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Inflation moderating, but the big worry this year is growth: Here’s why

Slower growth will further worsen the unemployment picture even as it upsets the Budget math through lower revenues and higher deficits

by News Desk
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Official data last week showed retail inflation grew by 5.7% in December — the fourth successive month when retail inflation has moderated. This was seen as a relief, given that inflation was the biggest economic story of calendar year 2022.

The elevated inflation levels robbed people of their purchasing power and worsened India’s trade deficit, which resulted in India’s currency becoming weaker and the RBI losing significant forex reserves as it tried to stem the rupee’s slide.

Does that mean inflation has been tamed now?

It is obvious that the inflation trend has moderated, and short of another black swan event (like the outbreak of the Covid-19 pandemic) or an unanticipated spike in the hostilities between major powers — such as Russia and Nato or the US and China — it is likely that the world has seen the worst of the inflationary spiral for now.This implies that while central banks may still continue to raise interest rates, these hikes are likely to be smaller and fewer.


For instance, the US Federal Reserve, which aims to bring down the annual rate of inflation to 2%, is likely to continue raising rates and stay at that level for longer; in India, the RBI may go for one more hike of 25 basis points before pausing to see how inflation is getting impacted by the cumulative effect of the past increases in interest rates.

Typically, higher interest rates bring down demand for money (both by consumers and producers) in the economy, and thus cool down inflation. The second way to look at this is the level of core inflation.

This is the inflation when one ignores the prices of food and fuel — two groups where prices fluctuate more. Core inflation is a measure of inflation in the broader economy and, typically, moves up and down far more gradually. In the last policy meeting, the RBI Governor had said that core inflation is a concern — it has stayed at the 6% mark since September, and in December inched up to 6.1%.

The core inflation picture suggests that while headline inflation may no longer be as big a worry as it was earlier, higher prices have seeped through in the broader economy. This means Indian consumers will have to pay higher prices even if food and fuel prices come down — everything from haircuts to rents will continue to be expensive.

This will cut into people’s budgets and drag down overall consumption. And that points to the bigger worry in 2023: sustaining fast economic growth.

Why is economic growth a bigger worry this year?

Essentially what India is likely to experience in 2023 is elevated core inflation — read higher prices across the board — and this will curtail consumption and dampen the demand among businesses to invest in new capacities. But there are three other big factors that are likely to drag down India’s economic growth in 2023.

One, the economy is already losing momentum. The First Advance Estimates of GDP for the current year released in the first week of January pointed to the economy slowing down significantly in the second half — that is, October to March. Data suggest while India’s GDP in the first six months of 2022-23 (April to September) grew by almost 10%, in the second half it is expected to grow by less than half that rate; just 4.5% to be precise.

Two, even while inflation hasn’t completely gone away, the RBI’s tighter monetary policy will take effect and drag down growth by making credit costlier.

Three, the domestic slowdown will likely to be exacerbated by the likely global slowdown. In a recent note, CRISIL research said: “Over the past two decades, India’s growth cycles have got increasingly synchronised with that of advanced economies since the 2000s due to enhanced integration of trade and capital flows.”

Given this past trend, the expected slowdown of GDP growth in the US from 1.8% in 2022 to a contraction of 0.1% in 2023, and from 3.3% to essentially zero growth in the European Union, does not portend well for India.

As a result, CRISIL expects the Indian economy to grow at just 6% in 2023-24. More to the point, in the 2023 calendar year, expectations are even more muted. Nomura Research, for instance, expects the GDP to grow by just about 5% in 2023.

Lower growth rate will make the already uncomfortable levels of joblessness in the country worse. Two, slower growth creates problems for the Union Budget because revenues start to falter and deficits begin to rise.

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