“We can derive satisfaction from the fact that the Indian economy and the financial sector stand out as strong and resilient in a world of unprecedented headwinds and swift cross currents.” – Shakti Kanta Das, RBI Governor. When there is all-round gloom, there is one bright spot and that is India, clocking good GDP growth.
In the last two years, there were a few significant developments that shaped the economic and monetary policy of Governments/Central Banks across the globe. Pandemic, followed by war and then raging inflation have taken centre stage. Throughout 2022-23, US Federal Reserve had increased Fed funds rate 10 times, from 1.0 per cent to 5.0 per cent. India too followed suit and hiked the repo rate from 4.0 per cent to 6.5 per cent in this period. One fallout of this aggressive rate increase, is the failure of niche banks in the US and Europe in early 2023 posing risks to financial market stability. Concerted and swift policy actions by US Federal Reserve, FDIC and the ECB ensured that any massive contagion was warded off. Risk aversion and outflows of capital from emerging market economies (due to currency depreciation in EMEs and higher interest rates in advanced economies) came to the fore.
Impact on Indian Economy
Amidst strong global headwinds, the Indian economy has performed well, clocking a growth of 7.2 per cent in real GDP in 2022-23. Impetus to the growth momentum was provided by a sustained recovery in discretionary spending, restoration of consumer confidence and the government’s thrust on capex. Agriculture and allied activities were resilient. Manufacturing activity withstood global spillovers, while electricity generation exhibited robust growth and mining recorded steady activity.
Sustained momentum was seen in construction activity, while infrastructure and capital goods production benefitted from the government-led investment in infrastructure. Production of consumer goods, on the other hand remained muted and recovery in sectors such as automobiles was lopsided.
Like many other economies, India also experienced a surge in inflation during 2022-23. As it spiked to 7 per cent in March 2022, sensing that the near-term inflation outlook would deteriorate sharply amidst geopolitical tensions, the Monetary Policy Committee (MPC) changed stance in April 2022 to remain focused on withdrawal of accommodation to ensure that inflation remained within the target going forward, while supporting growth. Cumulatively, the MPC increased the policy repo rate by 250 bps during 2022-23 from 4 per cent to 6.50 per cent. Overall, the surplus liquidity was flushed out – as reflected in net amounts absorbed under the Liquidity Adjustment Facility – moderated from a daily average of Rs 6.6 lakh crore in March 2022 to Rs 0.14 lakh crore in March 2023.
As geopolitical tensions intensified, interest rate hikes by the US Fed turned aggressive and the global growth outlook deteriorated, investors’ sentiments dampened leading to financial markets’ volatile phase in 2022-23. Despite weak global cues amid emergence of financial stability risks, and FII outflows increasing in H2:2022-23, domestic equity markets moving lower in H1 of 2022-23, recovered in early H2 and closed at an all-time high on December 1, 2022, buoyed by robust corporate earnings. Overall, equity markets in India, gained marginally in 2022-23 despite portfolio outflows and forex market pressures, reflecting India’s growth resilience and rising investment in the market by resident entities.
Fiscal scenario
The gross fiscal deficit (GFD) of the centre declined from 6.75 per cent of GDP to 6.45 per cent in 2022-23, reflecting the withdrawal of pandemic-related stimulus, even as targeted fiscal measures were undertaken to shield domestic consumers from high food and energy prices. Capex remained the lynchpin of the government’s spending strategy. Tax revenues remained robust – gross tax revenues exceeded budget estimates by Rs 2.9 lakh crore – underpinned by higher goods and services tax (GST) and direct tax collections.
External sector resilience
India’s merchandise exports touched USD 450.4 billion during 2022- 23, a 6.7 per cent higher than the previous year. India became net exporter in areas such as mobile phones and toys and registered a 10-fold increase in exports of defence goods in a short span, leveraging on policies such as ‘Make in India’ and ‘AatmaNirbhar Bharat’. India’s merchandise imports, after recording high growth in the first half of the year, decelerated during the second half. India’s merchandise trade deficit increased during the year, but the pace of increase slowed in the second half. Strong growth of 27.9 per cent was witnessed in services exports, led by software services.
Net Foreign direct investment (FDI) inflows albeit strong, were lower during 2022-23 at USD 28 billion compared to USD 38.6 billion a year ago. Moreover, there were net portfolio outflows during the year to the tune of USD 5.9 billion, reflecting risk-off sentiments that impacted flows to EMEs as an asset class. The rising cost of borrowing in 2022-23 rendered ECBs less appealing for raising funds. Belying market fears of a possible spike in India’s external vulnerabilities, India’s current account deficit (CAD) at 2.7 per cent of GDP (during April-December 2022) remained sustainable. These developments, with lower net capital inflows, led to a depletion in the foreign exchange reserves; a decline by USD 28.9 billion, including valuation effects, during 2022-23.
Banking and Non-banking developments
The banking system continued the efforts to augment capital and improve asset quality. Fresh lending cycle started in early 2022 gained momentum during 2022-23, resulting in double digit credit growth. Gross NPA and net NPA ratios of scheduled commercial banks (SCBs) declined and the quarterly slippage ratio cooled off. The provisioning coverage ratio also steadily increased. Net interest margin witnessed an improvement, due to higher lending rates. Consequently, Profit after tax, Return on Equity and Return on Assets of SCBs improved further during the year. The strengthening operational ratios, helped banks to bolster their capital adequacy levels and obviated the need for recapitalisation.
Non-banking financial companies (NBFCs) maintained robust credit growth during 2022-23, supported by the broad-based revival in economic activity. The sector augmented its financial soundness during the year through robust capital buffers, improved asset quality and consolidation of balance sheet.
Global Economy: Prospects for 2023-24
Global growth is expected to slow down in 2023 and may remain subdued. As per the IMF global growth for 2023 at 2.8 per cent is likely to be followed by the medium-term growth not crossing 3.0 per cent. Headline inflation is expected to fall from 7.3 per cent to 4.7 per cent in 2023 among AEs, and from 9.8 per cent to 8.6 per cent among emerging market and developing economies. Progress is, however, likely to be gradual amidst sticky and elevated upside pressures. Central banks continue to face a challenging trade-off between restoring price stability and addressing growth slowdown. Potential financial risks can give rise to unanticipated build-up of stress with strong adverse spillovers across the global financial system. Financial markets are signalling the likely end of the global monetary policy tightening cycle. Commodity prices have also softened, as fears of growth slowdown dominate market sentiments. With policy tightening by global central banks having moderated, the US dollar is likely to depreciate, even as the outlook for capital flows to EMEs remains uncertain.
Overall, the prospects for the global economy continue to be shadowed by high inflation, the adverse effects of geo-economic fragmentation operating through restrictions on movements of trade, labour, capital and potential amplification of financial sector vulnerabilities. Medium to long-term challenges such as climate change, cyber security, crypto currencies, FinTech and tech disruptions can also potentially vitiate the outlook.
Domestic Economic outlook for 2023-24
Domestic economic activity faces challenges from an uninspiring global outlook. But resilient macroeconomic and financial conditions, expected dividends from past reforms and new growth opportunities from global geo-economic shifts place India at an advantageous position. Taking into account softer global commodity and food prices, good rabi crop prospects, buoyancy in services, the government’s continued thrust on capex, higher capacity utilisation in manufacturing, double digit credit growth and rising optimism among businesses and consumers, real GDP growth for 2023-24 is projected at 6.5 per cent with risks evenly balanced.
Risks to inflation have moderated with downward corrections in global commodity and food prices and easing of high input cost pressures of last year. The inflation trajectory is expected to move down, with headline inflation edging down to 5.2 per cent from the average level of 6.7 per cent recorded last year. Monetary policy remains focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target of 4 per cent, while supporting growth.
Consumer confidence seems to have improved. Manufacturing firms are exuding positive sentiments on production, order books, employment conditions and capacity utilisation for H2 of 2023-24. Private companies expect the job landscape to improve in Q1:2023-24 despite lower optimism on profit margins and selling prices. Robust balance sheets of corporates and banks, coupled with high capacity utilisation, is expected to aid in strengthening the momentum in private investment. Burgeoning credit growth, especially housing and personal loans, reflects steady domestic household demand. Robust agriculture production buoyed by expectation of a bountiful rabi harvest and resilience in allied sector activity are also brightening the outlook for rural demand. Port cargo traffic and railway freight traffic movements also point to industrial activity picking up amidst gradual easing of input cost pressures.
Higher private investment
Sustained increase in government capex over recent years is expected to spur higher private investment in 2023-24. In the Union Budget 2023-24, budgeted capital expenditure has increased by 37.4 per cent. Union Budget has announced several other measures, which are likely to provide a fillip to the growth momentum such as diversification and promotion of allied sectors; boosting logistics infrastructure for last-mile connectivity; export promotion; strengthening agricultural extension services through digital public infrastructure; and spurring private investment through Agri-Startups. Private investment growth is also expected to strengthen with the production-linked incentive (PLI) scheme.
The outlook for services sector remains positive in 2023-24. Real estate and construction have witnessed a revival post-pandemic and are expected to perform well. In the external sector, the current account deficit (CAD) is expected to remain moderate, drawing strength from robust services exports and the salubrious impact of moderation in commodity prices of imports. With global uncertainties persisting, FPI flows may remain volatile. The favourable domestic growth outlook, lower inflation, and business-friendly policy reforms could, however, help sustain buoyant FDI inflows. As a result, external vulnerability risks may ease further during 2023-24.
While Indian banks and nonbanking financial intermediaries remain sound and resilient, they need to stress test for the new shocks to financial stability in the wake of western bank failures. Capital buffer and liquidity position, therefore, must be constantly reviewed and strengthened.
Projections suggest a weaker outlook for the global economy in 2023 and 2024. Several shocks tested the resilience of the Indian economy in 2022-23. India’s growth momentum is likely to be sustained in 2023-24 in an atmosphere of easing inflationary pressures.
It is important to sustain structural reforms to improve India’s medium-term growth potential. The impact of western recession on our industries, particularly exports of goods and services poses an important risk factor going into 2024. Recession-induced job losses, wage cuts and export contraction can upset urban demand; while the behaviour of monsoon and smaller agricultural output, can play spoil sport to rural demand.
Sustaining the growth momentum achieved in 2022-23 will be a difficult task given the global and geo-political risks. In this backdrop achieving the estimated GDP growth of 6.5 per cent will turn out to be a formidable task. “We must continue to focus on what works for us, address remaining challenges, and deliver on our potential and promises”, as nudged by the Chief Economic Advisor.
Data Source: RBI Annual Report 2022-23
