What’s in store for the economy in the second half? | explained

The story so far: The Indian economy, measured in terms of gross domestic product (GDP) and gross value added (GVA), grew by 7.8% between April and June (first quarter or Q1) this year, the fourth straight quarter of growth. The finance ministry believes the pace of economic activity picked up in the July-September quarter, despite retail inflation tightening from 4.7% to 6.4%. Growth estimates for Q2 will come next month, but the Reserve Bank of India (RBI) expects GDP growth to be 6.5%. A week into the second half of the year, the Israeli-Palestinian conflict erupted and new dark clouds are now hovering over the economy.

How have experts responded to recent events?

Economists believe that prolonged conflict in West Asia could push crude oil prices beyond India’s comfort zone, and if other countries join the fray, disruptions to critical sea lanes and increased transport and insurance costs. The government may not pass on higher petrol prices to consumers ahead of crucial elections, but producers’ costs may still rise. For example, airlines are raising fares in line with jet fuel costs. Also, higher fuel import tariffs may have implications for the exchequer as oil marketing companies may need support for lower recoveries. Finance Minister Nirmala Sitharaman, in her first remarks since the Gaza unrest, said it had brought concerns about fuel, food security and supply chains back to the fore. He flagged concerns about the impact of any disruptions on inflation in the future. In subsequent remarks, he also emphasized the need to ensure that global food, fertilizer and fuel supplies do not become „an instrument of war and disruption”.

RBI Governor Shaktikanta Das presided over a monetary policy review hours before Hamas launched the first salvo in the conflict. „We all thought the period of uncertainty was over, but as you’ve seen in the last fortnight, new uncertainties have been thrown in, while some of the pre-existing volatility in oil prices and financial markets has become even more pronounced.” He said last Friday. Amid fresh uncertainty, he cited a surge in U.S. bond yields that hit a 16-year high this month and mixed global data points amid „longer-term high” interest rates. A cut in India’s interest rates is not on the cards, he asserted. „Interest rates will stay high…for how long…only time and the way the world evolves will tell.” Higher interest rates may affect investment flows in markets such as India.

Is there a change in the assessment of risks to the economy?

The International Monetary Fund (IMF) this month raised its 2023-24 GDP growth estimate for India to 6.3% from 6.1%. This follows last year’s 7.2% growth and is slightly lower than the 6.5% GDP growth forecast by the finance ministry and the Reserve Bank for this year. In its monthly economic survey report released last month, the Department of Economic Affairs (DEA) in the finance ministry said 6.5% of confidence was comfortable with „balanced risks”. Bright spots in corporate profits, private sector capital formation, bank credit growth and construction sector activity offset risks at the time. These included a steady rise in crude oil prices („but no alarms yet”) and a delayed global stock market correction, which it said was an „ever-present risk”. The RBI, this month, asserted that risks from erratic monsoon, geopolitical tensions, global market volatility and economic slowdown are „balanced”. The RBI expects GDP growth to be 6% in the current quarter and 5.7% in January-March 2024 before rising to 6.6% in the first quarter of 2024-25. Despite the uncertainties that emerged this month, Governor Das expressed confidence in the overall macro fundamentals of the Indian economy.

Last Monday, the DEA noted in its latest economic review that while domestic fundamentals are strong and improving, downside risks arise from global headwinds due to recent developments in the Persian Gulf and uncertainty in weather conditions due to El Niño effects. „Depending on how the situation develops, crude oil prices may rise. Also, the unrelenting supply of US Treasuries and continued tight monetary policy in the US (and monetary policy tightening is not ruled out) may cause financial conditions to remain restrained,” it said. It was also a foreshadowing that US stock markets are at risk of a major correction, which could have spillover effects on other markets. India’s stock markets suffered six straight days of sharp declines before seeing some recovery on Friday. The DEA has flagged broader concerns about the fraught geopolitical conditions fueling the rise of risk aversion. „If these risks worsen and persist, they could affect economic activity in other countries, including India,” it noted, adding that India’s growth story remains on track. Inflation eased to 5% in September from a 15-month high of 7.4% in July and rising industrial capacity utilization levels, private consumption and investment, retail loans to vehicles and housing raised the bright spots in its economic outlook. . The report cited 'upbeat’ findings from the RBI’s forward-looking surveys on manufacturing, consumer confidence, employment and inflation expectations.

What are the domestic factors to consider?

Inflation may have eased last month, but could climb again. Expecting average inflation of 5.4% through 2023-24, the RBI has projected an average price increase of 5.6% for the October-December quarter and 5.2% for the six months to 2024. Although some vegetable prices have been corrected, inflation will keep the prices of onions, pulses and some grains higher for a while. The IMF and World Bank expect inflation to average 5.5% and 5.9%. The RBI’s preferred 4% inflation target remains elusive, as do prospects for an interest rate cut. This does not augur well for the continued rise in consumption demand which is essential to revive private investment. Production of ready-made garments, mobile phones, hair dye, shampoo, cookers and ice cream fell by 12% to 20% in the first five months of this year, according to a Bank of Baroda survey. „Households generally tend to cut back on discretionary spending when inflation is high, which is the case today,” it noted. The bank’s economists said the next two months will determine whether consumption has actually picked up as the spillover effects fade. Lagging rural demand will be critical and may come under greater pressure if production of some crops is affected. Last but not the least, an economist from a rating agency said the upcoming election season could mean some slowdown in the public sector in infrastructure that has buoyed the economy in recent quarters.