A frank assessment of the Indian economy

Oct 14, 2022

PRANJUL BHANDARI intuitively looks under the hood to get a grasp of all the moving parts. That is what makes her insights on the contours of the economic landscape so illuminating.

Do read the perspectives of the Chief India Economist at HSBC Securities & Capital Markets (India), shared during a panel discussion at the Morningstar Investment Conference India on September 20.


Fact: Some great reforms have been implemented - Goods and Services Tax (GST), Insolvency and Bankruptcy Code (IBC), Digital infrastructure.


We have to solve the small firms' problem because 90% of India's manufacturing units are either micro, small or medium-sized. They don't enjoy economies of scale. They can't be efficient producers, especially when we have so many efficient producers around the world. This is the big problem we have to solve.

This is constantly on my radar when I track the economy. Are we giving an ecosystem to manufacturing where small firms grow overtime? Or are we creating a situation in which they remain dwarfs for long?

While we have made progress, a lot many reforms must come into being. Factor market reforms on land, skilled labour, regulatory reform, bringing down the regulatory burden small firms face, increasing hard and soft infrastructure. They are tough and they won't happen easily, but we must persevere.

On the eve of the pandemic, India's potential growth was about 6%.

New India is all the promising things like high-tech exports and start-ups. If we continue to grow, our potential growth could go back to somewhere between 6% and 6.5%. That growth is good, but it doesn't create jobs.

We need old India – manufacturing, the creaking infrastructure, and all of that - to rise as well. This will create employment. If we can do that, along with digitisation of manufacturing processes and reforms, the impact will be powerful. We can go up to a 7% economy.


Fact: Capital Expenditure (capex) has been a key thrust for the government.


Undoubtedly, we are all excited about strong capex by the central government. But if we look at the figures, 75% of investment in India is private sector led and 25% is government led. Out of that 25%, only half is central government. Over the last three to four years, central government capex has only been increased by 1% to 1.5% of GDP. It's good, but it's only a start. I feel we should do more on capex.

We need to have an ecosystem in which private sector capex flourishes, particularly in infrastructure. The PPP models worked for a while early 2000s. It's time to revamp them to be able to get the public sector and private sector work together on infrastructure capex in particular.


Fact: Inflation in India has been much lower than what we have witnessed in the developed world.


The tragedy of inflation is that there were many different shocks all at once in the system.

We had this big commodity price shock in March that is still in the system. It started with rural inflation being very high, because they use a lot of oil which is not regulated like kerosene. Now, it's coming down to urban inflation. It started with goods inflation rising. It's now coming to services inflation. The patchy unequal rainfall experience over the last couple of months put some crops, particularly cereal and pulses, under pressure.

Inflation expectation is 150 basis points higher than it was on the eve of the pandemic.

The rate hiking cycle is not over. The RBI spoke about real neutral rates of 1% recently. If you have a one-year ahead inflation forecast of, say, 5.25%, then at least the repo rate should go to 6.25%. Will that be good enough to bring inflation down to the 4% target? I don't think so. If you want to bring inflation down to 4%, you need to hike more. Then the question would be, does RBI want to bring inflation down to 4%, which is their stated target?

By the way, is 4% the right target to have? The global economy has changed. Trade, as we know, has changed. There are structural increases in prices. Do we need to revisit our target inflation? I think this is something we'll have to think about very carefully over the next year or two. It's still very volatile so we have to let the dust settle before we can get a read on it.


Fact: Exports have been a huge driver of India's recovery.


Exports have grown rapidly; a 20% growth between June 2019 and June 2022. India's high skill exports are really taking off. For instance, India's start-ups are really taking off. At the first grade, they focused on things like e-commerce. But eventually, as they start taking up more challenges, for example, things like digitisation of manufacturing, that could have huge growth and jobs pay off. This is a huge medium-term positive.

We must change our mindset from viewing imports as an enemy: Imports make you non-sustainable. Do anything to reduce imports. Slap a lot of import tariffs.

Every single exporting powerhouse is also a huge importer. That is how value chains work. You import a lot of things, you add value, and then you export it back.

We have been slapping import tariffs that actually increases the cost of production in the economy. In turn, this makes us inefficient in the export market. So, a medium-term suggestion is not to go heavy handed on import tariffs as it can be counterproductive.

Also, now with global growth slowing, exports will get hit.


Fact: The rupee has been very stable in the 79 to 80 range.


Since the start of the year till date (September 20 was when the conference took place and this statement was made) is that the dollar has strengthened 14%, but the rupee has only weakened 7%. Anybody would have imagined that rupee would have also weakened about 14%, right?

At the end of the day, this is an oil price shock. We're a big oil importer. The RBI has really stood in the way and is not letting the rupee cross 80. My sense is that it is wasting too many resources right now. It has already spent about $65 billion too soon in the day. The BOP deficit in India could continue for the next 2-3 years.

It would be better suited if the RBI lets the rupee weaken a little bit. If rupee goes to 81-82 to the dollar, it actually will have a lot of positives. It could make exports more competitive. It would disincentivize some unnecessary imports. And at some point, when people start thinking that the rupee is fairly valued, it could also trigger inflows. So, if the RBI lets the rupee slide a bit, there could be some self-correction, and the BOP problem could be solved to some extent.

Let's look at the rupee. One of the reasons it's been so stable between 79 and 80 is that the RBI is intervening very aggressively in the forex market. But it's also losing forex reserves. While our forex reserves are at a good level, we must also look at the burn rate. At some point, the RBI will have to become a little more thoughtful on how it wants to use the next dollar.


Fact: We have been running a trade deficit of roughly around $28 billion to $30 billion per month.


What level of current account deficit can India sustain without getting into the external sector crisis?

I think literature sort of suggests that sustainable CAD for India is about 2.5% of GDP. In 2012-2013, when we came very close to a BOP crisis, our CAD was about 4.5% to 5% of GDP. So, we are not as good as 2.5%, but we are not as bad as 4.5%, 5%.

I think this year our CAD will be under 4%. Also, our forex reserves are almost double of where we were in 2012-2013. So, I don't think this is a panic situation, but we have to be careful.

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