Inflation may have peaked in India – falling from 7.8% in April to 6.7% in July – and the RBI may have kept the growth projection for FY23 constant at 7.2% – unchanged since May – but the economy is not out of troubled waters yet as the fear of global recession accentuated with more bad news from Eurozone. Latest data reveals that the 19-country Eurozone's economic activity contracted for the second consecutive month in August – hitting an 18-month low.

This was the bad news economists were fearing. The Eurozone's contraction comes close on the heels of another bad news – a record high inflation of 8.9% in July. This forced the European Central Bank (ECB) to raise interest rate for the first time in 11 years, since 2011. Further, the ECB has indicated another large interest hike next month as recession risks harden, which it isn't ruling out either.

The last few days have seen a series of bad news flowing in.

The UK recorded an inflation of 10.1% in the past 12 months (up to July 2022) – its highest since early 1980s, and above expectations. The Bank of England (BoE) raised its policy rate with the UK projected to enter recession from the last quarter of 2022 (October-December). More bad news has come from China, which lowered its interest and mortgage reference rate by a bigger margin than earlier – in a desperate bid to revive its economy – hobbled as it is by a real estate crisis and resurgence in Covid-19 cases.

The US has already gone through negative growth in the last two quarters – qualifying it for a technical recession. But the trouble is far from over. Its treasury yield, which inverted in May for the first time in a long time, was inverted in July too – the long-term treasury (10-year) yield falling behind short-term (two-year) treasury yield. Historically speaking, this has been a sure sign of impending recession in 6 to 24 months' time. The US dollar also went up last week, against global currencies, to a three-week high after the minutes of US Federal Reserve revealed further interest rate hikes to battle its 40 years' high inflation.

In the meanwhile, there is no end in sight for the Russia-Ukraine war and end to the energy (gas supply) crisis in Eurozone. Commodity prices and crude oil prices may have softened but remain elevated. The minutes of RBI's monetary policy committee (MPC) deliberations point to further interest hikes (after three hikes has taken repo rate from 4% to 5.4% since May 2022). That is because inflation is expected to remain 6.7% for the entire FY23 – above the upper tolerance level of 6%. Inflation is likely to moderate to 5.8% only in the last quarter (January-March 2023). RBI governor Shaktikanta Das has said the central bank "would like to bring down inflation over a time cycle of two years" – that is, bring the inflation to the target rate of 4% slowly so that it doesn't hurt growth.

The RBI's latest bulletin recognises that "global growth prospects have turned gloomier over the month" and have adverse consequences for India ("imported inflation"). It says: "Spillovers from geopolitical shocks are imparting considerable uncertainty to the inflation trajectory. More recently, food and metal prices have come off their peaks. International crude oil prices have eased in recent weeks but remain elevated and volatile on supply concerns even as the global demand outlook is weakening. The appreciation of the US dollar can feed into imported inflation pressures."

What about "imported" and "domestic" threats to India's growth?

Is India recession-proof?

All of the external threats mentioned earlier – record high inflation in the US and Europe, tightening of interest rates, two quarters of recession in the US and further recession threat to it, the recession risks to the UK and Eurozone and China's battle with recovery and resumption of full-scale supply to the world – pose multiple threats to India's growth. These are the major economies India primarily deals with. The IMF has not only lowered the global growth prospects for 2022 by 0.4% recently, it lowered China's growth even more, by -1.1% (from its projection in April 2022).

Rising interest rates in developed economies and rising dollar value would not only weaken rupee and put inflationary pressures as the RBI said, elevated domestic inflation alone would be causing immense harm to India's growth prospects. Inflation has remained above 6% since January 2022 and would continue to be so at least till December 2022 – coming down to 5.8% in January-March 2023. High inflation hits consumption demand. In FY22, consumption demand (PFCE) was barely 1.4% over the pre-pandemic FY20 level. Per capita GDP in FY22 was -0.5% of FY20 – indicating loss of income. Per capita GDP doesn't reflect true household finance as it includes incomes of government, corporate entities, partnership firms also. The actual household income of a vast majority is likely much worse since corporates, for example, have recorded historic high net profits in the pandemic fiscal of FY21 and FY22.

Investment is threatened too. The FII and FDI inflows show worrying signs. FIIs pulled out a record $39 billion since October 2021. The trend reversed in July 2022, but with further tightening of global interest rates and dollar strengthening, the threat of FII outflows continues. So is to FDI inflows. In FY22, growth in FDI inflows dropped to 2% – from a healthy 10% in FY21. This would have adverse consequences for India's forex reserve which is fast dwindling, from $606 billion to $571 billion between April and July 22, 2022.

A global recessionary trend also means weakening of consumption demand in those countries and consequently, another growth engine of India – exports – is affected. The July numbers showed exports falling to five-month low of $35.2 billion, taking trade deficit (merchandise goods) to a record high of $31 billion in July 2022 – three times more than $10.6 billion in July 2021. Details showed exports fell in seven of top 10 export items: engineering goods, petroleum products, gems and jewellery, pharmaceuticals, readymade garments, cotton yarn and plastics. Going forward, trade deficit may go further up.

India was banking on rupee trade with Russia to bail itself out (rise in USD) but that is petering out as Indian companies are fearful of attracting sanctions from the US and European countries. Now the government has told them to find on their own which Russian banks are not subject to the western sanctions so as to avoid being black-listed by the western powers.

There is yet another threat to India's growth story.

The RBI is expected to raise interest rates further. Its latest "state of the economy" report clearly says this: "Inflation has edged down, but its persistence at elevated levels warrants appropriate policy responses to anchor expectations going forward." Tightening of interest rates chokes credit-driven growth in production of goods and services. Credit growth to "large industry", the main anchor for growth, has been sluggish – a mere 1.3% growth in FY22 over FY21. In FY23, two out of three months (April-June 2022) for which data is available, credit growth turned negative (-0.9% in April and -0.1% in June).

The Index of Industrial Production (IIP), which also reflects the consumption demand in the economy, has grown by 12.7% during the first quarter of FY23 (year-on-year). But this growth is from a low base of the corresponding quarter of FY22 when IIP was at its lowest level (compared to the rest of FY22) because of the second pandemic wave shutdowns. Besides, in June 2022, IIP growth at 12.3% was lower than 19.6% in May 2022.

Why RBI is optimistic?

So, what is the RBI banking on to stick to 7.2% for FY23 since June 2022?

Its reasoning, stated in its "state of the economy" report is: "In India, supply conditions are improving, with the recent monsoon pick-up, strong momentum in manufacturing and a rebound in services. The onset of festival season should boost consumer demand, including rural, also as sowing activity picks up. Robust central government capital outlays are supporting investment activity."

None of these are certain to deliver or deliver enough push for 7.2% growth.

Contrary to impression, kharif sowing has been impacted in many big states due to a drought-like situation. These include Uttar Pradesh, Bihar, Jharkhand and West Bengal, which together produce a third of the country's total food grains. The same RBI report admits that rice sowing has fallen by 12.7%, pulses by 2.5% and the overall kharif by 3% from the previous kharif year. It also admits that during August 1-12, there was an increase in prices of cereals, primarily on account of "a surge in wheat prices" and "pulses prices have registered a broad-based increase", although edible prices have declined. There is a constant buzz about wheat being imported as FCI stocks dwindle and additional rice is given in the PDS to compensate for wheat shortages. The government recently denied plans of importing wheat but that may not be the final word.

Assuming a good monsoon, the overall contribution of agriculture, comprising of not just kharif harvest but rabi harvests, animal husbandry and fisheries, to the GDP was 15.5% in FY22. The kharif crop is down, the fate of rabi harvest will be known next year. Thus, agriculture's contribution to the GDP growth doesn't seem very convincing.

As for the two other sectors of the economy, the RBI's arguments don't seem convincing either. The case for a strong momentum in manufacturing is exaggerated (explained earlier using IIP growth). As for a rebound in services, the RBI's credit outflow data shows, the numbers are disappointing. The average growth in monthly credit to the services sector during the first quarter of FY23 is just 0.59%. Tracked from March 2022, it is a growth of 1.77% in June 2022. The RBI seems more driven by the growth in credit in FY22 over FY21 – which was 14%. But that may or may not be the case in FY23.

As for capex, the Centre's capex is 23% up from the budget estimate during the first quarter of FY23. This is a positive development but this is not a driver of growth. Consider some facts. First, the total general government expenditure (Centre and states) is just about 11% of the GDP. This includes a larger portion of revenue expenditure. For example, in FY22, the Centre's capex was 16%, the rest 84% accounted for revenue expenditure.

Second, the Centre's share in total capex is nearly half that of states. On average, states have spent 63% of the total capex, the rest 37% by the Centre, during the last 11 fiscals of FY12-FY22. States are now in a big fiscal trouble after the GST Compensation was discontinued from July 2022. Since the GST Compensation accounted for 34% of their SGST, expect capex from states to drastically fall – pulling down the total capex (for more, read Fortune India's Revenue shock to hit state capex as GST compensation ends). It shouldn't surprise anyone if states' capex falls drastically in FY23.

This leaves the festival sale – among the factors the RBI listed.

It would be too optimistic to expect festive sale to deliver 7.2% GDP growth for FY22.

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