19 Jan 2023
A multitude of headwinds continue to make global growth prospects gloomier. These include rising interest rates, geopolitical tensions, which are keeping international commodity prices elevated, broader European energy insecurity, and lingering effects of Covid-19 (particularly in China).
As advanced-economy central banks raise rates aggressively to tame inflation, they will find it hard to stave off a sharp downturn in economic activity. In fact, the latest survey-based indicators (purchasing managers’ indices), which gauge the momentum of economic activity in the manufacturing and services space, have turned into the contractionary zone in most advanced economies and some emerging market economies.
S&P Global recently lowered its 2022 global growth forecast by 20 basis points (bps) to 3.1 per cent and 2023 forecast by a greater 110 bps to 2.4 per cent. Global growth faces increased headwinds next year, evincing that monetary policy actions work with a lag. To be sure, this year, growth in many parts of the world (barring China) received support from pent-up demand as Covid-related restrictions were eased after almost two years.
Growth in advanced economies is expected to decelerate more than that in emerging market economies. Many of the latter are benefiting from higher commodity prices and have seen a lower surge in inflation, thereby requiring a less stringent monetary policy response.
S&P Global projects US and Eurozone economies to grow a mere 0.2 per cent and 0.3 per cent, respectively, next year, in the base case. In the downside scenario, where high inflation persists and the US Federal Reserve (Fed) is forced to tighten the monetary policy more aggressively (rates hiked to at least 5.00-5.25 per cent by mid-2023, and remain higher for longer), the US economy could contract 0.3 per cent next year. Meanwhile, Eurozone, in the downside scenario, would see high prices and rationing of energy, and the European Central Bank would follow the US Fed because of the depreciation of the euro versus the US dollar, fuelling imported inflation. The Eurozone’s gross domestic product (GDP) would then contract 1.3 per cent next year.
The slowdown in the global economy, especially in the advanced world, poses downside risks to India’s growth outlook. Our analysis of the long-term growth movements posits that despite being on divergent paths, India’s growth cycles have been remarkably synchronised with those of advanced economies since the 2000s. Put another way, there is no escaping the short-term demand fluctuations around the trend. This reflects India’s greater inter-linkage with the world, both via trade and financial channels. For instance, India’s export-to-GDP ratio almost doubled from 11.4 per cent in fiscal 2000 to 21.4 per cent in fiscal 2022. The share of foreign portfolio investment (FPI) flows in GDP grew almost sixfold, from 2.2 per cent to 12.3 per cent. Greater inter-linkages imply any change in demand and policies in advanced countries would spill over to India and other emerging countries. The domestic economy has already started feeling the brunt of global headwinds, both in the real and financial economies. India’s core (non-oil, non-gold) exports contracted an average 7.8 per cent on-year in the last three months, with the decline in October being as high as 16.9 per cent. To be sure, advanced economies account for ~45 per cent of India’s merchandise exports. The US and European Union, which together account for 72 per cent of advanced economies’ GDP, are the two largest export destinations, with 18.0 per cent and 15.4 per cent share, respectively. With both these economies projected to slow down sharply next year, India’s exports are likely to remain under
pressure. On the other hand, given India’s healthy growth momentum, imports continue to be buoyant, which means net trade is going to remain a drag on growth.
Systemically important advanced-economy central banks, led by the US Fed, are hiking interest rates to slow down the demand impulse in their economies to tame inflation. Most recently, in November, the US Fed hiked the policy rate by 75 bps for the fourth straight time, to 3.75-4.00 per cent. A higher interest rate, buttressed with demand for safe-haven assets amidst the ongoing geopolitical turmoil, has led to massive appreciation of the US dollar. The US dollar index, which measures the strength of the US dollar, rose 10.8 per cent between January and October, indicating depreciation of currencies against the greenback. Rupee, for instance, depreciated from 74.4/US dollar to 82.3/US dollar. That said, it has appreciated to ~81/US dollar in the last few days. This is important because exchange rate movement (along with other factors such as growth outlook and risk perception) plays an important role in driving FPI flows. No wonder, with some appreciation in the rupee lately, FPIs have once again turned net buyers in Indian capital markets — they net bought US$3.2 billion in the first half of November — after being net sellers in September and October, withdrawing an average US$0.4 billion. The bottom line is that foreign flows are expected to remain volatile in the near term.
Imported inflation is another fallout of rupee depreciation. Elevated commodity prices and a depreciating currency act like a double-edged sword and remain a challenge at a time when the central bank is trying to bring inflation back to its target range.
While there has been some softening in international commodity prices recently, it is not in line with slowing global growth prospects thanks to geopolitical issues. For instance, after the OPEC+ decided to reduce oil supply, crude oil prices started moving northward again. To be sure, though international commodity prices are expected to fall next year, they would remain above the pre-pandemic 5-year average.
The Indian economy’s several structural strengths will help cushion the blow from the external headwinds. The domestic financial sector and corporate balance sheets are robust. Corporates have been deleveraging: the median gearing ratio (a measure of indebtedness) of the CRISIL Ratings portfolio is expected to touch a decadal low of less than 0.5 this fiscal. Hence, strong balance sheets are expected to shield India Inc amidst global uncertainties. Banks remain well capitalised, and CRISIL expects gross non-performing assets (GNPA) of the banking sector to improve 90 bps to 5 per cent this fiscal, thanks to post-pandemic recovery and higher credit growth. For non-banks, too, GNPA is expected to improve 50 bps to 3 per cent. This bodes well for the financial sector’s ability to support economic growth.
The government’s tax collections remain healthy and provide legroom for capital expenditure despite higher outgo on subsidies and revenue loss due to tax and import duty cuts on fuels and select imported items. For instance, the central government has already received 52 per cent — or Rs 10 lakh crore — of this fiscal’s budgeted net tax revenue of Rs 19.3 lakh crore in the first half. Most of this is on account of higher inflows through the Goods and Services Tax, income tax and corporate tax.
The government’s focus on capital spending, coupled with its plan to lower the fiscal deficit only gradually, should continue to support investment and consumption demand in the economy. These factors will help soften the blow from global headwinds to some extent, but they cannot completely insulate India. The impact will be more pronounced next fiscal, when the peak impact of the global slowdown and rate hikes materialises. That said, India will remain a growth outperformer this and next year.
The article was contributed by Mr Dharmakirti Joshi, Member, CII Economic Affairs Council & Chief Economist, CRISIL and Mr Adhish Verma, Senior Economist, CRISIL.
The article was first published in CII ARTHA, Quarterly Journal of Economics.