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Growth slowing but risk of stagflation low: Ministry of Finance

Growth slowing but risk of stagflation low: Ministry of Finance

Indian financial markets have tanked in recent weeks amid concerns of growth, inflation and tracking global markets, reflected in the ministry's May report

The Ministry of Finance said today that agencies worldwide had already projected a slowing of global economic growth, which is expected to witness headwinds with rising commodity prices, supply chain bottlenecks and faster than the projected withdrawal of monetary accommodation and so the Indian economy is expected to witness slow growth as well, which will still be higher than the other emerging market economies. “The World is looking at a distinct possibility of widespread stagflation. India, however, is at low risk of stagflation, owing to its prudent stabilization policies,” the ministry said in its May update.

India faces multiple near-term challenges like managing its fiscal deficit, sustaining economic growth, reining in inflation and containing the current account deficit while maintaining a fair value of its currency, the finance ministry said in its monthly economic report on 20 June. “Many countries around the world, including and especially developed countries, face similar challenges. India is relatively better placed to weather these challenges because of its financial sector stability and its vaccination success in enabling the economy to open up,” the ministry said.

The challenges need to be managed carefully without sacrificing the hard-earned macroeconomic stability, the finance ministry said.

The recent 50 basis point repo rate hike by the Reserve Bank of India (RBI) taking the repo rate to 4.9% and counteractive policy action by the government in form of duty cuts, rationalisation of custom duties, enhanced subsidy to targeted sections, trade policy changes and the government’s continuous commitment to enhancing capex are expected to restrain inflation while underpinning economic growth in the ongoing fiscal year, the Monthly Economic Report for May 2022 said.

In the medium term, the successful launch of the Production Linked Incentive Scheme, development of renewable sources of while diversifying import dependence on crude oil and strengthening of the financial sector are expected to drive economic growth, it said.

The tightrope walk between maintaining growth momentum, restraining inflation, keeping the fiscal deficit within budget and ensuring a gradual evolution of the exchange rate in line with underlying external fundamentals of the economy is the challenge for policymaking this financial year.

“Successfully pulling it off will require prioritising macroeconomic stability over near-term growth. The reward for such a policy discipline will be the availability of adequate domestic and foreign capital to finance India’s investment needs and economic growth that fulfils the employment and quality of life aspirations of millions of Indians,” the ministry said.

The economy grew 4.1% in the quarter ended 31 March, the slowest pace in a year, showed the official released last month. For the full year, the economy expanded by 8.7%, slower than the government’s second advance estimate of 8.9%.

Economic activity was poised to rebound after the lifting of pandemic restrictions when the Russian invasion of Ukraine sent and commodity soaring, further strained global supply chains and hit business confidence. Surging inflation has since forced the central bank to raise interest rates since May.

India’s fiscal deficit ballooned in the wake of the pandemic as revenues plummeted while spending was boosted on health and welfare measures.

While the budget gap for FY22 came in at 6.7% of the gross domestic product, lower than the revised target of 6.9%, economists expect the fiscal deficit for FY23 may exceed the target of 6.4% by as much as 50 basis points.

The Narendra Modi government has sought to boost growth through reforms and spending on infrastructure. However, volatile geopolitical, economic and financial conditions threaten to drag it down. India and many parts of the world are facing the challenge of elevated inflation as crude and commodities have surged and supply chain issues remain.

With tax collections likely to take a hit following cuts in taxes on diesel and petrol, a risk to the budgeted level of gross fiscal deficit has emerged, it said.

“Increase in the fiscal deficit may cause the current account deficit to widen, compounding the effect of costlier imports, and weaken the value of the rupee thereby further aggravating external imbalances, creating the risk (admittedly low, at this time) of a cycle of wider deficits and a weaker currency,” it said.

The rationalisation of non-capex expenditure has become critical, not only for protecting growth supportive capex but for avoiding fiscal slippages, the ministry said.

Meanwhile, depreciation risk to the rupee remains as long as net foreign portfolio investor outflows continue in response to the quantitative tightening in advanced economies as they wage a prolonged battle to calm inflation, it said.

Indian financial markets have tanked in recent weeks amid concerns of growth, inflation and tracking global markets. Meanwhile, the rupee has hit record lows against the dollar, while bond yields have shot up.

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