The Reserve Bank of India (RBI) has been caught between a rock and a hard place, trying to support growth in the face of shrinking fiscal space and an external situation that is worsening by the day. There is also no respite from the domestic market, since with the general election approaching pre-poll announcements of freebies is gaining momentum across states.
In a panel discussion post the release of the IMF’s Regional Economic Outlook for Asia at the National Stock Exchange, Sajjid Chinoy, Managing Director and Chief India Economist at JP Morgan, said, “Fiscal policy is forced to tighten given the growing debt and the debt sustainability issues.”
For example, India has set a glide path to reduce the fiscal deficit to 4.5 per cent of GDP by 2025-26. In the post-pandemic period, the deficit expanded to 9.1 per cent in the first Covid-19 year. The huge government capex was possible because of the higher fiscal deficit.
Madan Sabnavis, Chief Economist at Bank of Baroda, said private investments have not picked up. “We need consumption to revive,” Sabnavis said. He explained that the government is spending around Rs 10 lakh crore on capex, which is not comparable to the size of the private investments that is needed. “Government capex cannot move the needle in a big way. We need private investments to come back,” he said.
“It is hard to expect people to invest, given the state of the global economy. Uncertainty is at multi-year highs, and interest rates are also elevated. It’s not a good environment. We will have to wait for a few quarters,” believed Chinoy.
“There is unevenness in consumption patterns. We are seeing a contraction in rural consumption, especially two-wheelers like scooters, mopeds, motorcycles, etc. The OEMs have scaled back production because of a lack of demand. Consumption growth has picked up only for ultra-rich people,” said Rupa Rege-Nitsure, Group Chief Economist of L&T Financial Services.
She listed rising crude oil prices, a high dollar index, and a narrowing of the interest rate differential between the US and India as big hurdles for Indian policymakers. There is already an outflow of FII money in the stock market. “More than anything, the exchange rate will be a decisive factor. The exchange rate will have more influence on the policy,” suggests Nitsure.
Due to worries about financial stability or the potential for imported inflation, policymakers in emerging markets have made a conscious effort to limit the extent of currency depreciation. The interest rate differential between the US and emerging markets has narrowed to record levels since the decade of 2000. The US yields are going up steadily, with central bankers talking about a 'high for long' interest rate environment. Many central banks in Malaysia and Indonesia have been tightening interest rates.
“While many of these economies possess substantial foreign exchange reserves, the question arises: if they are hesitant to raise interest rates and instead rely on forex reserves to alleviate exchange rate pressure, will this strategy remain sustainable if the global financial conditions remain tight for very long?” asked Chinoy.
“The depreciation of the rupee will not be bad per se. The depreciation will actually help the exporters,” said Nitsure.
Krishna Srinivasan, Director, Asia and Pacific Department, IMF, said that the exchange rate will act as a buffer for any disorderly fluctuation in the currency. “Uncertainty is very high. It is time to build buffers both on the fiscal and financial sides,” said Srinivasan. In fact, the RBI has been using the forex reserves to reduce volatility in the rupee value against the US dollar. In the last year, the forex reserves have come down from a high of USD 620 billion to USD 590 billion.
“But we have comfortable reserve positions in terms of interest payment and external debt coverage both short term and long term,” said Chenoy.
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