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5 factors will shape Indian economy in 2022, and you can be cautiously optimistic despite Covid

The third wave of the Covid-19 pandemic has hit India and it’s surging fast. But there is hope that it will be milder and shorter, and the Indian economy will continue to show the growth momentum it has shown over the past few months.

As Indians step into the new year, here are five key macroeconomic factors that will shape their economy in 2022.

Higher economic growth in 2022-23

The growth in gross domestic product (GDP) is expected to be higher in the 2022-23 fiscal. 

Incomes and output will rise not only because of the low base effect but also due to the recovery in business expectations and the anticipated improvement in both global and domestic demand. While the first few weeks of this year appear to be difficult due to the Omicron-led third wave, the following months are expected to see recovery getting back on track.

While the Omicron variant is highly transmissible, it has been seen to be less severe as compared to the previous variants. With improving vaccination rates, herd immunity and our ability to cope, the damage to life and livelihoods is likely to be limited.

By the end of 2021, over 61 per cent of the adult population had received both doses of the vaccine and about 90 per cent of the adult population had been given a single dose of the vaccine. Vaccination of teenagers has begun. The third dose of vaccination for healthcare workers and those above 60 years with co-morbidities is being rolled out. High vaccination rates will enable greater mobility and support demand recovery.

Given the uncertain nature of the virus, there could be some downside risks to growth, especially to contact intensive sectors, but these are likely to be restricted to the first few months of the year. Higher capital expenditure, push to infrastructure through the new institutional framework, boost to the manufacturing sector and buoyant exports are likely to be the key drivers of growth.

Also read: Omicron worries hit Indian economy just when it seemed poised to recover lost ground

High inflation

Inflation in advanced economies and emerging market economies has surged to record levels. The trajectory in India will be influenced by global headwinds such as elevated commodity prices, global logistics, supply side bottlenecks and prices of industrial raw materials.

The Wholesale Price Index (WPI)-based inflation, which captures these global factors, rose to a record high at 14.32 per cent in November 2021. The Consumer Price Index (CPI)-based retail inflation for November also spiked to 4.91 per cent. But the wide gap between WPI and CPI reflects price pressures on the wholesale side, which is likely to be passed on to the retail level in the coming months.

Several firms, particularly in the consumer goods sector have hiked the prices of their products due to rise in input costs. Cost push pressures are likely to weigh on core inflation in the coming months.

Further restrictions could lead to supply-side disruptions and add to inflationary pressures in early months of 2022. As supply disruptions ease and demand normalises, inflation could see a moderation during the course of the year. 

The Reserve Bank of India (RBI) has projected CPI inflation at 5.7 per cent for the January-March quarter. For the first half of the next fiscal year, inflation is projected to be at 5 per cent.

Also read: Why RBI must stick to fundamentals amid global churn to ensure macroeconomic stability

Volatile interest rates

The RBI has embarked on a normalisation of eased monetary policy undertaken since March 2020 to mitigate the distress due to the pandemic. 

While the RBI has kept the repo and reverse repo rate unchanged in its recent policy announcements, policy normalisation has begun through other measures such as the variable rate reverse repo auctions and sale of government securities. 

These actions have led to absorption of liquidity and have driven the short-term rates closer to 4 per cent. Short-term rates are expected to rise further in the coming months as the RBI will continue with policy normalisation amid elevated inflation.

Rates on long term bonds are at elevated levels driven by higher yields on US bonds and higher domestic inflation. The path of the long term yields will further depend on the fiscal situation. Yields on 10-year bonds are likely to climb further if the government targets a higher borrowing programme for the next fiscal.

Choppy financial markets

The year 2021 yielded massive returns for stock market investors. Improved profitability of companies, increased participation by retail investors, and a series of initial public offerings (IPOs) drove the rally in the market.

Global factors like the US Federal Reserve’s taper announcement and interest rate hikes along with risk from the Omicron variant are likely to cause volatility in markets. Foreign investors’ exposure to Indian assets and US dollar movement will also impact the market direction in the coming months.

Also read: Keep calm & continue reform — mantra for Modi govt and RBI as Indian economy braces for 2022

NPA growth in banking 

The RBI’s Financial Stability Report last week noted that banks have remained resilient amid the pandemic, cushioned by policy support. Bad loans across banks fell to a six-year low of 6.9 per cent in September 2021. The capital position of banks has also seen substantial improvement.

However, with the unwinding of policy support, the balance-sheets of banks may come under stress. Emerging signs of stress are visible in the micro, small and medium enterprises and personal loans segments. 

The report projects non-performing assets (NPAs) to rise to above 8 per cent by September under the baseline scenario. State-owned banks are likely to see a steeper jump in bad loans. They may also require higher capital to deal with the emerging stress being faced by some categories of borrowers. It may also make banks more cautious lenders.

In short, with both GDP and inflation rising, central banks around the world, including the RBI, may hike interest rates leading to instability in financial markets.

The new year is expected to bring both hope and caution.

Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy.

Radhika Pandey is a consultant at NIPFP.

Views are personal.

Also read: Modi govt’s pandemic strategy focused on revival has worked. Economic indicators prove it

Source: The Print

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