The Indian economy witnessed a marked recovery through 2022, the growth over pre-Covid levels improving steadily, aided by pent-up demand, particularly in the services segment. While the global backdrop has soured in the year’s second half, affecting India’s exports, domestic demand has held up reasonably well, culminating in an upbeat festive season. However, global headwinds are set to intensify in 2023, posing significant challenges to India’s macroeconomic outlook.
The global backdrop is expected to remain volatile through most of 2023. The US Federal Reserve has raised its projections of the terminal Federal funds rate sharply between June-December 2022, paving the way for rate hikes to continue in early 2023. The extent of the growth slowdown or recession in the US and expectations around the Fed’s pivot would impart considerable uncertainty to the global economy.
Besides, China’s tryst with Covid-19 would have a bearing on global supply chains and commodity prices. Finally, monetary tightening in the EU amidst elevated inflation and slowing growth and the evolution of the Russia-Ukraine conflict would also cloud the global outlook.
These factors impart considerable uncertainty to India’s growth outlook through three predominant channels: demand for exports, sentiment, which will affect FII flows and exchange rate dynamics, and commodity prices. Weak merchandise and services exports would drag on GDP growth, implying that domestic growth drivers, i.e., consumption and investment demand, would be crucial to support GDP growth in FY24, akin to H2 FY23.
Several pre-conditions for a private Capex lift-off are prevalent. The quantum of profits of the listed corporate sector surged post the pandemic, and their balance sheets are cleaner, providing an impetus to invest in fresh capacities. Besides, capacity utilisation levels have improved rapidly through CY21 and H1 CY22. Further, new project announcements are expected to surge in Q3 FY23, with multiple states holding investor meets in the quarter.
The intent to invest may not be immediate owing to continuing uncertainty around the demand outlook. Nevertheless, Capex is likely to pick up in certain sectors, including auto, steel, airport infrastructure, hotels and telecom, and a step up in execution under the PLI schemes. Regardless, the Centre and the states would need to do the heavy lifting on the Capex front through their budgets in FY24. A significant step-up in Capex, particularly by the states, would be crucial to support investment demand and, thereby, GDP growth in the coming quarters.
Per the RBI’s consumer confidence survey, consumer sentiments have continuously improved through 2022, and households’ expectations around spending on essential and non-essential items have witnessed an uptick. However, its sustenance after the festive season remains uncertain, with a possibility that consumption of services may be prioritised over that of goods, a trend that prevailed in 2022 after the third wave of Covid-19 had ebbed away. Besides, expectations of lower inflation, particularly in the food segment, may support the discretionary consumption of low-income households during the year. Overall, ICRA expects India’s GDP growth to moderate to approximately 6% in FY24, from around 7% in FY23, despite a grim global outlook. We are currently projecting GDP growth at approximately 5% in H2 FY24, which is assessed to be relatively free from base effects. This is below our projection for the potential GDP growth for the Indian economy, an unpleasant reminder that while India’s growth may beat many other large economies, it may fall short of our aspiration.
Offering welcome relief, the headline CPI inflation prints have cooled off between September 2022 and November 2022, falling below the 6.0% mark after a gap of 10 months on account of a sharp fall in the food segment. However, core inflation remains elevated amidst a robust demand recovery in the services category. Given the base effects, we expect the headline CPI print to moderate further to approximately 5.0% by April 2022, and average at approximately 5.3% in FY24 as against our estimate of 6.6% in FY23, largely on account of a dip in food inflation. However, core inflation is likely to moderate at a relatively slower pace vis-à-vis the headline print amidst a continued healthy demand for services.
Given the expected moderation in the CPI inflation and the growth outlook for H2 FY24 and the minutes of the MPC’s December 2022 meeting, we believe that India is close to the end of the rate hike cycle, irrespective of how much the US Fed tightens hereafter. We expect the February 2023 decision to be close between a pause and a 25 bps hike, depending on the MPC’s expectations around how much the CPI inflation eases in Q4 FY23. We do not expect any rate hikes through FY24.
The outlook for the twin deficits appears mixed. For FY24, we expect the fiscal deficit to be budgeted at 5.8% of GDP, a step down from 6.4% of GDP in FY23. While tax revenue growth is expected to moderate along the lines of nominal GDP growth, a lower food and fertiliser subsidy bill relative to FY23 is likely to provide a cushion on the expenditure front, aiding in bringing down the fiscal deficit during the year. Despite the lower fiscal impulse, spending quality is likely to improve, with expectations of a sharper rise in Capex vis-à-vis revex.
Given the expectations of a relatively stronger domestic growth outlook vis-à-vis the global outlook, we expect India’s imports to outpace exports in FY24, similar to the expectations for FY23. Nevertheless, softer commodity prices are likely to provide some respite, limiting the upside in the merchandise trade deficit. We expect India’s current account deficit to remain steady at 3.2–3.4% in FY24, similar to the levels expected in FY23. A parting thought on the exchange rate which vexed the markets in 2022: 82–83 seems to have found market acceptance as the new normal for the USD-INR cross rate. Overshooting on both sides of this range is highly probable in 2023.
Aditi Nayar
Chief Economist, ICRA