The cloud darkens | The Financial Express

The cloud darkens

The sombre economic growth projections by Moody’s will make things tougher for govt, RBI

The cloud darkens
In July, the trade deficit widened sharply to a record $31 billion from an already-high $26 billion in June. While the monthly deficit may have peaked thanks to the softening of prices of key commodities, the trade deficit for FY23 could nonetheless rise to 3.5% of GDP compared with 1.2% in FY22.

The projection of rating agency Moody’s of a sharp deceleration in the growth of G20 economies to 2.5% in 2022, and an anaemic 2.1% in 2023, comes as a confirmation of what has been feared for some time now. Essentially, the slowdown would be the outcome of tighter financial conditions following the efforts of central bankers to tame inflation, which is becoming broad-based. Moody’s believes that even if core inflation was to come off, the US Fed would be uncomfortable with an easier monetary policy and would wait until it is absolutely certain before reversing the policy. The consequent global slowdown and weakening demand in the advanced economies is expected to weigh on growth in emerging markets including India. Historically, there has been a correlation between India’s domestic growth cycle and global growth, directly via a slowdown in exports and indirectly through manufacturing and investment. The impact is typically seen with a lag of a few quarters.

The high dependence on imports of key commodities would result in a depreciation of the currency, which in turn would leave inflation elevated. As such, both tighter liquidity conditions and the slowdown in global trade would impact India. Given that global trade is mostly concentrated in goods, the ongoing shift in consumer demand from goods to services in the US, Europe and elsewhere would contribute to a deceleration in trade growth. Worryingly, real exports of goods from India have been slowing even as services exports continue to do well. Having grown by an average of 8.7% year-on-year in the April-July period of 2019-21, the increase in real exports of goods slowed to 4.9% in the April-July period of 2022. Indeed, the June quarter saw a very big drag from net exports of roughly 600 basis points. To be sure, the impact of net exports should be relatively smaller in the coming quarters, because, if the local economy slows, imports may also come down sharply.

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However, there are those who argue that imports of items of consumption—electronics, for instance—and also crude oil, could remain high. In July, the trade deficit widened sharply to a record $31 billion from an already-high $26 billion in June. While the monthly deficit may have peaked thanks to the softening of prices of key commodities, the trade deficit for FY23 could nonetheless rise to 3.5% of GDP compared with 1.2% in FY22. The government, of course, has acted by imposing windfall profit taxes on exports of diesel and ATF and more such measures could follow. However, it will be the Reserve Bank of India (RBI) that plays a crucial role in managing inflation, and thereby, the currency.

Should it continue to raise interest rates, there’s the risk of money becoming too costly and hurting credit demand. There is also the chance that the currency may not depreciate enough to help exporters, who would even otherwise be struggling. At this time, given that India’s Q1FY23 GDP growth of 13.5% y-o-y has come in below estimates and the Indian economy has actually grown by just 4-5% over a three-year period, the central bank should probably work to support the nascent recovery. Moody’s sees India growth slowing to 5.2% in 2023. If the economy has to be less listless, consumption demand needs to be robust so as to encourage private sector investments. That would require monetary conditions to be reasonably accommodative. It’s a tough call but the central bank must step in with the global economy becoming even more unsupportive.

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