consist of a 0.5 percentage point improvement in 2023-24 and his 2.5 percentage point improvement over the next two years.

It would help if the Treasury reinstated its previous practice of displaying deficits for the next two years after the budget year. Since 2024 will be an election year, the usual budget will only be presented after the vote, but setting a respectable financial target beforehand is an important signal.

If the budget’s growth projections are cut to more than a realistic 6% next year, there will be pressure to increase public spending to boost demand to unlock higher growth. There is a need to increase public investment, especially in the emerging climate change sector, but these investments must be met by reducing other non-productive expenditures.

Private investment is a way to increase investment without exacerbating the budget deficit. The Finance Minister, in a recent exchange with Indian companies, addressed the issue when he asked them why the private sector would not invest even though the corporate tax rate had been reduced to a level competitive with other countries. Several large homes have announced several large investments. This is good, but announcements by some large companies do not fix the underlying problem of a significant slowdown in private sector investment, including in agriculture and household sector investment, including in small industries. .

This widespread slowdown undoubtedly reflects that huge budget deficits crowd out private investment. The combined center and state deficit now stands at nearly 11% of GDP, more than the overall fiscal savings of the household sector. This deficit reduction provides room to fund private sector expansion. The need for this compression is driven by tight liquidity in global markets, a heavy reliance on non-bank funding from global markets and a lack of funding for start-ups, a key positive feature of India’s economic conditions. When depleted, it grows larger and larger.

If the world were to experience a sharp slowdown, exports would be a problem. This is reason enough to allow the rupee to fall. Exporters have already said the declines seen so far are useless as the currencies of their competitors have fallen so much. They are exploring alternative fiscal policies, but a weaker rupee may be a better option.

This must be supported by long-term policies to support exports by improving export-related infrastructure and logistics. There is an urgent need to conclude the various free trade agreements under negotiation. We also need to reconsider previous negative stances on the trade pillar of the Indo-Pacific Economic Framework. These measures are necessary if exports want to benefit from the ongoing global pivot out of China. Exports may not react immediately, but these actions tell markets that they are shaping macroeconomic policies to realistically address the new world emerging around us.

Confidence is a key component of any strategy for managing crises. We should articulate a balanced strategy that builds confidence based on progress in macroeconomic balance and reform implementation. It’s important to not just announce it, but actually do it.

Montek Singh Ahluwalia is a former Vice-President of the Planning Commission and currently a Fellow of the Center for Socio-Economic Progress.

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