Looming global recession threats and the stance of Reserve Bank of India
India might be touted as the best performing economy but there are concerns on inflation and resilience that keep pricking Indians on a daily basis. Here's an attempt to answer them...
Since 2021, the world is concerned about falling into recession. The Advanced Economies (AE) like USA, Japan, Germany, etc. have been the torchbearers of this threat and some countries already went into what media claimed as a ‘technical recession’. Technical recession simply means that the economy has contracted (shown negative growth) for two consecutive quarters (this is also the exact definition of recession). In fact, you still might stumble upon some article today talking about how the threat of recession is looming large, but we have been conditioned so frequently on this issue that you probably would not even care to open it. It won’t even be surprising if you think ‘we’ll see when it actually happens’, just like our attitude had become on agencies warning us about every new virus carrying a potential to become the next pandemic right after covid lockdowns.
The media / governments were just trying to give it a fancy prefix so that people don’t create havoc in panic - and to the credit of the agencies, they succeeded. If someone argues that these countries were successfully able to circumvent the threat of recession, going by the normal economic cycle, they have just delayed it.
Why did these countries face recession? Among a lot of common factors, there were several country specific issues-
1. Like for USA, it was excessive bailout packages* pumped in the economy to keep it alive during covid.
2. For Germany, it was the subsidies** given to their citizens on energy prices amidst the Russia Ukraine war.
*Bailout package is an injection of money in the economy by the government from its coffers in the form of direct cash, low interest/interest free loans, etc to support its citizens in the time of crisis.
**subsidies are the payment by the government on behalf of a person such that the burden of that expense is shared. This too can be through cheaper credit, tax holidays or providing with minimum free utilities.
In both cases, there was excessive flow of money in the system that led to people having more money to spend. However, one thing that these governments could not see was that due to supply disruptions, availability of resources was a big problem, which automatically pushed the prices up. In addition to this, considering the unstable atmosphere during Covid people chose to only spend on the necessities irrespective of whether they benefited from these schemes.
But can you blame the governments for putting us into this position?
Absolutely not.
They obliged to what was the need of the hour. Even doctors must at times treat an ailing disorder in the body first, knowing that they are risking something else to come up in the future.
Imagine the kind of helplessness, stress, and depression, their citizens have gone through had the governments not done what they did. This would also have been a time when the people who are genuinely needy of the government aid wouldn’t have received it, and we would have seen their stories become a breaking news article for everybody else to consume and panic.
Today, the central banks of these countries are trying their best to control the inflation. These stalwarts meet once in every two months to review the impact of the decisions on the economy and to decide the way forward. Lately, to everybody's surprise, every meeting has brought an unpleasant news for the public.
This started with higher inflation numbers, which the banks assured will be tamed quickly. Then these banks showed light at the end of the tunnel where they will eventually start reducing rates once the inflation is grappled. Slowly, what was supposed to be the light at the end of the tunnel just turned out to be lights beaming out of the roof. Visible, yet not reachable.
The expectation of rate cuts went down from 3 to 4 cuts per year to 2 rates per year and eventually to just one rate cut (maybe!) at the end of this year. The rates I am talking about are the ones set by the Central banks to control the flow of money in the overall economy, when the central banks set the high, that means there is more than required money flow in the economy and vice versa.
Where does India stand?
India is looked up as a safe haven in the world grappling with slow growth rates and recession. This is because India is a subset of the world. We have a strong hold in export of services through our highly respected tech brains, our manufacturing base is growing stronger by the day and have a relatively stronger reserves of natural resources, we are an agrarian economy since the beginning of time. And the cherry on the icing on top of the cake is our resilient internal demand that is not much affected by geopolitical shocks like recession, Russia-Ukraine war, and unrest in the Middle East.
Being the most populous country in the world growing in all directions, the opportunities are aplenty. We are seeing the government coming up with several initiatives to not only attract FDI, but also give incentives to larger players through PLI and smaller players through various schemes for MSMEs and undergoing CAPEX spends to develop infrastructure to attain last mile connectivity. Sure, we are not bulletproof when it comes to dependence of critical resources like oil, semiconductors, etc from other countries, especially China. Our balance of payments (exports vs imports) is still negative by a substantial number.
In a recent statement by the Governor of RBI and the Monetary Policy Statement released on April 5, 2024, the Committee decided to keep the repo rate constant at 6.5% keeping in sight their targets of keeping inflation in the range of 2% to 6%. Here are some other notable matrices -
Domestic economy is experiencing a strong momentum with rural demand picking up.
Monsoon expected to be normal.
Real GDP growth projected at 7%.
Geopolitical shocks pose a threat.
Headline inflation - total inflation in the economy - softened to 5.1% in Jan-Feb 2024 from 5.7%.
Fuel inflation has dropped marginally.
Food inflation is still high at 7.8%.
The core inflation - inflation in goods and services EXCEPT food and fuel - has dropped to an all-time low of 3.4%.
This means that food inflation is dragging the inflation number higher. It’s interesting to note that food prices are determined largely by demand and supply and are highly dependent on monsoons. It is also important to note that food, being the necessity, is pretty inelastic to interest rates set by the central bank. For certain income groups, government is already running subsidies to ensure food is afforded by them which further eclipses the impact on food prices affected by interest rate changes.
While various factors are working in the favour of the economy and keeping the inflation under check is the topmost priority, sustaining a real growth rate of 7% is an uphill task and will demand more from all pockets of economy. So far, the credit goes to the government for attaining favourable figures showcasing the strength of the Indian economy as the lion’s share of the improvement is due to government’s CAPEX in nation’s infrastructure push and this CAPEX can be sustained only for some time. In order to get a perennial growth, sustained contributions will be required from the private sector which is possible only when the money is available cheap.
Considering the above factors and their repercussions, the only reason I can think of why the Committee has kept the rates high is to maintain balance of payments stable. India is a net importer having total exports of USD 447.46 billion in FY 2022-23 against total imports of USD 714.24 billion in the same period. In order to pay for the difference between the imports and exports, the central bank maintains forex reserves in different forms to enable the trades. If the central bank does not have forex reserves, the businesses cannot buy foreign currency from their banks for payment to their vendors (Bangladesh is going through such a situation as you read this).
In addition to this, RBI has to follow the tunes of the central banks of advance economies like USA (in order to maintain the dollar reserves) and China (biggest trading partner of India) in order to maintain the exchange rate. Consequently, the decision for keeping the interest rates high could be a result of external factors than internal. Hypothetically, if the RBI focusses on internal factors more and reduces the interest rate, higher flow of money within the country can lead to higher demand of discretionary goods and we could be under the threat of worsening our balance of payments (higher imports vs same exports). This will eventually increase the demand of USD and render USD to be more expensive (INR / USD will reach 95 or 100 instead of current levels of 83-odd).
Sure, the exports will also get a push as our goods and services will become cheaper (in USD terms) but considering our Import to Export ratio of 1.6 times, the support will not be enough. The central bank will have to buy more USD at a higher price to support the higher imports at the expense of allocating the same money for internal development of the country or will have to maintain a very thin reserves which will be at a constant risk of default. The unstable outlook will eventually result in higher country risk worse ratings for the economy. Consequently, the risk premium for investing in India will increase and we will be stripped off our tag of a safe haven due to higher premiums warranted by FIIs and FPIs to invest in India.
Considering all the above points, it is only prudent for the central bank to put a higher weightage on external factors and maintain the balance of payments as the worst-case scenario in following this could be a slower than expected GDP growth, which is a rather temporary symptom. RBI (and its Monetary Policy Committee) is doing a fabulous job by weighing their options correctly and not succumbing to the pressure of expectations. The move may affect our attractiveness in the short run but the resilience that we will have in the long run will be unparalleled.