CPI inflation has ruled at or above the upper tolerance threshold of 6 per cent since January 2022 albeit with some moderation in recent months (Chapter II). Looking ahead, the three months and one year ahead median inflation expectations of urban households increased by 50 bps each in the September 2022 round of the Reserve Bank’s survey compared to the previous round4 . The proportion of respondents expecting the general price level to increase by more than the current rate also increased in both the three months and one year ahead horizons vis-à-vis the previous round (Chart I.3). Manufacturing firms polled in the July-September 2022 round of the Reserve Bank’s industrial outlook survey expected reduction in cost of raw materials as well as selling prices in Q3:2022-23 (Chart I.4a).5 Services and infrastructure sector companies also expected softening in input costs and selling prices in Q3:2022-23 (Charts I.4b and I.4c).6 The respondents in manufacturing and services PMI reported increase in input and output prices in August 2022, although with some moderation in the pace of inflationary pressures.
Professional forecasters surveyed by the Reserve Bank in September 2022 expected CPI inflation to soften from 7.3 per cent in Q1:2022-23, to 6.0 per cent in Q4, and 4.9-5.0 per cent in H1:2023-24 (Chart I.5a and Table I.3).7 Long-run inflation expectations of professional forecasters – measured by their 5- and 10-year ahead expectations – remained broadly aligned around the inflation target, albeit with a slight upward drift during the pandemic period. In the September round, the 5-year ahead expected inflation rose by 10 bps to 5.0 per cent while the 10-year ahead expectation remained unchanged at 4.5 per cent (Chart I.5b). Looking ahead, several exogenous factors – global and domestic – will impinge on the inflation outlook. Global commodity prices have come off their highs on weaker global prospects but remain elevated and volatile. Global supply chains are gradually normalising, although they remain vulnerable to geopolitical disturbances, pandemic-related lockdowns in major production hubs, and financial market volatility. Domestically, the record foodgrains production in 2021-22, the above normal southwest monsoon during 2022, the recovery in kharif sowing, ample buffer stocks and improved reservoir position augur well for agricultural prospects and the future trajectory of food inflation. Taking into account the initial conditions, signals from forward looking surveys and estimates from structural and other time-series models, CPI inflation is projected to average 6.7 per cent in 2022-23 – 7.1 per cent in Q2, 6.5 per cent in Q3 and 5.8 per cent in Q4, with risks evenly balanced. The 50 per cent and the 70 per cent confidence intervals for headline inflation in Q4:2022-23 are 4.7-6.9 per cent and 4.0-7.6 per cent, respectively. For 2023-24, assuming a normal monsoon, a progressive normalisation of supply chains, and no further exogenous or policy shocks, structural model estimates indicate that inflation will average 5.2 per cent. In Q4:2023-24, CPI inflation is projected at 5.2 per cent, with the 50 per cent and the 70 per cent confidence intervals at 3.5-7.0 per cent and 2.5-7.9 per cent, respectively. The baseline forecasts are subject to several upside and downside risks. The upside risks emanate from a further ratcheting up of geopolitical tensions, higher global crude and commodity prices, escalation in global financial market volatility due to aggressive monetary policy actions, longer-than-expected supply chain disruptions with shocks getting transmitted through highly integrated global supply chains, shortfall in kharif production, unseasonal rainfall and larger pass-through of input cost pressures to output prices as demand strengthens. The downside risks could arise from an early resolution of geopolitical tensions, further correction in global commodity prices due to slowing global demand, and further improvement in supply conditions with the ebbing of the pandemic.
The Outlook for Growth
Ebbing COVID-19 infections and improving consumer sentiment facilitated a rebound in demand for contact-intensive services and supported domestic demand in H1:2022-23. Industry and services sectors are holding up well and kharif sowing has seen a smart recovery. The above-normal southwest monsoon has improved reservoir levels which bodes well for the winter crops. Investment activity is expected to benefit from the government’s capex push, growth in bank credit, improving demand conditions and rising capacity utilisation. Geopolitical tensions, the upsurge in global financial market volatility and tightening global financial conditions, however, weigh heavily on the outlook. Turning to the key messages from forward-looking surveys, consumer confidence (the current situation index) increased further in the September 2022 survey round on account of improved perception on general economic situation and overall spending, though overall confidence remained in the pessimistic zone. Households remained optimistic for the year ahead, with the future expectations index remaining unchanged vis-à-vis the July 2022 survey round.
Optimism on demand conditions in the manufacturing sector for the quarter ahead waned marginally in the July-September 2022 round of the Reserve Bank’s industrial outlook survey, though it remained well in the expansion zone. Services sector companies expected slight moderation while infrastructure companies expected a minor uptick in Q3:2022-23 in terms of the overall business situation. Recent surveys by other agencies indicate a dip in business expectations over their respective previous rounds (Table I.4). In the August 2022 round of the PMI survey, business expectations of manufacturing and services firms improved to multi-year highs on optimism over strengthening demand. Professional forecasters polled in the September 2022 round of the Reserve Bank’s survey expected real GDP growth at 6.3 per cent in Q2:2022-23, 4.8 per cent in Q3 and 4.2 per cent in Q4, and at 6.4-6.6 per cent in H1:2023-24. Taking into account the baseline assumptions, survey indicators and model forecasts, real GDP growth is expected at 7.0 per cent in 2022-23 – 6.3 per cent in Q2; and 4.6 per cent each in Q3 and Q4 – with risks broadly balanced around this baseline path. For 2023-24, assuming a normal monsoon, and no major exogenous or policy shocks, the structural model estimates indicate real GDP growth at 6.5 per cent. There are upside and downside risks to the baseline growth path. Upside risks to the baseline trajectory could emanate from stronger-than-expected expansion in demand for contact-intensive services with the receding threat of the pandemic and festival spending; a boost to private investment activity from government’s capex push, improving bank credit, rising capacity utilisation, and healthier corporate balance sheets; and a favourable terms of trade shock in the case of a sharp correction in crude and commodity prices. On the contrary, an escalation in geopolitical tensions, further hardening of international crude oil and other commodity prices, sustained disruptions to supply chains, the upsurge in global financial market volatility, and a sharper loss of momentum in global trade and demand pose downside risks to the baseline growth path.
Balance of Risks
Baseline projections of inflation and growth are conditional on assumptions of the future course of key domestic and international macroeconomic variables set out in Table I.2. There are, however, sizeable uncertainties around the baseline assumptions, as stated earlier. This section explores plausible alternative scenarios to assess the balance of risks around the baseline projections.
(i) Global Growth Uncertainties The downside risks to global growth flagged in the April 2022 MPR have materialised. Headwinds from the war, elevated commodity prices, tightening financial conditions, capital outflows from emerging economies, and the slowing global activities could pull global growth further below the baseline. There are growing concerns of recession in major economies and the global outlook is bleak and risks are tilted to the downside. In such a scenario, if global growth is 100 bps below the baseline, domestic growth and inflation could be around 40 bps and 20 bps, respectively, below the baseline trajectories. Conversely, if there is an early deescalation in geopolitical tensions, the recent trend in falling commodity prices continues, and global inflation ebbs faster than expected, there can be a fillip to global growth. In this scenario, assuming that global growth surprises by 50 bps on the upside, domestic growth and inflation could edge higher by around 20 bps and 10 bps, respectively.
(ii) International Crude Oil Prices
Global crude oil prices remain at elevated levels, driven by geopolitical tensions, sanctions and supply management by OPEC plus. Further production curtailment by OPEC plus and the spike in the seasonal winter demand for energy amidst high natural gas prices could harden international crude oil prices. Assuming crude oil prices (Indian basket) to be 10 per cent above the baseline of US$ 100 per barrel, domestic inflation and growth could be higher by 30 bps and weaker by around 20 bps, respectively, over the baseline. Conversely, crude oil prices could soften below the baseline owing to global demand losing momentum and an easing of geopolitical tensions. As a result, if the Indian basket of crude prices falls by 10 per cent relative to the baseline, inflation could ease by around 30 bps with a boost of 20 bps to growth.
(iii) Exchange Rate
The INR depreciated in H1, driven by the generalised strengthening of the US dollar, higher crude oil prices and sales by foreign portfolio investors. Volatility in global financial markets is expected to persist due to the uncertainty around monetary policy normalisation in the US and other major advanced economies, which could put downward pressure on the INR. Should the INR depreciate by 5 per cent from the baseline, inflation could edge up by around 20 bps while GDP growth could be higher by around 15 bps through boost to exports. On the other hand, given India’s relatively better growth performance and outlook and strong domestic macroeconomic fundamentals, portfolio equity flows turned significantly positive in August 2022 and could increase further. In this scenario, if the INR appreciates by 5 per cent relative to the baseline, inflation and GDP growth could moderate by around 20 bps and 15 bps, respectively.
(iv) Food Inflation
Food inflation remained high during H1, driven by the war-induced jump in global food prices. Global food prices have started correcting and these are being reflected in the softening of domestic edible oil prices. Furthermore, kharif sowing has caught up with its long-term average. Reservoir levels are above last year’s and the decadal average, which augur well for the rabi crop. Although the area under paddy sowing has been lower than a year ago due to uneven distribution of south-west monsoon rainfall, ample buffer stocks of rice and effective supply management measures could soften food inflation more than anticipated, and push headline inflation 50 bps below the baseline. Conversely, global food prices could harden in view of the fragile geopolitical outlook and sustained input price pressures on critical inputs like energy and fertilisers. Furthermore, unseasonal heavy rainfalls during the harvesting period could impact the domestic crop. In such a scenario, there could be upward pressures on food prices and headline inflation could be around 50 bps above the baseline.
I.5 Conclusion
The Indian economy is advancing steadily, and is expected to be one of the fastest growing major economies in 2022. The above-normal south-west monsoon, improved reservoir position, government’s capex push, improvement in capacity utilisation, a broad-based revival in credit growth, strong corporate and bank balance sheets, upbeat consumer and business confidence and receding threat of the pandemic are all factors likely to provide impetus to growth. While inflation has eased somewhat from the April high, supported by some correction in global prices, it has ruled above the upper tolerance threshold around the target since January 2022. Monetary policy has moved into the withdrawal of accommodation mode and remains focussed to ensure that inflation returns to the target while supporting growth. The daunting global environment, however, imparts considerable uncertainty to the outlook.