‘Inflation May Have Peaked in India,’ Says Chief Economic Adviser V. Anantha Nageswaran

Chief Economic Adviser V. Anantha Nageswaran, who took charge earlier this year, is at a loss to understand the pessimism among global think tanks on India’s medium-term growth prospects. India, the CEA says, may be poised to repeat the credit boom it had witnessed between 2003 and 2008, though the magnitude may not be the same. In an exclusive interview with Business Today’s Global Business Editor Udayan Mukherjee, Nageswaran says inflation has peaked in India and financing the current account deficit for the next two years isn’t an insurmountable challenge, adding that he is optimistic about the country’s economy. Edited excerpts:

Q: The two big problems facing the world today are inflation and a growth slowdown. Till a couple of months ago, all the worry seemed centred around inflation, but in the last few weeks it seems to have changed to slowing growth and recession. Of these two devils which we are battling globally, and locally, which worries you more?

A: As you correctly put it Udayan, in the last few weeks, the focus has indeed shifted to growth concerns rather than inflation concerns and the reason is commodity prices, particularly that of crude oil. Commodity prices have declined meaningfully in the last several weeks, whether it is the price of crude oil, industrial metals, some food items, and the cost of shipping reflected in the Baltic Dry Index; even semiconductor prices have begun to come down and the general feeling, therefore, [is that] central bank tightening will slowly bring inflation back under control.

Even Mohamed El-Erian, the well-known economist and bond-market strategist, says maybe the inflation rate has peaked. And even in India, because of all these global developments and due to the monsoon becoming very active, the concerns now will shift towards growth because inflation may have peaked at 7 per cent. But if oil prices had remained very high in the $120-130s, then the concern would have been on both. Though, of course, that is still quite possible as we head into the winter months. Inflation concerns may resurface in Europe and North America if prices of energy commodities go up, but right now I think the feeling is that inflation may be getting tamed precisely because financial markets and commodities markets have begun to price in the impact of the higher interest rates on economic growth. So, between the two, as we speak, the concern indeed has shifted towards growth decline, rather than inflation remaining persistently at very high single digits or in double digits in Europe or North America.

Q: So let me ask you Anantha, is this reason to be happy or unhappy? While one can heave a sigh of relief that inflation is showing signs of peaking, should we be celebrating the fact that growth concerns are on the rise? Surely, the prospect of a deep recession in the US and Europe cannot be great news for the rest of us, can it?

A: Obviously it is difficult to say that one should be happy that the focus is shifting towards a growth slowdown because it may well be inevitable, and also too late to reverse then. And, in the process of reversing, if central banks prematurely shift towards an accommodative stance, or abruptly end their monetary tightening, once again inflation concerns may resurface. So, it is not easy to say whether this is a happy situation, or even a happier situation compared to what we faced. But from the Indian standpoint, I think the decline in commodity prices caused by concerns about growth in the developed world is a blessing in disguise. To some extent, concerns of economic slowdown in the developed world will necessarily have an impact on export prospects of developing countries including that of India. But, given that we are going to have a much better growth rate than many other developing countries, we are more concerned about ensuring that inflation doesn’t get out of hand.

Thus, the financial markets’ concerns with economic growth in the developed world having resulted in a fall in global commodity prices is a welcome development from the Indian standpoint. Therefore, I would argue that in the last few weeks, if anything, the global macroeconomic conditions, including that of commodity prices and interest rates in the US, especially the bond market, have moved in favour of India.

Q: My question then is if the West were to slow down significantly, and you would have noted that there has been a couple of recent instances of bond yield reversion in the US which is often a reliable indicator of recession, how much of an impact do you see on Indian economic growth in the next six to eight quarters?

A: That is sort of a consolidated or net effect of two competing forces; one is the adverse impact on Indian exports because of a recession or—as you put it—near-recessionary conditions there. The other is that if the central banks in the developed world react to the onset of economic recession by halting or slowing interest rate increases, or in some cases even reversing them, then liquidity conditions in reserve currencies become easier.

Capital flows into emerging markets and to countries like India will resume and the tightness in dollar supply will ease globally and therefore, without doing any explicit or formal modelling, I would argue that on balance it will be beneficial to India rather than hurtful.

Q: That’s a very interesting assertion. You’re basically saying that if we get very tepid growth in the US and the Euro zone over the next four to six quarters, then actually it may work in India’s favour because we are not in a bad economic position ourselves. We just don’t want a very bad inflation situation and we don’t want major capital outflows out of India. The rest we can more or less manage.

A: Exactly! You put it very well, Udayan. [When] I think of all the competing objectives, these two are primarily important at the moment. It is about inflation, it is about the import bill, it is about, therefore, financing the current account deficit. And, then there are growth considerations since the bulk of our growth is indeed coming from domestic demand. These three factors and the combined beneficial effects of the growth slowdown in the developed world would help alleviate these concerns for us quite a bit and that I think dominates the negative impact on external demand, exports, etc. I think you summed it up really well.

Q: But having said that, Anantha, you would have noticed that over the last few weeks, a lot of observers—analysts, brokerages, even global think tanks—have started paring down growth expectations for India. So, they’re saying that we may get 7 per cent-plus growth in 2022, but for 2023 some are down to 6.3-6.4 per cent, and one or two have gone down all the way to 5.5 per cent! Is that being alarmist or do you think it is probable?

A: I’m not sure why people have turned so pessimistic for growth in 2023-24 as far as India is concerned, compared to 2022-23. I guess it is partly because they think that with the post-pandemic catch-up now over, there will be more moderate growth given global conditions, weak external demand, etc. But even then, I think there is an underestimation, in the fact that India’s potential growth is not as low as many of them might be thinking. I happened to attend a World Bank seminar on that a few weeks ago in Delhi. There, they looked up the last decade’s capital formation and that was obviously a dismal capital formation scenario, because companies were trimming their balance sheets, banks were trimming their balance sheets, and we experienced financial system stress. Now, if you take that into consideration and extrapolate on that basis, the potential GDP growth would obviously appear lower. But, I would argue that on the contrary, because we went through a balance sheet repair phase in the financial sector, both banking and non-banking, and in the corporate sector, once the current uncertainties regarding the pandemic and the conflict in Europe fade slowly over time, the opposite may happen. India may be poised to repeat, if not exactly in the same magnitude as we did between 2003 and 2008, the same sort of capex, or credit boom, as we experienced in the first decade of the new millennium. Therefore, I am at a loss to understand the pessimism on India’s medium-term growth, starting 2023.

Q: That really is the crux of the matter because all of us have been hoping and dreaming of this resurgence of the capex cycle. In the last Budget as well, the Finance Minister tried to do her bit by shifting resources from revenue expenditure to capital expenditure in the hope it will crowd in private investment but let me ask you, frankly, what is the evidence of the last one year? Do you see substantial evidence that this crowding in of private capex has happened or not quite to the extent that was desired?

A: I think there are only nascent signs of that at the moment and the reasons are not hard to find. We were worried about a third wave until this January, and only after the month ended, we could heave a sigh of relief that the third wave wasn’t as severe as we had feared. And as soon as the pandemic got over, the geopolitical conflict started, and for the next three months until early-June or mid-June, we were witnessing rising commodity [prices], oil prices, fertiliser prices, food prices, etc. Simultaneously, monetary policy tightening began to happen in the developed world starting from April. So, despite the fact that the corporate sector had witnessed rising profitability in 2021 and 2022, naturally, they would pull back and wait to invest when demand conditions became clearer.

Therefore, to say that this crowding in hasn’t materialised is to ignore the fact that we have been buffeted by temporary shocks which were very significant in nature. And that is why the government is still continuing to focus on its capital expenditure until such time the private sector is willing to go all out and use its improved profitability, improved balance sheet, and improved cash position to start investing in a big way. We are beginning to see that in a small way. If you look at bank credit growth, non-food credit growth is now running at double digits for the last four months or so; there is an uptick and the banking balance sheets are in good shape; there is capital adequacy; even the RBI’s latest financial stability report with the stress test shows that banks can withstand the most severe tests. So all the underlying conditions or building blocks are in place, but we have to wait for the current uncertainties to dissipate and then I’m confident that the much-awaited capital expenditure on the part of the primary sector or what we call the capex cycle will be evident in the data.

Q: When one talks to companies though, they agree with your point about too many external uncertainties, but also mention that capacity utilisation domestically is still running at sub-70 per cent in many industries, because of a lingering demand issue, and that does not give them the confidence to go ahead and do that capex. What would you say to that?

A: That is true, as far as the last financial [year] is concerned, but if we look at the current financial year, I think the underlying demand conditions are beginning to improve. All of us have been pleasantly surprised by the resilience of India’s economic activity in the first quarter of the financial year. And, you can see that anecdotally as you cross the airport or as you visit hotels and restaurants. Also if you look at the capacity utilisation, it is picking up and in some sectors, has even crossed 75 per cent. Indeed, there are some core sectors where capacity utilisation has picked up to the point where additional capacities may be needed soon. And, if you look at two-wheeler and four-wheeler sales, they have picked up quite a bit after the slump last year. So in that sense, there are signs that both in the services sector and in some segments of manufactured goods, there is a nascent demand revival. But even if what you say is true, that this demand revival is not sufficiently durable and sustained enough for companies to start investing, I can understand that because both the companies as well as households have been waiting and watching to see whether the pandemic has fully receded from their consciousness. That is not yet the case, and before that could happen, we had the commodity price shock which affects both businesses as well as households. So, that is why I believe a more visible and evident recovery in demand, to be followed by a capex cycle, will start to happen hopefully in the second half of the year.

The caveat of course is that we are living in an uncertain world and have to accept that the timing of some of these things is getting a bit more uncertain and variable than we would have liked them to be.

Q: I certainly hope you’re right on that front. But you spoke about the commodity price shock. Let me bring you back to inflation in India, where there are clear signs of peaking in many parts of the commodity universe, but Indian core CPI inflation is still running at 6 per cent. Even if you look at the month of June, is there an element of stickiness that you see or you fear in Indian inflation because you know what one worries about is whether inflation expectations are getting entrenched after a few months of running very high? Where do you stand on that?

A: I mean, look, forget about this cycle. You could have asked a question about India’s inflation stickiness at any point in time in the last 40 years or 50 years. And, in my opinion, that stickiness comes from the fact that business compliance cost our logistics efficiencies—[which] still need to be addressed. They are being addressed with respect to the introduction of GST and the physical infrastructure improvements, etc., but it will take some time for them to again be visible in terms of data. So there is a certain stickiness and also it could be due to the fact that the capacities in India in several sectors are very small... I mean, both the Indian industry and farm sector are fragmented. I understand that we don’t need behemoths, but we do need a vibrant mittelstand [small and mid-size companies], as they say in Germany. So we have extremely fragmented [and] inefficient spread of capacity both in the farm sector and in the factories. So these are all the reasons for the stickiness that you pointed out. But on the cyclical side, definitely, the fact is we are concerned about 7 per cent inflation when the inflation rate in Germany is close to 8-8.5 per cent and in the US it is 9 per cent. And in some other European countries, it is even close to double digits. That gives me comfort that we are becoming intolerant of inflation, and that inflation intolerance will naturally feed into slower and more stable inflation expectations down the road. Our inflation expectations are not out of control, as they were in the early part of the millennium between 2009 and 2014. So in that sense, I will say India’s inflation, while it is definitely above the target 2-6 per cent range, has peaked and a combination of measures, both fiscal and monetary, have played a part in stabilising expectations.

Q: You spoke about exports being hit by a global slowdown. I want your thoughts on what it could be doing to India’s current account deficit that has started growing again. Equally, while our macros may not be as vulnerable as the taper tantrum period of 2013, what it could mean for the rupee.

A: Udayan, if you had asked me this even a month ago, I would have been far more worried, but as we discussed earlier in the conversation—with the decline in the commodity prices, oil, industrial metals, food, etc., I’m much more sanguine about the current account situation today. Yes, of course, there is going to be a slowdown in export growth because last year was a catch-up year and we did very well both in manufacturing... by the way, you must have noticed that Infosys upped its revenue guidance. So the services sector... IT sector exports are still doing well. And therefore whatever we might lose in terms of momentum, the actual growth rate will still be positive on manufacturing exports or on merchandise exports in general. But the growth rate may be lower than what we saw in 2021-22. So in that sense, there is a possibility that the overall export growth, including services, may not be as badly affected as we think because of the external slowdown.

But on the demand side, we know the oil import bill, fertiliser import bill, etc., are all contributing to the potential rise in current account deficit to the tune of 2.8-3 per cent of GDP, somewhere in the vicinity of $100-105 billion. And, because of the monetary tightening, which usually is accompanied by a flight to dollar and risk aversion on the part of portfolio investors, there is concern about financing this current account deficit. But the RBI governor put it so well, when he said that is why you buy an umbrella when there is going to be rain, alluding to the fact that we have $580 billion of reserves, and we have liberalised some interest rate calculations for non-resident Indian deposits and debt flows, and the government has raised the import duty on gold. So on balance, even though it’s a challenging situation, the incremental developments of the last few weeks are actually in India’s favour. If anything, India’s risk perception has improved and Fitch improved the outlook for India’s credit rating from negative to stable. So if you put all these things together, I don’t think it’s an insurmountable challenge for India’s monetary policy authorities or the fiscal authorities to handle the financing of the current account deficit this year or next year.