Domestic demand key to 2023 growth
Reopening after Covid-19 was a major positive catalyst for India’s growth in 2022, leading to a shift in growth momentum from goods to services. This trend was most obvious in private consumption (~60% of GDP), which contributed over 80% to GDP growth in the first three quarters of 2022, compared to 60% in the previous year. This was also clearly seen in retail services - a contact-intensive sector - with GDP data showing that the pace of growth in the trade, hotels and transport industry accelerated to nearly 14% y/y in the same period. Fixed investment (29% of GDP) rose again in 2022, although the contribution to growth was notably smaller than in the previous year. Net exports meanwhile was a larger drag on GDP due to the adverse shock in terms of trade caused by the surge in input and commodity prices.
A global slowdown, and further normalisation of domestic fiscal and monetary policies will weigh on India’s growth outlook in 2023. However, we expect the Indian economy to continue expanding at a robust pace, supported by domestic demand. Consumption recovery is expected to continue, helped by improving urban employment, and a potential uptick in rural income linked to larger rabi crops). Easing inflationary pressures will also benefit household purchasing power.
The central government’s continued emphasis on infrastructure investment through flagship programmes such as the National Infrastructure Pipeline and the National Logistics Policy will play a larger role in the country’s capital spending in 2023. Central government capital expenditure (capex) jumped 50% y/y to 3.42 trillion rupees in the April-September 2022 period, and a further increase was announced in the FY2023-24 budget in February 2023. The authorities’ supply-side push towards manufacturing such as the Make in India initiative, a production-linked incentive scheme, a programme for semiconductor and display manufacturing, and continued supply diversification would also provide the impetus for private sector investments. Private companies are also in a stronger financial position to raise capex after years of deleveraging and a boost in profits during the pandemic, which pushed corporate debt (52% of GDP in Q3 2022) to its lowest level since 2005. Conversely, goods and services exports face a challenging outlook in 2023 as growth is expected to slow markedly in advanced economies. This means that the net exports’ drag on GDP will likely widen and weigh on India’s growth momentum.
Narrowing the twin deficits
Slower growth and lower energy prices will help to narrow the current account deficit in 2023. The moderation in imports will likely be sharper than the slowdown in export growth, which is expected to be cushioned by resilient services exports. The current account deficit widened to 2.7% of GDP in the first nine months of 2022, due mainly to a sharp widening of the merchandise trade deficit to 8% of GDP, on back of sharply higher import values, and continued net outflows from the primary income account, reflecting payments of foreign investment income. Strong growth in the services trade balance (3.7% of GDP), on the back of rising exports of software, business and travel services, helped to partially ease the current account deficit.
Fiscal consolidation should continue, with the central government committed to bringing the budget deficit down to -6.4% of GDP in FY2022-23. Strong revenue, helped by rapid formalisation of the economy and windfall tax from excise fuel duties, partially offset a larger subsidy spending, and an increase in capex allocations. More careful targeting of subsidies and additional revenue generation (new taxes or asset sales) will be necessary to achieve a longstanding plan to narrow the fiscal deficit to -4.5% of GDP by FY2025-26.
Inflation and monetary policy
Headline inflation peaked in September 2022 and has begun to ease. The country is likely to have seen the worst of food inflation following a predicted strong 2023 harvest, and softening global food prices in the final months of 2022. Core inflation, however, is likely to be slower in catching up due to the delay in passing on higher costs and in the uptick of the services sector.
Inflation remains elevated despite interest rate hikes of 225 bps by the Reserve Bank of India in 2022, and moves to tightening liquidity. This implies the rate hike cycle has a little further to run, though the central bank is likely to be close to a pause in the latter half of 2023, especially if core inflation slows.
Stable political outlook
The ruling Hindu nationalist Bharatiya Janata Party (BJP) won four out of five state elections in March 2022, and secured a landslide victory in Gujarat in December 2022, the home state of prime minister Narendra Modi. This places the BJP well ahead of competition at the next general election that needs to be held by May 2024. The dominance of the BJP has been helped by the fragmentation of the opposition, particularly the Congress Party, at both the national and local levels.