OECD Economic Outlook, Volume 2022 Issue 1

India

After recording the strongest GDP rebound in the G20 in 2021, the Indian economy is progressively losing momentum as inflationary expectations remain elevated due to rising global energy and food prices, monetary policy normalises and global conditions deteriorate. Real GDP is projected to grow by 6.9% in fiscal year (FY) 2022-23 and 6.2% in FY 2023-24, despite a pick-up of corporate investment facilitated by the Production-Linked Incentive (PLI) Scheme. While inflation will gradually decline, the current account deficit will widen due to the surge in energy import costs.

The Reserve Bank of India (RBI) began monetary policy tightening in May, intending to anchor inflation expectations and limit second-round effects. Given the financial and social costs of high inflation, the RBI should gradually move towards a more neutral monetary stance. The government should counter signs of a rapid deterioration in living standards with income support for vulnerable households. Risks include the appearance of a new COVID variant, failure to tame inflation, a reversal of capital flows to emerging markets, and a significant widening of the current account deficit.

Improved sanitary conditions underpinned a strong recovery, which is now slowing

The waning scale of the COVID-19 shock, the elimination of containment measures, the ability of exporters to take advantage of favourable external conditions, and government support to vulnerable households combined to produce remarkably high GDP growth in FY 2021-22. Merchandise exports rose to a record level, exceeding official government targets and validating India’s strategy of managed liberalisation through preferential trade agreements with major partners. However, consumption growth has slowed, with sales of two-wheelers falling to a 10-year minimum, subdued private sector credit growth, and contracting employment, although companies report difficulties in filling vacancies. Consumer price inflation forenergy‑related items and edible oils started trending up even before the Ukraine war and has accelerated afterwards. Inflation has also risen and become wide-ranging: almost 75% of the CPI sub-components exceed the 4% inflation target. Despite uncertainty, reflected in the higher yield on 10-year government bonds, equity markets have been boosted by the initial public offer (IPO) of state-owned Life Insurance Corp., India’s largest ever IPO. Meanwhile, the import coverage of foreign exchange reserves, which exceeded 18 months in March 2021, declined to 12 months in March 2022.

India: Trade and fiscal indicators

1. The first bar for each year represents revenue and capital receipts excluding borrowings and other liabilities. The second bar for each year represents total expenditure excluding interest payments and grants in aid for creation of capital assets. 2019 refers to the average of data over the fiscal year 2017-18, 2018-19 and 2019-20. Other years are fiscal years ending on 31 March of the following calendar year.

Source: OECD Economic Outlook 111 database; Ministry of Finance; Budget Union; Reserve Bank of India; and Ministry of Commerce and Industry.

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India: Demand, output and prices

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India: Fiscal and inflation indicators

1. The unweighted average of general government debt ratio for similarly-rated countries (Bulgaria, Costa Rica, Indonesia, Hungary, Kazakhstan, Mexico, Malaysia, Peru, the Philippines, Romania, Thailand and Uruguay).

2. Headline inflation refers to the change in price of all goods in the basket. Seasonally adjusted and based on the monthly consumer price index and core CPI (index 2012 = 100) provided by the Central Statistics Office.

Source: IMF World Economic Outlook; and CEIC.

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The direct impact of the war in Ukraine is relatively limited, as trade between India and both Russia and Ukraine is small. Russia accounts for less than 1% of India’s crude oil consumption in 2015-21 and 1% of 2020 coal consumption. Nonetheless, for selected industries, notably pharmaceuticals and weapons, Russia is an important destination and source, respectively. The indirect impact, through global commodity and energy market shifts, is much larger. In the 2015-21 period, India imported 88% of its annual consumption of oil and 29% for coal in 2020. It is also the world’s largest nitrogen fertiliser importer, with Ukraine and Russia accounting for 9% of imports. These forces, together with the lockdowns in China and the EU embargo, are contributing to high inflation, although pressures may subside in coming months. Potential opportunities for Indian grain exporters to take the place of Ukrainian suppliers in third markets, in particular for wheat, have been prevented, at least temporarily, by the export-restrictive measures introduced in May.

Monetary policy is becoming less supportive

Facing increasing inflationary pressures, the RBI signalled its shift from an accommodative to a neutral stance in May, with an off-cycle increase of the repo rate by 40 basis points. The cash reserve ratio was also raised to drain liquidity from the inter-bank market. The policy rate is projected to rise to 5.3% by the end of 2022 and remain there in 2023. With food and energy accounting for 53% of the consumer price index basket, measures have also been taken to contain domestically-generated inflation, such as cutting central excise duties on petrol and diesel and import duties on edible oils and coal, as well as restricting exports of selected agricultural produces. Such interventions should be supplemented by policy actions to reduce excess margins in high-concentration and/or low-competition sectors.

The central government financial deficit will decline, despite an increase in capital expenditure, in the expectation that private investment will be crowded in. The strategic emphasis is on improving logistics, with challenges due to execution capabilities. Railways and roads will also receive a considerable boost through 50-year interest-free loans (Scheme of Financial Assistance to States for Capital Investment). Income support to vulnerable groups is set to remain contained, with fewer funds allocated to the National Rural Employment Guarantee scheme (MGNREGA) and housing spending unchanged. A growing gender gap in terms of labour participation and employment, as well as time spent on household chores, is a cause of concern, as it affects social mobility and poverty reduction. Welfare spending ought to be prioritised in the budget allocation process, and resources can be found by reducing non-targeted subsidies.

Growth will moderate in 2022 and 2023

Monetary policy normalisation and weaker external demand will weigh on GDP growth in FY 2022-23 and FY 2023-24, though strong government spending will continue to support activity. An ambitious set of measures to simplify the business environment, create a ‘bad bank’ (National Asset Reconstruction Company) tasked with cleaning up balance sheets, and improve logistics is expected to mitigate the impact of higher credit costs on private investment. However, households maintain cautious views regarding short- and medium-term prospects, amid signs of labour market softening, deteriorating purchasing power and flattening real incomes.

Major risks continue to surround the outlook. The COVID-19 pandemic may not subside as fast and broadly as expected and the booster vaccine campaign may stall at far from universal coverage levels. A significant deterioration in investors’ risk appetite for emerging economy assets may ignite a negative feedback loop between the financial sector and real economy, which in turn may weaken banks’ capital positions. Private business, including large enterprises and business groups that were largely immune from the worst consequences of the COVID-19 crisis, may revisit investment plans if interest rates keep increasing. Rising food inflation is an upside risk to the overall inflation outlook, as it may lead to more food protectionism and prompt retaliatory measures. Failure to contain the increase in the cost of living may also exacerbate food security risks, especially among children, and further aggravate the social costs of school closures during the pandemic.

Energy transformations are needed on a scale no country has achieved in history

India is set to see the largest increase in energy demand of any country over next 20 years. The combination of a growing and industrialising economy and an expanding and increasingly urban population will drive energy use higher, raising the question of how best to meet the swelling demand without exacerbating issues like costly energy imports, air pollution and greenhouse gas emissions. Climate action was framed as one of the pillars of the budget, including plans for low-carbon and climate-resilient development. Based on India’s current policy settings, nearly 60% of its CO₂ emissions in the late 2030s will be coming from infrastructure and machines that do not exist today. This represents a huge opportunity for policies to steer India onto a more secure and sustainable energy path and requires efforts to electrify processes, enhance material and energy efficiency, use carbon capture technologies, and switch to lower‑carbon fuels. Continued reliance on imported fuels – which the International Energy Agency expects to rise above 90% by 2040, up from 75% today – creates vulnerabilities to price cycles and volatility, as well as possible disruptions to supply. Reinforcing energy security in the electricity sector requires significant increases in system flexibility, improvements to the financial health of many distribution companies, and further efforts to develop renewable energy and storage capacities.