Indian economy in relatively better position but needs to remain overly cautious in this precarious environment

From Rajani Sinha

The new financial year began with renewed global turbulence. Slowing growth in major economies, still high inflation and tightening financing conditions have made the global landscape volatile, although recent bank failures in the US and EU have increased the risk of financial instability. To make matters worse, the production cut recently announced by OPEC and the resulting rise in global crude oil prices have exacerbated the dangers of inflation.

In the midst of all this global turmoil, India is in a relatively good place. While India’s GDP growth is expected to moderate from an estimated 7% in FY23, it would still be around 6.1% in FY24. CPI inflation is also likely to moderate, helped by the base effect. Corporate and bank balance sheets are in good shape, indicating the economy’s relative resilience to contagion risks. As exports slow, a likely weakening of the current account deficit and ample foreign exchange reserves imply less external sector vulnerability to India. While these data points paint a rosy picture for the Indian economy in FY24, challenges abound and we must remain vigilant.

Consumption, the main pillar of India’s economy, has unilaterally rebounded after the pandemic. While urban demand has been strong, rural demand has lagged behind. While the high-income category has strong pent-up demand for luxury items, the low- and middle-income categories are similarly cautious about spending on consumer items. However, recent data from the RBI Household Survey shows an improvement in household spending on discretionary items. Rural demand is also showing signs of improvement, as shown by improving IIP consumption data for non-durable consumer goods. However, the verdict is still not very clear, as some rural demand indicators such as two-wheeler sales remain weak, while others such as tractor sales show improvement. Looking ahead, it will be crucial to watch for a broad-based recovery in consumer demand.

Inflation in the economy is likely to moderate, which should support a pick-up in consumer demand. However, average CPI inflation for FY24 is forecast at 5.1%, still above the RBI’s target of 4%. Core inflation, which is proving stubborn, is also likely to average above 5.5% in FY24. In addition, given the heightened El Nino risk, there is a risk that global crude oil prices will skyrocket or food inflation will flare up.

Investment, the other major pillar of the Indian economy, has also been somewhat lopsided. The government is looking to use the investment to boost the economy, as reflected in strong budgeted investment growth of 37% for FY24 after already strong investment in FY23. Unfortunately, the private sector has been slow with its investment plans so far. Although manufacturing capacity utilization has increased to around 74 (close to the long-term average), the private sector has been cautious due to the uncertain economic environment and tight financial conditions. The good point is that the announced data for the new investment project (CMIE) shows increasing private sector investment intent. The announced new investment project is up 36% (YoY) in Q4 FY23 with private sector share at a peak of 92%.

The external sector is already feeling the pinch of the economic slowdown as exports slow. Overall, exports of goods are expected to contract by 5% in FY24, against estimated growth of 3.5% in FY23. However, strong export growth in the service sector will cushion the fall in goods exports. The CAD/GDP ratio is likely to weaken to 1.6% in FY24 from an estimated 2.1% in FY23. However, capital inflows would remain volatile amid an uncertain global environment.

In summary, while India is in a relatively better position, it needs to remain overly cautious in this precarious environment. The RBI has also shown caution by not raising interest rates amid looming economic uncertainties. At the same time, we should use our favorable macroeconomic conditions for a broad-based recovery, because only then will growth be sustainable. India should also use its current favorable position to strengthen its position on the global stage. After recovering from the pandemic, the global economy is increasingly embracing diversification/friend-shoring and India must be prepared to seize this opportunity.

(Rajani Sinha is Chief Economist at CareEdge Ratings. Views expressed are those of the author.)