OECD Economic Outlook, Volume 2021 Issue 2

India

After the second infection wave that peaked in May, the recovery is gaining momentum and GDP is projected to grow at 9.4% in fiscal year (FY) 2021-22 before reverting to 8.1% in FY 2022-23 and 5½ per cent in FY 2023‑24. Inflation has remained close to the upper band of the Reserve Bank of India (RBI), but should ebb as supply chain disruptions are overcome. Financial markets remain strong and capital inflows support the build‑up in reserves. The appearance of a new virus variant, especially if combined with a relaxation of attitudes, is the major downside risk, together with a less supportive global economic and financial environment.

The macroeconomic policy mix is well balanced. The RBI stands ready to act forcefully if increases in global commodity prices feed into wages and then to core prices. The government is also committed to invest more in social and physical infrastructure, although well-targeted, direct fiscal support to vulnerable households and firms should also be increased. Reducing unnecessary regulation in product and labour markets, accelerating the sale of public companies in non-strategic sectors, following the successful sale of Air India, and restructuring state-owned banks would boost investment and job creation.

After a dramatic second wave, the pandemic is steadily receding

The normalisation momentum came to a halt in winter and spring 2021 as the Delta variant caused a sharp increase in cases and fatalities. Intensive care capacity came under acute pressure and confinement measures were re-introduced, albeit limited to the most affected areas. The vaccine rollout started in January, covering 30 million healthcare and front-line workers, and was progressively extended to wider swathes of the adult population. By end-September, more than half of the eligible population had been given at least one jab and at mid-November, more than one Indian out of four was fully vaccinated.

India: Vaccination and confidence indicators

1. Based on every two-month current situation index (CSI). The missing monthly data are proxied by the average of neighbouring monthly data.

Source: CEIC; Oxford COVID-19 Government Response Tracker, Blavatnik School of Government; Markit; and OECD calculations.

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India: Demand, output and prices

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India: Economic activity and inflation indicators

1. Headline inflation refers to the change in price of all goods in the basket, while core inflation excludes food and fuel items. Seasonally adjusted and based on monthly consumer price index and core CPI (index 2012 = 100) provided by the Central Statistics Office.

Source: OECD Economic Outlook 110 database; and CEIC.

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The economic shock has been weaker than during the 2020 wave. Since the summer of 2021, growth has rebounded, pulled by exports, consumer demand and, more importantly, a very strong base effect. Most key high-frequency indicators, including sales of two-wheelers and tractors, are rising gradually and mobility indices sharply improved during the Diwali festive season and remain well-oriented. Consumer price inflation stood at 4.5% in October, a significant decline from the October 2020 reading of 7.6%. The recent moderation can be explained by base effects, an excellent monsoon season, a resumption of agriculture supply chains that lowered food prices (which account for 39% of the CPI basket) and administrative steps (such as lower import duties on edible oils). Both merchandise exports and imports have expanded forcefully, boosted by oil trade. Easier conditions in capital markets have benefited large corporates and young start-ups, with a record 51 initial public offers (IPOs) on the two main stock exchanges between January and November 2021. Foreign exchange reserves have increased due to strong foreign direct and portfolio investment flows. In 2021, the rupee has experienced a smaller depreciation against the US dollar than most emerging Asian peers.

The policy mix is appropriate and structural reforms would strengthen the recovery

Despite the economic recovery, GDP is still far from the pre‑crisis levels. Most fiscal measures taken in response to the pandemic, including enhanced support to informal workers, migrants and disadvantaged groups, remain in place. Tax revenues have soared, driven by the recovery in activity and deferred payments of taxes due in 2020. The privatisation of the state-run airline in October 2021 may open the way to further deals that make public enterprises more efficient under new ownership and augment fiscal space. Monetary policy has been similarly supportive, through rate easing and liquidity provision, although bank credit growth has remained subdued. Given the pressures from global commodity prices and supply disruptions maintaining RBI transparent communication of its commitment to the inflation target and exchange rate flexibility will be essential in the upcoming phase of monetary policy normalisation. With policy rates projected to rise in 2022, the exit of non-viable 'zombie' firms and effective non-performing loans (NPLs) resolution should be made easier. Two new entities have been established: the National Asset Reconstruction Company will acquire stressed assets from commercial banks, while the India Debt Resolution Company will sell them in the market.

In 2020-21, important structural reforms, including labour, insurance and ports liberalisation, advanced despite the pandemic. The priority should now be steady implementation of the new legislation. Other measures currently under consideration include the Mines and Minerals Bill, the reform of the judiciary, and the Insolvency and Bankruptcy Code (Amendment) Ordinance. The new National Bank for Financing Infrastructure and Development will address sizeable gaps in physical infrastructure, especially in rural areas. It will be important to put in place a credible medium-term fiscal strategy to bring down the debt‑to‑GDP ratio and create the fiscal space to meet multi-faceted development needs. At the recent COP26, India pledged to reach net zero by 2070 and to produce half of its energy from renewable resources by 2030. In this regard, investment needs to upgrade the power grid and scale up the share of renewables in installed capacity are huge and require a co-ordinated institutional framework and supportive regulation to attract capital.

Growth will remain robust, although it will slow down in 2023

Prospects of an economic rebound in India are firming up as GDP is set to expand by 9.4% in FY 2021‑22 and 8.1% in FY 2022-23, before moderating to 5½ per cent in FY 2023-24. Activity is supported by the increasing pace of vaccination, which is boosting consumers’ sentiment, and the inflation slowdown, which protects purchasing power. In the medium term, however, uncertainty over employment and earnings prospects will slow down the revival of households’ consumption. Growth, moreover, will be uneven: rural areas are struggling to absorb the huge flows of migrant returnees, while on the supply side the buoyancy of manufacturing boosted by the Production-Linked Incentive scheme contrasts with the slow return to normalcy of contact-intensive services. The current account will return to deficit, after the exceptional 2020 surplus. The economic outlook in FY 2023-24 is projected to deteriorate due to the lingering negative legacy of COVID-19 on key growth-drivers such as business investment in new machinery.

Headline inflation is projected to remain below the upper tolerance limit of the flexible inflation targeting approach, which it exceeded in FY 2021 due to rising commodity prices and supply disruptions, such as coal and chip shortages. The main risk is related to such disruptions: if they become entrenched, this could weigh on growth and un-anchor inflation expectations. An acceleration in consumer price inflation would weaken real income growth, affecting poor households in particular. Rising oil import prices could also worsen both the fiscal and current account balances.

Fighting poverty and investing in the future should remain the policy priority

India has made remarkable progress over the past two decades in accelerating economic growth and making a dent on poverty. Improving social policy delivery and targeting it better are now fundamental challenges to heal the scars left by the pandemic. Even though poverty rates have fallen from the peak reached in the 2020 lockdown, they are still well above 2019 levels as labour markets have yet to fully recover. In particular, low-skilled domestic migrants and urban workers, who bore the brunt of employment shocks in both waves, have yet to see their earnings return to pre-pandemic levels. And while India still enjoys a demographic dividend, the young face an adverse outlook. Schools have been mostly shut since March 2020, worsening the educational gap between different parts of society, and extra resources may be needed to avoid long-lasting damage to educational attainment and well-being. Inequality is also rising and in many industries market power is increasingly concentrated. Even during the crisis, the authorities have launched structural reforms that could boost potential growth, create better jobs and make it possible to achieve the Sustainable Development Goals. This momentum must be extended into other policy areas, such as sustainable energy and competition, and maintained in a spirit of open dialogue with all stakeholders, including independent civil society organisations.