India’s growth-inflation challenge in four charts

The International Monetary Fund’s (IMF) April 2022 World Economic Outlook (WEO) slashed India’s projected growth rate for 2022-23 by 80 basis points – one basis point is one hundredth of a percentage point – on April 19 to 8.2%.

Earlier this week, the ministry of commerce and industry released the wholesale price index (WPI) for the month of March. At 14.5%, it was the second highest since 2012. Almost all institutional and private forecasts expect tailwinds to inflation and headwinds to growth in the global economy. What does this mean for the Indian economy?

1 IMF’S global outlook is more worrying than its growth forecast for India

IMF’S latest WEO expects the Indian economy to grow at 8.2% in 2022-23. This number was 9% in the January 2022 update to the October 2021 WEO projection. To be sure, the latest IMF projection is still significantly higher than the 7.2% growth forecast made by the Reserve Bank of India’s Monetary Policy Committee (MPC) in its April meeting. While MPC, too, slashed its growth forecast from 7.8% in the February 2022 meeting, IMF’S latest projection is still higher. And, at 8.2%, India will be the fastest growing major economy in the world – by a bit. Where IMF’S latest WEO should raise concern is its general outlook about the global economy going forward.

“Global growth is projected to slow from an estimated 6.1% in 2021 to 3.6% in 2022 and 2023. This is 0.8 and 0.2 percentage points lower for 2022 and 2023 than in the January World Economic Outlook Update. Beyond 2023, global growth is forecast to decline to about 3.3% over the medium term… With a few exceptions, employment and output will typically remain below pre-pandemic trends through 2026”, the executive summary of the latest WEO says. And economic conditions are going to be more difficult in emerging market economies than their advanced counterparts. “Scarring effects are expected to be much larger in emerging market and developing economies than in advanced economies — reflecting more limited policy support and generally slower vaccination — with output expected to remain below the pre-pandemic trend throughout the forecast horizon”, the WEO added. India will not be immune from these global headwinds.

2 There is more to Indian inflation than the fuel price impact

Fuel prices were the biggest driver of WPI in March 2022. However, the spike in latest wholesale inflation is not just on account of fuel prices. A disaggregated analysis of the WPI numbers shows this clearly. While the fuel and power component of the WPI grew at 34.5% on an annual basis in March, even the non-fuel part of the WPI basket saw an annual growth of 12.1%, the highest since 2012. This means that price pressures in the producer economy – the WPI is not meant to capture household budgets unlike the Consumer Price Index (CPI) – are quite broad based. With cascading effects of crude oil prices on other commodities, price pressures on non-fuel items will only increase going forward.

3 The inflationary surge will also feed rising capacity utilisation levels

Unlike in the first half of the last decade, when the Indian economy was experiencing overheating, the post-pandemic situation has seen inflation despite a slack in economic activities. In fact, RBI’S MPC maintained for long that the inflationary surge was because of supply-side shocks and therefore did not merit withdrawing monetary policy support to growth.

While most analysts continue to believe that there still exists a positive output gap – it is the difference between actual and potential growth – in the Indian economy, the demand threat to inflation might not be as benign as it was some time ago. One comparison which captures this changing reality is the juxtaposition of capacity utilisation levels from RBI’S Order Books, Inventories and Capacity Utilisation Survey (OBICUS) with WPI levels. With capacity utilisation levels rising significantly over the last two quarters (the most recent data is for December 2021), price pressures are likely to increase.

4 Terms of trade will matter for eventual growth during this turmoil

The only silver lining, if there is one, in this inflationary scenario is that spike in food prices will bring some windfall gains to Indian farmers. Such gains have the potential of pushing growth to some extent as farmers will experience a boost in their purchasing power. The extent of any such effect, however, will depend on the movement in terms of trade or relative prices between various commodities in the economy. This argument is based on the simple idea that any class only makes income gains when it experiences an improvement in ratio of prices received and paid.

Given the fact that price pressures in the economy are broad-based, and commodities such as fertilisers which are crucial inputs in farming have also seen a sharp price hike, terms of trade movement will play an important role in the Indian economy. At the moment, the non-food part of the WPI basket is growing at a faster rate than the food sub-component. If this continues to be the case, real farm incomes might actually see a squeeze. This is bound to put pressure on rural demand and overall growth.