How can India restore growth while minimizing the impact of crude prices and supply bottlenecks?

While the Indian economy is expected to normalize in FY23, it has to address emergent global challenges.

With reference to baseline FY23 real GDP growth at 7% and CPI inflation at 5%, the revised levels of these variables may be put at 6.3% and 6% respectively after taking into account, the impact of crude price increase by a margin of US$25/bbl. as per scenario 1 (Table 2). The impact would be larger if other factors are also taken into account, or if the margin of increase is enhanced.

There may also be some sectoral supply-side bottlenecks and cost escalation. Sectors that draw heavily on petroleum products such as fertilizers, iron and steel foundries, transportation, construction and coal would be adversely affected. Some adverse effects in regard to financial flows have also become noticeable. Net FPI outflows during October 2021 to January 2022 increased to US$11.2 billion. Net FDI inflows, although positive, have also been falling during this period as compared to the corresponding period of the previous year.

Scope for additional fiscal capacity

The FY23 budget estimates may have to be modified due to two main reasons: 

• likely upward revision of expenditures/ subsidies particularly those related to global crude prices and 
• likely additional fiscal capacity due to underassessment of some critical determinants of Center’s gross tax revenues (GTR). These determinants relate to an underestimation of:
  1. base magnitude that is FY22 GTR, 
  2. FY23 assumed tax buoyancy and 
  3. FY23 assumed nominal GDP growth

The nominal GDP growth for FY23 was budgeted at 11.1%. However, assuming a revised real growth component of 6.3% and an IPD-based inflation component of 6.5%, we may estimate a revised nominal GDP growth close to 13.0%. This would also be the growth of Center’s GTR if the tax buoyancy is 1^[1]. Using a modified FY22 GTR base magnitude and applying on this, a growth of 13%, the resultant Centre’s GTR for FY23 would be higher than the budgeted magnitude of INR27.6 lakh crore by a margin of about INR3.2 lakh crore (Table 3). Alongside, there would also be increases in some components of expenditures linked to global crude prices including petroleum and fertilizer subsidies which were budgeted at INR5,813 crore and INR1,05,222 crore respectively. Already in FY22, the third and last supplementary demand for grants has been presented involving an increase of INR14,902 crores in fertilizer subsidies when the original allocation as per the RE was INR1,40,122 crores. In FY23, the corresponding allocation being considerably lower, there is a strong likelihood of its upward revision.

Relying on fiscal policy for supporting growth

The developed countries are uplifting their interest rates under inflationary pressures. The US Fed raised its policy rate by 25 basis points on 16 March 2022^[2]. This may be considered as the first tranche of the likely increases during the course of the year. In this context, the RBI may find it advisable to uplift the policy rate with a view to stemming inflationary pressures and outward flow of US dollar. In February 2022, CPI inflation at 6.1% was at or above the 6% upper end of the RBI’s inflation tolerance range for the second successive month. WPI inflation also remained elevated at 13.1% during the month. With monetary policy options getting constrained by rising inflation, the main policy support to growth may have to come from the fiscal side.

Post-COVID, as the Indian economy has started to normalize, focus may be on some of the immediate compulsions emanating from the current pressures on prices of global crude and primary products. Other things remaining the same, this may have an adverse impact on real growth and CPI inflation. There would also be some slippage in fiscal and current account deficits relative to GDP. The magnitude of such an adverse impact will depend on the extent to which crude prices increase in FY23 on average. Policymakers may have to exercise a critical choice regarding who bears the burden of higher prices of petroleum products in India amongst consumers and industrial users, oil marketing companies (OMCs), and the government. The government may have to strike an appropriate balance amongst these options.

Some of the adverse effects can be mitigated by undertaking policy initiatives that would support demand and growth. One critical segment of demand pertains to private final consumption expenditure (PFCE). This would partly get supported by Center’s current thrust on accelerating infrastructure investment which is expected to have strong positive multiplier effects. As investment side multipliers have a longer time lag, it may be advisable to support demand through revenue expenditures by extending for example, the employment guarantee scheme to urban areas to complement the existing scheme for the rural areas. Some state-governments have taken an initiative on this account (Rajasthan, Kerala, Odisha, Himachal Pradesh, Madhya Pradesh and Jharkhand)^[3]. It may be useful to evolve a unified employment guarantee scheme covering both rural and urban areas.

India now requires laying a solid foundation for achieving a high and stable medium-term growth consistent with its potential in the range of 7-7.5%. For this purpose, Center’s FRBM in which critical state-level debt and deficit targets are also embedded, may require to be recast. We consider that in view of Center’s larger responsibility with respect to macro stabilization, it may be given a higher fiscal deficit benchmark of 4% of GDP while states may continue with the target of 3% of GDP. Both tiers of government should be made to achieve revenue account balance so that the combined fiscal deficit can be devoted to financing capital expenditures which will support infrastructure expansion at an adequate pace.