Global environment affecting manufacturing, inflation has peaked

The week has seen a deluge of numbers – from GDP to GST collections and PMI to auto sales. CRISIL chief economist Dharmakirti Joshi tells TOI’s Sidhartha what they mean for the India economy in times of inflation and a tad slow GDP growth. Excerpts … Q: Let’s discuss the recent numbers -- whether it is GDP, GST collections, auto sales or PMI. Everything suggests that the Indian economy is holding up so far. A: The economy was in pretty good shape in the second quarter. Although GDP growth slowed down to 6.3%, it was largely because of the base effect. We are seeing a strong rebound in contact intensive sectors and the agriculture sector has been a saviour all through the pandemic. Despite weather related disturbances, the sector performed pretty well. One area of concern is the manufacturing sector, where GDP decreased by almost 4%. Manufacturing is also getting impacted by the global environment and exports have begun to slow down. So that remains a point of concern. But overall, from the demand and investment side, I think the growth has become more balanced because the pandemic is now behind us. Apart from that, the corporate sector enjoys healthy balance sheets. The banking sector is in a position to lubricate the economy because the NPA levels are low, they are well capitalised. That’s why you’re seeing such healthy growth in credit. And in the third quarter also from a growth perspective, the number may look smaller again because of the base effect. But in the third and fourth quarters too, the overall momentum will be enough to give us 7% GDP growth in this fiscal year. Q: You touched upon exports. Given the global outlook, where do you see exports going and what does the current global uncertainty mean for the Indian economy? A: Global growth is slowing and the slowdown is largely coming from advanced countries. If you were to correlate India’s GDP growth to advanced countries, we find that our growth cycles are well synchronised because our linkages with the world economy have increased. What it means is that in the short run, if there is pain in advanced countries that will also transmit to us. For example, I think the advanced countries which are expected to slow down sharply account for 45% of India’s merchandise exports, and within that US and Euro zone are almost 33%. So clearly, a flat growth there next year will mean that the pain transmits to us as well. We are already seeing exports registering very low negative growth rather in the month of October and I think the journey here from here on will be similar in nature where the external sector will remain a drag for the economy. In the coming quarters, the resilience of domestic demand will be tested in this environment. Q: Now the government and the industry want exports to be a driver of growth and given that there is a slowdown in global demand, what can be the solution to boost exports because diversification of markets doesn't happen overnight. Do you see the FDAs … we signed one with the UAE and the one with Australia is getting implemented this month. Do you see the FDAs playing a bigger role in helping our exports grow faster? A: Over the medium run, yes. They cannot cushion against the downturn in advanced countries in the short run. So as I said the growth cycles are fairly synchronised. These will come into play over the medium run. The fact that there is now diversification of supply chains in general, this will also benefit us to some extent. I think some production facilities will come to us and we will use them as platforms for exports. But from a very short run point of view, there could be pain points particularly from the export side and government can try to push through the fiscal measures to some extent. But I think you can't offset the tide. I mean the slowing of the West. Q: The other big challenge has been inflation, not just for India, where it is comparatively lower than some of the advanced economies. How do you see inflation playing out in the third and the fourth quarters, the December quarter, and the March quarter? And what is your overall sense for the full year? A: Our forecast for the full year is 6.8%. We do believe that inflation has reached its peak, but it is still perched above RBI’s tolerance limit of 6%. So, in the October to December quarter, which is the third quarter of this fiscal, we see inflation at 6.7. And in the last quarter, we see inflation coming down to 5.9%. So, inflation is coming down, but it is still above where RBI would like it to be. Now there are three drivers of inflation, so you need to look at each of them. One is food. On the food side, there is some encouraging sign because the winter crop is expected to be good as the swing is progressing well. Soil moisture is good and on top of that reservoir levels are also in good shape. All that should help Rabi crop production provided there is no weather impact. Also, crude prices have come down due to climate related factors. But, geopolitics can be messy and hence it remains a risk. So, in the base case, we do expect food and fuel inflation to come down next in the second half and also next year. Core inflation is an area that the central bank is most concerned about and they believe that the pressure on core inflation can keep the overall headline inflation higher. There are two things happening here. One, the input price pressure is there, companies are not in a position to pass on the recent reduction in input cost to end consumers, because from a level perspective, the input costs are still very high. To cushion their margins. they might pass on the higher input cost to the end consumer. The second factor is service inflation. It’s in good shape and services demand rising also means that the prices in the services sector rise and that is also putting pressure on core inflation. When the central bank talked about inflation, it did talk about it coming down. But, it also said that there are a lot of uncertainties to the trajectory. Our expectation is 6.8% this fiscal year, coming down to 5% in the next. 5% is also above where the central bank would like it to be. Q: Given this background, how do you see RBI taking its next steps and where do you see the Monetary Policy Committee (MPC) moving? A: The December rate hike of 35 basis points was essentially to break the persistence of core inflation because RBI cannot influence the prices of fuel or for food. We expect that the central bank would be in an observant position. Right now, they will observe the impact of the previous rate hikes on the economy. They will also see how it is impacting inflation. But we cannot rule out another 25 basis points hike in the next policy. After that the central bank will get into a pause mode because the Western central banks may still be raising rates. But, since inflation is not comparatively less of a problem in India than it is there, the rate hikes there will be much more aggressive than here. So I would say that 6.5 is where the interest rates could peak in this cycle. Q: This one is related to the supplementary demand for grants which were tabled in Parliament. There is an additional spending, largely on account of subsidies for food, fertiliser as well as fuel, and there's an additional cash outflow of about Rs 3.25 lakh crore. How do you see the fiscal situation playing out and do you see the Centre meeting the deficit target for the current financial year? A: What has happened this year is that immediately after the budget was announced, we saw all the assumptions go alright. I think there was the Russia-Ukraine, conflict, inflation went up more than was expected. So, two things happened. One, the subsidy bill got bloated and they have asked for more supplementary grants. Also what happened with the rise in inflation was that the nominal GDP growth, which is a base for tax collections, also went up. The budget had talked about 11.1% growth in nominal GDP. It could well be 15%. So, your fiscal deficit to GDP, the base, which is GDP, has increased. On top of that because nominal GDP growth has been higher. The tax collections are quite strong. So they have, in a way, offset some of the extra spending that was needed for the subsidy bill and the government did not have to compromise on the overall capital spending.The mix of developments has ensured that the fiscal deficit would be closer to the target of 6.4% this fiscal year, and I think the borrowings that the government has announced are on target as far as the overall borrowings for this fiscal year is concerned. I don't see much of a chance of slippage this year.Audio production: Prateek Kapoor