Play it safe on the economy this year

But there are risks that need to be monitored. The primary one is a return to higher commodity prices. The capex thrust promised is being funded by cuts in the food and fertiliser subsidy bill. But, if fertiliser prices ratchet back up, the maths may not work out. And then, there is the health of rural India. After a difficult year, it has begun to revive again. Real agricultural wages have finally risen above pre-pandemic levels. The Budget has softened its overall spend on rural India, and that seems fine for now. But, if rural stress re-emerges, that spend will have to be raised, again hurting the fiscal maths.

Then, there are challenges. The main one is to get all that capex worth 4.5% of GDP done. The last time India managed such a large increase in any single year was back in FY08, when conditions were different, and the base was low. Raising it so rapidly now, especially after two previous years of large hikes, could be a challenge for both the Centre and the states. Another hurdle is to continue on the fiscal consolidation path. The need cannot be emphasised enough. Today, half of the central government’s tax revenues are used for servicing the interest bill on debt, leaving little for anything else. But can the government reduce the fiscal deficit year after year, without hurting some recent fiscal reforms, such as higher capex and timely payments to vendors such as Food Corporation of India? It’s possible, but will need a steady hand.

How will growth pan out? Growth is likely to decelerate in FY24 on the back of slowing exports as the global economy hits the brakes. Domestically, too, pent up demand from the lockdown period will eventually peter out. Household savings have fallen below pre-pandemic levels. And, finally, rate hikes and fiscal consolidation will lower vulnerabilities such as high inflation, but also lower growth.

Four aspects need to be noted.

One, domestic growth has been far more resilient than global growth, as is clear from the growth in non-oil imports outpacing that of non-oil exports. But there are some distinct messages in the export basket. While goods exports have fallen 15% since the 2022 highs, services exports have risen by 15%.

Two, investment has been more buoyant than consumption over the last year. Even though higher central government capex was offset to an extent by weak state capex, private sector replacement capex demand and new investment intentions by large firms have kept investment ticking.

Three, urban demand far outstripped rural demand over 2022. As lockdowns ended, labourers returned to their urban jobs. On average, each time a worker moves from a rural to urban area, incomes rise 2.5 times. But the transition is now complete. Urban jobs are back to pre-pandemic levels. On the other hand, with strong winter crop sowing, and the capex push in the Budget creating construction jobs, rural demand could rise from here.

Four, large firms have performed better than small firms. The back-to- back shocks of the lockdowns and rising commodity prices hurt small firms more. Their market share and profitability fell, and those working in these firms earned relatively low wages. But, if there are no new shocks in 2023, small firms and the informal sector at large could recover.

So, even if growth slows in FY24, it could be more equally distributed than in the last few years, as the rural and informal sectors recover. This may have been one of the motivations to keep social welfare spending contained in the Budget despite it being a pre-election year.

Will India stabilise? What troubled us more than concerns over the absolute level of growth in 2022 was the disturbances to macro stability. There was a wide trade deficit that hurt the rupee, rising inflation which hit both consumers and producers, and a high fiscal deficit, leading to concerns around too much public sector borrowing.

The budgeted fall in the fiscal deficit is clearly a positive, not just directly (as it lowers government borrowing and the interest bill), but also indirectly. The negative fiscal impulse on growth is likely to put a lid on both the trade deficit and inflation. As the year progresses, we believe concerns over India’s trade deficit will ease as oil prices come in lower and domestic growth slows. Instead, concerns could move towards capital inflows.

A subdued fiscal impulse may keep a lid on inflation. Helped by a good winter crop, inflation could fall below 5% over the next few months but only possibly temporarily. Through this year, we expect core inflation to remain elevated. Permanent changes such as large firms gaining pricing power, extreme weather events keeping inflation expectations elevated, and a raft of increases in import tariffs have been raising the core cost structure of the economy. True, the government lowered some import tariffs in the budget to make manufacturing more competitive, but several other import tariffs were raised.

We expect the Reserve Bank of India to raise rates by 25 basis points but with growth slowing, we expect no further rate hikes (although risks remain). And, because core inflation will likely remain elevated, we expect no rate cuts in FY24, either.

Macro stability may be more important than high growth at this point, as it prepares the ground for growth to take off sustainably when global uncertainty subsides. The Budget has played well, but execution will be key. It’s a year to play it safe on all fronts, just as Rahul Dravid did for the Indian cricket team in difficult conditions.

Pranjul Bhandari is chief economist, HSBC

The views expressed are personal