The heightened political tension during the last two weeks has affected some important developments on the economic front.
The most important of these is inflation. During 2020-21 and 2021-22, the headline consumer price index (CPI) inflation rate remained well above the Reserve Bank of India (RBI) target of 4% and often above the 6% upper limit of the tolerance band. , Core inflation (excluding food and fuel) remained above or near 6%. Non-food inflation was even higher, sometimes exceeding 7%. The GDP deflator for 2021-22 was in double digits. The Wholesale Price Index (WPI) inflation rate was also in double digits throughout 2021-22 and has risen to over 15% in April and May 2022.
Despite these multiple indicators, and despite its single formal order to ensure low inflation at 4% (+/- 2%), the RBI maintained that high inflation was transient and should spur growth, maintain low policy rates and high liquidity. Continuing to focus on keeping. It is understandable that in exceptional circumstances, such as a sharp drop in economic activity due to the COVID pandemic, the RBI has had to temporarily withdraw from its mandate to contain the economic contraction, and this has made a significant difference to the economic impact of 2020-21. way done. But it still needs to get back on its inflation mandate as quickly as possible, leaving it to the government to focus on growth.
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Several economists, including this columnist, have emphasized this on several occasions (see Mint, 17 December 2021). However, the RBI continued to prioritize growth until CPI inflation exceeded 7% in April and again in May. It then suddenly changed its stance and announced an increase of 40 basis points in the off-cycle repo rate in May, followed by a hike of 50 basis points on June 8. The rate of the fixed deposit facility, which has effectively replaced the reverse repo rate, has also been increased, while the cash reserve ratio has been raised by 50 basis points to 4.5% to absorb excess liquidity. The central bank’s change in policy stance and its prompt measures to rein in inflation are welcome, but the RBI has projected that inflation for the financial year 2022-23 will still remain above its tolerance band at 6.7%.
What are the prospects of India doing better on the inflation front? It is not clear how quickly Ukraine will improve the war situation and ease global supply constraints. But monetary policy is being tightened significantly in the US and other advanced countries. Therefore, on balance, the external pressures driving Indian inflation are likely to weaken in the coming months. On the domestic front, assuming a normal monsoon, no new supply side disruptions or duty hike on fuel is expected to add to inflationary pressures. For its part, the RBI is likely to again raise the policy rate and take further measures to infuse liquidity. Therefore, inflation may actually be below 6%, although the 4% target seems out of reach.
What about development? After an unprecedented 6.6% contraction in 2020-21, due to the pandemic, growth returned to 8.9% in 2021-22. on gross domestic product (GDP) surpassed its previous peak of 148 trillion 145 trillion in 2019-20. But how is GDP likely to grow going forward? Based on the high frequency data available at that time, our forecast model was indicating in November that GDP would grow by only 5.2% in 2022-23. As the data was updated, our growth forecast was progressively revised upward to 7.5%, while other early forecasts of growth of more than 8% were revised downwards. The views have now converged that GDP will grow at a rate of around 7%-7.5% in 2022-23. RBI has retained the growth forecast at 7.2 per cent.
real GDP 158 trillion in 2022-23 will still be far less than The trend increase of 176 trillion would have been generated without a pandemic (see chart). However, the growth rate of over 7% is higher than the pre-pandemic growth of 3.7% in 2019-20 and the trend growth of 6.6% achieved during the 5 years before the pandemic. Will such a high growth be sustainable? We are probably on the cusp of a new private investment cycle. Corporates used their surplus during the last two years to reduce debt instead of investing in creating new capacity. Therefore, the corporate sector is now less leveraged, while rising capacity utilization is indicating that it is time to invest in new capacity. The investment rate has started rising accordingly and today it is more than 33% which was in 2019-20.
This new investment cycle can be driven by the Production Linked Investment Scheme, which has proved to be very popular and can be expanded. Another important development that could boost investment significantly in the medium term is the US-led Indo-Pacific Economic Framework (IPEF) which was launched in May, with India as one of its 13 founding members. . An open regional formation in which other countries can join, the IPEF is not a traditional free trade agreement. But business is one of its four main pillars, along with supply chain resilience, clean energy and decarbonization infrastructure and tax and anti-corruption. The details are yet to be worked out, but this is potentially a new opportunity for Indian producers to embed themselves in regional and global supply chains, an opportunity that was missed by staying out of the Regional Comprehensive Economic Partnership. If IPEF starts and India can negotiate quickly and successfully using domain experts, not only using bureaucrats to secure its national interests, it could be a game changer for India, thereby making exports and enable higher growth led by investment.
Sudipto Mundele is the President of the Center for Development Studies.