Inflation’s positive fiscal spinoff
Additional fiscal capacity linked to high nominal growth may facilitate further reduction in petroleum taxes and/or increased infrastructure investment.
Even with high CPI and WPI inflation rates, there is one silver lining for the Indian economy. This emerges from the high expected IPD based inflation. In 4QFY22, WPI inflation rate at 13.8% exceeded the CPI inflation at 6.3% by a margin of 7.5% points. Based on NAS data, the IPD-based inflation estimated at 8.7% for 4QFY22, falls between the WPI and CPI inflation levels. A relatively high IPD-based inflation implies that the nominal GDP growth would be tangibly higher than the real GDP growth. This has already been seen for FY22 where the nominal GDP was at 19.4% and real GDP was at 8.9%. For FY23, our expectation is that of a nominal GDP growth in the range of 14.5–15.0% with IPD-based inflation at 7.5%. This relatively high nominal GDP growth for two years in succession, that is, FY22 and FY23 is likely to lead to significant additional fiscal space for the central and state governments compared to previous trends.
It is this additional fiscal capacity which has facilitated a reduction in the union excise duty on petroleum products. Further, since there would still be some additional resources available for the central government over and above the budgetary resources, these may partly be used to support growth by frontloading infrastructure investment in the initial months of FY23 and partly to further reduce tax rates on petroleum products with a view to containing inflation while avoiding any significant increase in the budgeted fiscal deficit. Alongside, the scope of production linked incentive schemes may also be expanded. The government, as per the FY23 budget announcements, is already committed to invest substantially in infrastructure for which National Infrastructure Pipeline (NIP) is already in place and has been integrated into the Gati Shakti masterplan so as to realise benefits of intersectoral linkages.
The RBI, in an out of schedule meeting of the Monetary Policy Committee (MPC) held on 4 May 2022, increased the repo rate by 40 basis points from 4.0% to 4.4%. The repo rate had been retained at 4% since May 2020. This change reflected RBI’s current concern with the rising inflation in India which is largely driven by global factors. Driven by continued global crude price upsurge which impacts food, fuel and light, and transport prices in the CPI basket, India’s April 2022 CPI inflation turned out to be a 95-month high of 7.8%. It was way back in May 2014 that CPI inflation rate was at 8.3%. Given these trends, the RBI may consider increasing the policy rate by increments of 25 basis points in one or more steps in the next few quarters.
Growth: India to overtake major world economies
India may be able to sustain a reasonably high growth rate based on the strength of its domestic demand.
In a comparative perspective, India is expected to do well in the short-to medium term. Its projected growth in FY23 is 8.2% as per IMF and 7.2% according to RBI. The ADB has forecasted India’s growth at 7.5% in FY23, increasing to 8% in FY24 based on continued momentum of infrastructure investment. With these prospects, India would be a global growth leader among major economies of the world. However, India may not remain unaffected by the subdued global growth prospects. Many developed countries are currently struggling with high inflation levels which is forcing them to raise domestic interest rates. This may lead to a growth slowdown and in some cases, even a recession. According to a recent research report2 the US economy is projected to be in recession by end 2023 due to unprecedented high levels of inflation that is expected to last longer than anticipated. India’s exports to the US and the European economies may be adversely affected if these economies go into a recession. Further, India’s foreign exchange reserves have depleted sharply over the period from end October 2021 up to 13 May 2022 by a margin of US$48.7 billion. In the medium term, India is projected to show the highest growth rate up to FY28. Its growth rate is expected to be well above the world average as well as that of China.