OCTOBER 03, 2022

By TIOL Edit Team

THE Indian economy might slip deep into the woods, if current account deficit, fiscal deficit, inflation and rupee depreciation are not reined in time.

This is the inference one would arrive at after reading all economic documents released by the Reserve Bank of India (RBI) on 30th September 2022. The disclosures were made at the conclusion of a three-day meeting of the Monetary Policy Committee (MPC).

The positivity infused in carefully worded documents can't overshadow dark clouds of uncertainty over the economy. We hope the decision-makers at the Centre spare time to meticulously read the documents and other inputs from different quarters that serve as alarms.

These should help moderate the cacophony about India's ostensibly strong fundamentals. The documents serve as a reminder for Modi Government to avoid complacency over the country's re-emergence as one of the world's fastest growing economies. The rebound is happening after twin shocks - Covid-19 pandemic & related lockdowns and ongoing Russia-Ukraine war (RUW).

RBI sees the West's response to these two shocks as the third shock for India and other emerging economies.

As put by RBI Governor Shaktikanta Das, "We are in the midst of a third major shock - a storm - arising from aggressive monetary policy actions and even more aggressive communication from Advanced Economy (AE) central banks."

He added: "Daunting challenges confront us at this juncture. The underlying fundamentals of our economy and the buffers built over the years have stood us in good stead."

This concern has been articulated by Monetary Policy Report (MPR). It says: "The daunting global environment, however, imparts considerable uncertainty to the outlook."

Pragmatism calls for balancing claims about strong fundamentals with certain major projections that form the basis of MPR. RBI Act stipulates that RBI would publish MPR twice a year to explain the sources of inflation; and forecast inflation for 6-18 months ahead.

MPR September 2022 assumes 0.3% rise in estimated, combined centre-state fiscal deficit (CFD) to 9.3% of GDP in 2022-23 from 9% assumed in MPR April 2022. Professional forecasters on the other hand have assumed CFD of 9.7% in 2022-23. International Monetary Fund (IMF) had projected this at 9.9% in its Fiscal Monitor released in April 2022.

This level of fiscal deficit, financed by marketing borrowings, is inflationary. We urge the Government to not delay further the implementation of new fiscal and debt framework recommended by 15th Finance Commission.

After reviewing prices & costs trend, MPR concludes: "The outlook is, however, fraught with considerable uncertainties, given the highly volatile geopolitical situation, spill overs from the elevated global financial market volatility and recurring adverse climatic conditions. Monetary policy remains focused on ensuring that inflation remains within the target going forward, while supporting growth."

According to MPC's resolution, Consumer Price Index (CPI) inflation rose to 7.0 per cent (y-o-y) in August 2022 from 6.7 per cent in July. It has projected inflation at 6.7% and real GDP growth at 7.0% in 2022-23.

MPC believes that "inflation is likely to be above the upper tolerance level of 6 per cent through the first three quarters of 2022-23, with core inflation remaining high."

It has pitched for "further calibrated monetary policy action," implying sustenance of dear-money policy. It feels that this approach will improve medium-term growth prospects.

According to RBI's 'Households' Inflation Expectations Survey', "Most categories of respondents expect higher inflation for both three months and one year ahead periods."

The survey was conducted during September 1 to 10, 2022 in 19 major cities. The results are based on responses from 6,052 urban households. It is one of the seven customary 'Forward Looking Surveys' released by RBI on 30th September, 2022.

All available indicators thus suggest that the public must bear the brunt of price spiral for several more months. Inflation leads to depreciation of rupee, which in turn, results in imported inflation via rise in cost of imports.

Depreciating Rupee has not increased exports adequately - a fact reflected in rise in trade deficit and current account deficit (CAD). RBI has reckoned CAD for Q1 of 2022-23 at 2.8% of GDP with trade deficit at 8.1% of GDP. Experience shows that the favourable impact of Rupee depreciation on exports is always short-lived.

Reuters last month cited Nomura's note dated Sept. 5, expecting India's CAD to rise to 3.5% of GDP in the current fiscal year from 1.2% last year. It had previously forecast the share to be 3.3% of GDP.

Similarly, ICRA expects the CAD to touch a record-high of US5-110 billion in FY2023 (3.1% of GDP), exceeding 3.0% of GDP for the first time since FY2013.

A RBI Working Paper, published in August 2012, concluded that CAD between 2.4 to 2.8 per cent of GDP is sustainable over the medium term. This is based on the assumption that GDP growth ranges between 6.0 and 8.0%, inflation hovering around 5.0% level and interest rate and size of capital flows broadly following their trends in the recent past.

Rise in CAD increases demand for hard currencies especially US dollars, thereby resulting in depreciation of rupee. It has already depreciated 7.4% against US$ up to 28 September in 2022-23. The nexus between CAD, Rupee exchange rate and forex reserves with RBI requires vigilance and effective interventions.

As wisely put by Mr. Das, "A stable exchange rate is a beacon of financial and overall macroeconomic stability and market confidence."

This calls for more synergetic and timely action on monetary and fiscal fronts including expenditure efficiency across all three tiers of governance.