State of the Indian Economy

Exports are emerging as the gamechanger and potentially the pivot of a higher growth trajectory for the economy. A dynamic export sector enables an economy to grow faster than the pace that is possible with the size of the domestic market. Beyond a vent for surpluses, exports are an expression of international competitiveness, technological maturity and productivity. Merchandise exports remained above US$ 30 billion for the sixth consecutive month. The pace of export growth has actually sustained and accelerated in the pandemic, emboldening the setting of an ambitious target of US$ 400 billion for 2021-22 and US$ 1 trillion by 2027-28. The export performance during the year so far is powered by double digit volume growth and market diversification. The Production Linked Incentive (PLI) scheme is attracting international attention as it works towards making Indian manufacturing globally competitive, creating economies of scale and integrating India into the global value chain. Districts as export hubs, scaling up micro, small and medium enterprise (MSME) exports from a share of 48 per cent of total exports to 60 per cent and exports of geographical indication (GI) products will impart competitive edge and product/market diversification. Agriculture exports have remained robust during the post-COVID-19 period. The new products with GI tags, having high nutritional and medicinal properties, have brought exclusivity in India's agricultural export basket, which would benefit more in the long run.

India's services exports remained strong in April-July 2021, rising by 15 per cent year-on-year (y-o-y) on the back of software exports. Major information technology (IT) companies recorded a revenue growth of over 20 per cent in Q1:2021-22 (y-o-y) in US dollar terms, led by the demand for cloud platform services, cyber security, analytics and insights and enterprise application services. The demand for IT services stemmed from verticals such as life sciences and healthcare, retail and consumer packaged goods, banking, financial services and insurance (BFSI) and manufacturing. Going forward, global IT spending (both software and hardware) is projected to increase by 8.6 per cent in 2021. In anticipation of growing demand, domestic IT companies are increasingly focusing on enhancing the domestic cloud talent pool.

In the financial markets, Indian equities have outperformed all emerging economy peers in 2021-22 so far, delivering the highest returns. By September 13, the BSE Sensex was more than 20 per cent higher on a year to date basis, on track for the best annual gain in four years. Valuations are stretched but supported by expectations of strong earnings growth (Chart 1)..

Typically, such rallies are driven by foreign portfolio investors (FPIs) and they are buying hand over fist, as discussed subsequently, but this time, the exuberance is a domestic investor story. Equity mutual funds attracted net inflows for the sixth consecutive month in August (Chart 2a). The number of systematic investment plan (SIPs) accounts registered in August alone was the highest-ever (Chart 2b). The phenomenon of the retail investor is also evident from the ballooning of the number of Demat accounts.

From net sellers in the market in the previous month, FPIs turned net buyers in August in both equity and debt markets. As a result, total FPI inflows crossed an intra-year peak in 2021-22 so far. India has become the third largest recipient of portfolio equity flows, after China and Brazil, in the calendar year 2021. FPI interest in the debt segment has gained traction in recent months in response to rising yield differentials and strengthening macro-fundamentals.

At the end of the month, the Q1 GDP data arrived. In April-June 2021, real GDP recorded its highest ever quarterly growth of 20.1 per cent, just a shade below the Reserve Bank's projection of 21.4 per cent and our nowcast of 22.1 per cent presented in the June edition of this article. In fact, if government final consumption expenditure is excluded, real GDP growth would have clocked 25.0 per cent. While attention has largely been drawn to base effects and the shortfall relative to pre-pandemic levels, the terrible experience with the second wave of the pandemic - when this GDP was being produced - should not be forgotten (Chart 3). The innate resilience of the Indian economy during the second wave stands out - the loss of output in Q1:2021-22 was 40 per cent of what was suffered during Q1:2020-21 when measured from the level of GDP recorded in Q1:2019-20 (pre-pandemic), owing no less to better adaptability of businesses and consumers and a surge in online deliveries and digital payments, as to the localised nature of restrictions.

Exports outstripped pre-pandemic levels and imports are poised to catch up, but private consumption and fixed investment are still work in progress. On the supply side, agriculture and allied activities continued to exhibit robust pandemic-proofing and industrial output reached 97 per cent of its pre-pandemic level. Financial, real estate and professional services, constituting the largest share in the services sector, are near catch-up but contact-intensive trade, hotels, transport and construction remained sluggish. The plateauing of infections and faster pace of vaccination is likely to hasten the convergence to pre-pandemic levels in various sectors. Authors' economic activity index (Kumar, 2021) nowcasts real GDP growth for Q2:2021-22 at 7.7 per cent, albeit, with support from the low base of last year.

Incoming data suggest that the global recovery has peaked, reflecting, in part, the wide divergences in the paths of advanced and emerging economies through the pandemic. With GDP data now available for the second quarter of 2021 across countries, the focus is shifting to the even wider divergences rending the emerging world asunder, which is most visible in recent monetary policy actions. Why have some emerging economies chosen to attack what they deem transitory inflation by tightening monetary policy even pre-emptively, while others like India have preferred to persist with accommodation and wait for their own cue to commence normalisation?

The proximate answer lies in differing underlying macroeconomic configurations. Countries that have tightened monetary policy are also growing rapidly. Several of them are commodity and services exporters. The boom in commodity prices and revenge tourism has translated into favourable terms of trade, growing incomes and the rapid escalation of inflationary pressures. A few emerging market economies (EMEs) are also beneficiaries of spillovers and trade advantages from better growth prospects in the US. Some of the most aggressive rate hikers of 2021 registered a near doubling of net exports in Q2 over Q1 (Chart 4). A few of these EMEs recovered to their pre-pandemic level of output by Q2:2021.

Commodity importers and/or those with relatively low proportions of their populations having been vaccinated are forced to tolerate above target inflation. These countries have resolutely maintained a pause as a hasty tightening in response to inflation largely brought on by supply-side disruptions and other pandemic-induced factors could stump growth prospects in a scenario where aggregate demand remains on a weak wicket.

There are a few EMEs - dominant global suppliers - which enjoy low inflation with economic expansion, in spite of the waves of the pandemic. With growth stalling in recent months, they have initiated monetary accommodation through cuts in reserve requirement ratios or targeted lending even in the face of increase in producer prices inflation.

Table 1: Economic Indicators for Select EMEs
Country	Inflation Target (Per cent)	Inflation (Per cent)	GDP Growth (Y-o-y growth, per cent)	YTD Change in Policy Rate (Basis points)	YTD Change in Exchange Rate (Per cent)	YTD Change in Stock Market Index (Per cent)
Average H1:2021	Average H2:2021 so far	Q2:2020	Q1:2021	Q2:2021
	Monetary Tightening; Terms of Trade Gainers
Brazil	3.75 1.5	6.5	9.3	-10.9	1.0	12.4	325	-1.0	-4.0
Chile	3.0 1.0	3.3	4.7	-14.3	0.5	18.1	100	-9.9	6.9
Hungary	3.0 1.0	4.2	4.8	-13.3	-2.1	17.9	90	0.2	25.5
Mexico	3.0 1.0	5.0	5.7	-18.7	-3.6	19.6	25	0.1	16.9
Russia	4.0	5.8	6.6	-7.8	-0.7	10.5	250	1.2	21.7
South Africa*	3.0 - 6.0	4.0	4.6	-16.9	-2.6	19.3	0	3.4	8.2
Turkey	5.0 2.0	16.3	19.1	-10.4	7.2	21.7	200	-12.2	-2.6
	Monetary Pause
India	4.0 2.0	5.2	5.4	-24.4	1.6	20.1	0	-0.9	22.1
Malaysia		2.4	2.2	-17.2	-0.5	16.1	0	-2.8	-3.1
Philippines	3.0 1.0	4.4	4.5	-17.0	-3.9	11.8	0	-3.9	-2.4
Saudi Arabia		5.5	0.4	-7.0	-3.0	1.8	0	0.0	31.4
	Monetary Easing; Subdued Growth
Indonesia	3.0 1.0	1.5	1.6	-5.3	-0.7	7.1	-25	-2.4	1.9
Thailand**	1.0 - 3.0	0.9	0.2	-12.1	-2.6	7.5	0	-8.5	8.2
	Monetary Easing; Economic Expansion and Low Inflation
China***		0.5	0.9	3.2	18.3	7.9	0	1.3	6.6
*: Not hiked rates yet, forward guidance of rate hike in Q4:2021. **: Not cut rates, last MPC meet one-third votes were for rate cut. ***: Not cut rates, non-rate actions to promote liquidity and lending. Note: Year-to-date (YTD) changes are up to September 10. Sources: Bloomberg; and centralbanking.com.

A smaller set of EMEs is experiencing low inflation, but growth is way below desirable rates (Table 1). These are the countries that are trying to rev up monetary stimulus, by either indicating a cut in rates going forward or extending asset purchase programmes. The proportion of their immunised population compares unfavourably with the countries that are growing strongly or have better growth prospects.

We have looked at a group of EMEs. This selection comprises the biggest EMEs, including BRICS and a few others from within the G20 group as also a few other prominent ones from outside the group. This selection includes both inflation targeting (IT) countries and non-IT countries. Also includes countries that have exchange rate pegged to the dollar. There is at least one country from each of the continents.

Growth rate - the current pace or the prognosis for subsequent quarters - is the main criterion for the compartmentalisation. Countries that have relatively higher growth are further bifurcated based on inflation outcomes. It is observed that amongst the 'growth leaders', IT countries have high inflation and the non-IT countries such as China have low consumer price inflation. Almost all IT growth leaders have tightened monetary policy or given indication of the same. These are the first group of countries inTable 1. These countries have a common characteristic of terms of trade gains accruing from commodity prices boom and also tourism revenues in a few cases. On the other hand, the non-IT growth leaders are initiating measures to support the flagging recovery.

Low growth countries are those where the rebound in Q2:2021 is not as strong as the decline in Q2:2020. This includes IT countries such as India and Philippines and non-IT countries such as Malaysia and Saudi Arabia. The latter two are also commodity exporters, but do not match up on the growth statistic with their peers. Inflation is a concern in two of them. Amongst low growth countries, there are two where central banks have undertaken further support measures.

1. Do you believe that the Indian economy is poised for a rapid comeback? What are the concern areas? (7 marks)
2. What are your thoughts on the growing threat of hyperinflation in emerging market economies (EMEs) from monetary expansion? (7 marks)
3. What types of economic policies, in light of the current economic climate, should be put in place? (6 marks)