Rational expectations: Downside risks to growth are increasing

The economy's resilience will be tested in the second half of the year and beyond

At a time when growth forecasts are being revised downwards in most parts of the world, the Union government seems confident about India’s prospects. The latest monthly report by the Ministry of Finance, for instance, argued that while slowing growth and higher inflation are affecting major economies, growth in India has been robust and inflation is under control. Further, in an interview with this newspaper, Chief Economic Advisor V Anantha Nageswaran noted the government is of the view that India will grow between 7.2 and 7.4 per cent in the current fiscal year. He further added that, on balance, the global slowdown would be good for India as it will lower the energy import bill and also influence monetary policy in advanced economies. While it is reasonable to expect the government to project an optimistic picture, hopefully, it recognises the challenges that the Indian economy will face in the near to medium term.

The real gross domestic product growth at 13.5 per cent in the first quarter of the current fiscal year was significantly lower than the Reserve Bank of India’s (RBI’s) projection of 16.2 per cent. Thus, even if growth in the rest of the year remains on expected lines, the full-year number would be lower than the RBI’s projected rate of 7.2 per cent. The central bank is widely expected to revise its growth forecast later this month. Meanwhile, the Asian Development Bank on Wednesday revised its growth forecast for the year to 7 per cent from 7.2 per cent. The full-year number looks relatively better because of higher growth in the first quarter on a weaker base. Growth in the second half of the fiscal year is expected to slip to about 4 per cent. Further, while it is being argued that inflation is under control, the rate has been above the RBI’s tolerance band for eight months. According to the law, an inflation rate above the tolerance band for three consecutive quarters would be deemed as a failure to attain the target.

Although it appears that the government is willing to tolerate higher inflation, the central bank will need to move forward with monetary tightening. Continued tightening, which is necessary at this stage, will also affect growth. Besides, the global environment is likely to worsen. According to a new study by the World Bank, the global economy might slip into a recession in 2023 because of interest rate hikes by central banks, which can lead to financial crises in emerging markets. A slowing global economy and tightening financial conditions will increase risks. At the time of going to press, the US Federal Reserve was expected to further increase interest rates. As the inflation rate in advanced economies, including the US, remains way above the target, interest rates may remain at higher levels for some time.

The combination of weaker global growth and tighter financial conditions would negatively affect both current and capital accounts, demanding careful macroeconomic management. It is also worth noting that growth is being supported by a very high level of general government budget deficit, which needs to be brought down in a reasonable time frame. Therefore, while it is likely that India will end the current fiscal year with a respectable number, largely because of the first quarter, its actual resilience will be tested in the second half of the year and beyond.