Risks to GDP Growth

Context: Recently, the World Bank cut its FY23 (2022-23) gross domestic product (GDP) growth forecast for India from 7.5 per cent to 6.5 per cent.

• It was largely due to a deteriorating global scenario. Rising interest rates and slowing external demand will dampen growth over the foreseeable But, even at 6.5 per cent, India will still be a global growth out-performer this year.

Comparison between India’s GDP growth with major economies of world:

• An examination of the GDP growth data for India and advanced countries over the past two decades leads to two conclusions
  • One, India’s growth cycles are in sync with those of the advanced economies. It implies that India cannot avoid the short-term pain of deceleration in the developed countries. Increasing global interconnectivity only accentuates this effect.
  • Two, the long-term trend rate of GDP growth of advanced economies and India is divergent.
  • For India, it has moved up over time, while for advanced economies it is the other way.
• So, when assessing India’s growth prospects for this year and next year, it’s important to keep the first conclusion in mind — though, in addition, domestic inflation dynamics and financial conditions will also influence growth outcomes.
• On the other hand, the long-term trend rate of growth will be influenced by many factors including efficiency-enhancing reforms.

Collective global events and economic situation impacting the growth:

• A complex interplay of geopolitical events, worryingly high inflation and sharp rate hikes has turned the global environment gloomier — more so for calendar 2023 than 2022
• As economies moved past the pandemic in early 2022, geopolitical risks emerged and have only escalated since then.
• S&P Global has recently marked down global growth to 3.1 per cent and 2.4 per cent for 2022 and 2023 respectively.
• The key contributors to this are the US and Eurozone which are expected to grow at an anaemic 0.2-0.3 per cent in 2023, while China is seen growing 2.7 per cent.
• A slowing world will hurt India via falling exports. Worse, it may not commensurately bring down prices of crude oil and commodities.

Rising or constant price of crude oil:

• Typically, global slowdowns soften crude and commodity prices, which eases the burden on India’s imports.
• However, this time around, the ongoing geopolitical stress is likely to limit the decline in their prices. OPEC’s recent move to cut oil output is an example of how geopolitics is shaping oil prices.
• From the beginning of this fiscal, geopolitical developments have had an outsized impact on India’s inflation, particularly the wholesale price inflation, which continues to be in double digits and spills over to consumer prices.
• he Russia-Ukraine dust-up has lifted crude oil and commodity prices and has created volatility for several agricultural commodities. Exporter nations have then imposed trade restrictions. While commodity prices have come off from their highs, volatility and uncertainty about their price trajectory continue.

Inflation around the world:

• The four-decade high inflation is forcing systemically important central banks such as the Fed and European Central Bank (ECB) to raise interest rates faster and by bigger magnitudes than anticipated earlier.
• With each 75 basis points hike, the Fed has turned more aggressive on its terminal rate forward guidance. Such hikes in the US have raised the spectre of currency depreciation and imported inflation for India.
• Although the rupee’s depreciation had been quite orderly so far thanks to the Reserve Bank of India’s deft interventions, the downward pressure has intensified again with the rupee breaching 82/$ last week.
• A weaker rupee will only make imports expensive. And though global food prices have climbed down, domestic food inflation is moving up.

Slowing global growth impacts on India’s export:

• Slowing global growth has an immediate impact on India’s exports, which have already started contracting.
• A 1 per cent decline in global GDP is associated with a 2.3 per cent reduction in exports. But every 1 per cent depreciation in the real effective exchange rate leads to a 1 per cent increase in exports.
• Thus, the impact of a slowing global economy on exports will overshadow the mild positive impulse from the rupee depreciating. The World Trade Organisation has already lowered global trade volume growth forecasts.

Slow export growth in Consumption-linked sectors and its impact on domestic currency:

• Consumption-linked sectors such as textiles (readymade garments and home furnishings) and leather are already facing lower export orders.
• Engineering and electronics goods are also getting hit. But since the domestic growth momentum remains strong, imports are sticky and continue to grow.
• During April-September this year, while exports have grown by 15.5 per cent, imports grew by 37.8 per cent. This is widening the trade deficit and consequently the current account deficit (CAD).
• A rising CAD requires more capital flows to finance it. The availability of this in the current risk-off scenario would be a challenge. Thus, the rupee is likely to remain volatile with a depreciation bias in the near term.

Weaking of Covid-19; is a good news for economy:

• On the domestic front, the good news is that Covid-19 has stopped causing functional disruption in the economy and activity indicators remain strong in the first half of the fiscal.
• Contact-intensive services are recovering at a fast pace aided by a weak base. It has positive outcomes such as
  • The Purchasing Manager’s Index for services and manufacturing remain in the expansion zone.
  • Bank credit growth is picking up and central government investments are broadly on track.
  • Large and mid-sized corporates enjoy healthy financial profiles and the banking sector is well-capitalised.
• Capacity utilisation in the manufacturing sector has improved as per the RBI’s surveys. This primes up the corporate sector for undertaking investments, but lingering uncertainty will hold them back.

Way Forward:

• Given so many moving parts and geopolitical complexity, policymakers and market participants have an unenviable task of anticipating turnarounds, and the speed of recovery or downturn.
• Typically, growth forecasts are heavily influenced by the prevailing macro environment such as Rising interest rates and slowing external demand which hampers the growth in the foreseeable future.
• These risks will be more pronounced in the second half of this fiscal FY23 (2022-23) and could intensify next fiscal (when the peak impact of rate hikes and the global slowdown will be felt).
• Therefore, forecasts at this juncture will have a short shelf life and a wider confidence interval (the range of values in which an estimate is expected to fall). This has been amply demonstrated by the slew of revisions in the past few months around the world.

Source:  Indian Express

Previous Year Question

Q.1) With reference to the Indian economy, demand-pull inflation can be caused/increased by which of the following? (2021)

1. Expansionary policies
2. Fiscal stimulus
3. Inflation-indexing wages
4. Higher purchasing power
5. Rising interest rates

Select the correct answer using the code given below.

1. 1, 2 and 4 only
2. 3, 4 and 5 only
3. 1, 2, 3 and 5 only
4. 1, 2, 3, 4 and 5

Q.2) Which among the following steps is most likely to be taken at the time of an economic recession?  (2021)

1. Cut in tax rates accompanied by increase in interest rate
2. Increase in expenditure on public projects
3. Increase in tax rates accompanied by reduction of interest rate
4. Reduction of expenditure on public projects