India faces slowing growth but low risk of stagflation: Treasury

The Finance Ministry said on Monday that while India faces less risk of stagflation than other nations, additional social and subsidy spending and recent consumption tax cuts mean that the gross budget deficit is now at upside risk and the economy faces slowing growth too global factors.

In its latest Monthly Economic Report (covering the month of May), the Ministry of Finance stated: “India faces short-term challenges in managing its budget deficit, sustaining economic growth, containing inflation and curbing the current account deficit while maintaining a fair value of the Indian currency .”

Many countries, especially developed ones, are facing similar challenges, and India is relatively better placed to meet these challenges due to its stability in the financial sector and vaccination success in opening up the economy, the report said.

The economy’s medium-term growth prospects remain strong as pent-up capacity expansion in the private sector is expected to spur capital formation and job creation over the remainder of this decade. Short-term challenges must be carefully managed without sacrificing hard-earned macroeconomic stability, it said.

India’s economy grew 8.7 percent in the past fiscal year (2021-22), compared to a 6.6 percent contraction in the previous year.

Headline retail inflation for May 2022 slowed from an eight-year high in April to 7.04 percent on the base effect and lower food prices. It was still the fifth straight month that headline retail inflation was above the Monetary Policy Committee’s medium-term target of 4 (+/-2) percent, justifying the two recent central bank rate hikes.

“Preliminary estimates of GDP released on May 31, 2022 have confirmed the full recovery of the Indian economy beyond pre-pandemic levels, although contact-intensive sectors have yet to recover. The recovery will be driven by continued growth in agriculture, higher investment and rising exports,” the report said.

“Looking forward, however, global growth is expected to face headwinds with rising commodity prices, supply chain constraint and faster than projected withdrawal of monetary policy accommodation. Various international agencies have forecast a slowdown in global economic growth,” the report said, adding that India’s economy is also expected to see slower growth, albeit still higher than that of other emerging economies.

Walking the tightrope between maintaining growth momentum, curbing inflation, maintaining fiscal deficit and ensuring gradual exchange rate movement in line with underlying external economic fundamentals is the challenge for policy makers this fiscal year, and successfully managing it will be require prioritizing macroeconomic stability over short-term growth,” it said.

“Trade disruptions, export bans and the resulting rise in global commodity prices will continue to fuel inflation as long as the conflict between Russia and Ukraine continues and global supply chains are not repaired. The world faces a clear possibility of widespread stagflation. However, India faces a low risk of stagflation due to its prudent stabilization policies,” it said.

Stagnation is a situation where the inflation rate is high, economic growth is slowing and unemployment remains consistently high.

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