Preface The India Development Update (IDU) reports on recent developments in India’s economy and places these in a medium-term and global context. Based on these developments and on policy changes over the period, the IDU updates the outlook for India’s economy. The report is prepared by a team from the Macroeconomics, Trade and Investment (MTI) Global Practice, under the guidance of Auguste Tano Kouame (Country Director), Mathew Verghis (Regional Director), and Hoon Sahib Soh (Practice Manager). The team is led by Dhruv Sharma (Senior Economist) and comprises, Ran Li, Tanvir Malik, Kanika Bhatnagar, Abhishek Anand, Aurélien Kruse, Mohini Gupta, Rishabh Chaudhury, Michel Ragnvald Mallberg, Nandini Krishnan, Nayantara Sarma, Naresh Kumar and Tushar Arora. The report benefited from in-depth feedback and inputs from Bhavna Bhatia. The findings, interpretations, and conclusions expressed in this report do not reflect the views of the Executive Directors of the World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The report does not necessarily reflect the views of the Government of India and the findings of the study are not binding on the Government of India. The report is based on data as of September 28, 2023. Photographs are copyright of World Bank. All rights reserved. To receive the IDU and related publications by email, please email: mbaruah@worldbank.org For questions and comments, please email: dsharma7@worldbank.org For information about the World Bank and its activities in India, please visit: www.worldbank.org www.linkedin.com/company/the-world-bank Table of Contents Preface ........................................................................................................................................... 1. EXECUTIVE SUMMARY ...........................................................................2 2. RECENT ECONOMIC DEVELOPMENTS .............................................4 a. Real sector and inflation ......................................................................................................... 4 b. Monetary and financial sector ...............................................................................................10 c. External sector .......................................................................................................................13 d. Fiscal sector and debt sustainability .....................................................................................17 3. OUTLOOK.................................................................................................. 20 REFERENCES ................................................................................................... 21 1. Executive Summary Global economic Global economic growth is set to slow in 2023, compared with the previous year. growth continues to Continued high inflation and the effects of monetary policy tightening added pressures slow down but to economic growth over the short term, particularly in the Europe. The fading rebound service activities of economic activities from the pandemic, combined with fragilities in the real estate remain robust, sectors, has eroded growth in China. While the growth outturn in the US over the first helping India’s half of 2023 has been stronger than expected, demand is weakening amid exhausting growth… excess savings accumulated during the pandemic; tightening credit conditions; and the banking sector turmoil earlier this year. Nevertheless, in contrast to softening global manufacturing activities, service sectors experienced solid growth in the past year, as measured by Purchasing Managers’ Indices (PMI). As a result, India, as a large service exporter, showed relative resilience against the challenging external conditions: India remained one of the fastest growing major economies in the world; in FY22/23, its GDP expanded by 7.2 percent, with robust growth in domestic demand bolstered by strong investment activity and solid private consumption. Net exports especially goods exports, however, were a drag on growth amid weakening global demand weighing on India’s merchandise exports and resilient domestic demand pushing up imports. …but the growth Growth is projected to moderate to 6.3 percent in FY23/24, as consumption growth momentum continues to decelerate, and external headwinds depress foreign demand. Real GDP grew moderated in the first 7.8 percent in Q1 FY23/24, thanks to strong public sector investment, steady private quarter of FY23/24 consumption growth, and lingering base effects. Private consumption growth accelerated relative to the second half of FY22/23 (to 6 percent), more than offsetting a contraction in government consumption, as remaining pandemic-related stimuli are progressively withdrawn. Investment grew strongly, with sharp increases in capital spending by both central and state governments. Slowing growth among major trading partner led to a contraction in India’s exports, while strong domestic demand kept import growth high. Thus, net exports contributed negatively to around 4.6 percent of total growth. Headline inflation Headline inflation averaged 5.3 percent y-o-y between April-July (compared to averaged 6.6 percent over FY22/23). After remaining within the Reserve Bank of India’s (RBI) 5.3 percent target range (2-6 percent) for the first quarter of FY23/24, inflation surged to 7.4 percent between y-o-y in July as unfavorable weather patterns caused food prices to spike. To mitigate the April-July impact on households, the government introduced temporary tariffs on onion exports, restrictions on stockpiling of certain crops, increased central government procurement and supplies to local markets from the central pool, as well as temporary bans on the export of several varieties of rice, wheat, and sugar. The impact of high food prices on overall inflation was partially offset by a moderation in fuel and energy inflation— primarily reflecting a high base effect (the prices of fuel and light grew by 10.5 percent on average during April-July 20221). Core inflation continued to moderate from 6.1 percent y-o-y in FY22/23 to 5.1 percent y-o-y in April-July—its lowest level since April 2020, thanks to modest growth in prices of transport and communication. 1 after the government removed subsidies on Liquid Petroleum Gas, used as cooking fuel, and kerosene The RBI has Given the expected transient supply-side drivers of inflation and moderate core inflation, held interest the Monetary Policy Committee (MPC) of the RBI kept the policy rate unchanged at rates steady 6.5 percent as of August 2023, and focused on withdrawal of monetary accommodation to and banks’ help keep inflation within the target range. The asset quality of scheduled commercial banks asset quality (SCBs)2 continued to improve, driven by higher loan growth, decline in slippages, better improved recoveries and write-offs of bad loans. The gross non-performing assets (GNPA) of SCBs as a ratio of gross advances reached its lowest level in a decade at 3.9 percent as of March 2023 compared to 5.9 percent in March 2022. With asset quality improving, bank credit grew by 15.8 percent in Q1 FY23/24 compared to 12.0 percent in Q1 FY22/23., driven primarily by personal loans and services segment. The current The current account deficit to GDP ratio widened to 1.1 percent in Q1 FY23/24, from a account deficit record low of 0.2 percent in the previous quarter (Q4 FY22/23). However, it remained widened to below the pre-pandemic average of 1.4 percent. The widening was driven by a sharp fall in 1.1 percent in exports, due to slowing demand from major trading partners and declining prices for Q1 FY23/24, refinery oil exports. Lower commodity prices also led to a drop in merchandise imports, but which remains this decline was not as steep as the fall in exports thanks to the relatively resilient domestic low demand. India’s current account balance remains adequately financed by net capital inflows. Foreign portfolio flows surged in Q1 FY23/24 and net foreign direct investment (FDI) inflows increased to 0.6 percent of GDP compared to a multi-year low of 0.2 percent in Q3 FY22/23, although remaining well below the pre-pandemic average of around 1.3 percent of GDP. Capital inflows, lower imports and RBI interventions to smooth exchange rate volatility helped the rupee remain relatively stable against the USD as of September 2023 data. The general The general government fiscal deficit declined to 9.0 percent of GDP in FY22/23 (from government 9.6 percent in FY21/22). The narrowing deficit, combined with the favorable growth- fiscal deficit interest rate dynamics, helped lower the public debt in FY22/23 to an estimated 82.9 percent declined in of GDP. In the first four months of FY23/24, both the central and state government front- FY22/23 along loaded spending, particularly on infrastructure and capital spending increased sharply, with the public- compared with the same period in FY22/23. Revenue growth was tepid at the start of the debt-to-GDP fiscal year but income tax collection picked up pace in August and September. While most ratio post-pandemic welfare support measures had already been withdrawn, the government announced an additional subsidy for cooking fuel in August. Nevertheless, the government remains committed to fiscal consolidation, especially on the current spending, expecting the annual fiscal deficit continues narrowing. Growth is Over the medium term, growth should hover around its potential rate between 6-6.5 projected to percent. Investment growth is projected to remain robust, supported by high public moderate investment and improved corporate and banking sector balance sheets. The current account further in deficit is expected to narrow as commodity prices are projected to decline relative to its peak FY23/24 as it in FY22/23, while services exports and remittances remain buoyant. The fiscal deficit is reverts to its projected to narrow gradually over the projection period, stabilizing public debt at around potential rate, 83 percent of GDP. Risks include slower-than-expected global growth, higher oil prices, and with external more persistent inflationary pressures. However, the risks remain manageable given India’s downside risks large and diversified economic base, and significant reserves buffers. 2Scheduled Commercial Banks refer to those commercial banks which have been included in the Second Schedule of the Reserve Bank of India (RBI) Act, 1934. These banks must have a paid-up capital and reserves of an aggregate value of not less than five lakh rupees. SCBs take up that vast majority of total assets of the commercial banks in India. 2. Recent Economic Developments a. Real sector and inflation Growth & labor market Real GDP growth Real GDP grew 7.8 percent year-on-year (y-o-y) in Q1 FY23/24. Though a deceleration remained high in from Q1 FY21/22, which also reflected prominent base effects, it is faster than over the Q1 FY23/24 preceding quarter (6.1 percent), driven by high public sector investment and private (April-June 23) consumption growth as well as lingering base effects. Private consumption growth accelerated to 6 percent (compared to 2.5 percent in the second half of FY22/23), more than offsetting a contraction in government consumption, as pandemic-related stimulus measures are being gradually withdrawn. Investment grew strongly, with a sharp increase in capital spending by both the central and state governments (Figure 2.1). Slowing global growth weighed on India’s exports, which contracted by 7 percent, while strong domestic demand kept import growth high at 10 percent. Thus, net exports had a large negative contribution to growth. Figure 2.1: Growth was bolstered by consumption and Figure 2.2: The services sector continued to drive growth investment in Q1 FY23/24 in Q1 FY23/24 (Contribution to GDP growth, percentage points, y-o-y) (Contribution to GDP growth, percentage points, y-o-y) 25 20 25 15 20 10 15 5 10 0 5 -5 0 -10 -5 -15 -10 Services C I Industry -20 -15 G Net exports Agriculture, Forestry and Fishing -25 Others GDP -20 GVA -30 -25 Q1 FY19/20 Q2 FY19/20 Q3 FY19/20 Q4 FY19/20 Q1 FY20/21 Q2 FY20/21 Q3 FY20/21 Q4 FY20/21 Q1 FY21/22 Q2 FY21/22 Q3 FY21/22 Q4 FY21/22 Q1 FY22/23 Q2 FY22/23 Q3 FY22/23 Q4 FY22/23 Q1 FY23/24 Q1 FY19/20 Q2 FY19/20 Q3 FY19/20 Q4 FY19/20 Q1 FY20/21 Q2 FY20/21 Q3 FY20/21 Q4 FY20/21 Q1 FY21/22 Q2 FY21/22 Q3 FY21/22 Q4 FY21/22 Q1 FY22/23 Q2 FY22/23 Q3 FY22/23 Q4 FY22/23 Q1 FY23/24 Source: NSO, CEIC and World Bank staff calculations. Note: “Others” includes change in inventories, valuables and discrepancies. The contribution of "others" was high in Q1 FY23/24 owi ng to large discrepancy between production and expenditure estimates of national accounts and may be expected to reconcile over time with subsequent revisions to the initial data release". On the supply side, Real Gross Value Added (GVA, which excludes subsidies and taxes on commodities) growth was driven by grew by 7.8 percent y-o-y in Q1 FY23/24 compared to 6.5 percent in Q4 FY22/23 services and (Figure 2.2). The services sector, accounting for over 50 percent of GVA, was the main construction … driver of growth. An acceleration in both credit and deposit growth in the financial sector, resilient growth in exports of technology and business services, and the continued recovery in high-contact services like retail, hospitality and travel all contributed to the double-digit growth. Meanwhile, the construction sector grew 7.9 percent on the back of strong public investment in infrastructure. However, growth remained modest in manufacturing due to the slowdown in global activity. Agriculture growth also slowed sequentially to 3.5 percent due to unseasonal rain during the harvest period. Economic indicators High frequency indicators suggest economic activity continued to expand in July-August. suggest robust The index of eight core industries, which account for 40 percent of the Index of Industrial activity in Production, grew by 8 percent in July (y-o-y). The Purchasing Managers’ Index (PMI) also Q2 FY23/24 remained high reflecting favorable conditions of the manufacturing and services sectors. Proxies for domestic demand like vehicle sales, domestic air travel, and GST e-way bills all showed that the growth momentum continued from the previous quarter. Bank credit growth also accelerated to nearly 20 percent, driven by greater credit demand in the services and retail sectors (Figure 2.3). Figure 2.3: Credit growth has accelerated Figure 2.4: The unemployment rate moderated in Q3 (contribution, percentage y-o-y) (unemployment rate, percentage) 20 25 Food Industry Covid- Covid-19 Covid-19 Services 19 first second third 15 Personal Loans 20 wave wave Others India Total credit, y/y 10 15 Urban Rural 5 10 0 5 -5 0 Nov-18 Nov-19 Nov-20 Nov-21 Nov-22 Mar-19 Mar-20 Mar-21 Mar-22 Mar-23 Jul-18 Jul-19 Jul-20 Jul-21 Jul-22 Jul-23 Apr-20 Apr-21 Apr-22 Aug-20 Aug-21 Aug-22 Jun-20 Dec-20 Jun-21 Dec-21 Jun-22 Dec-22 Oct-20 Feb-21 Oct-21 Feb-22 Oct-22 Feb-23 Source: NSO and World Bank staff calculations. Source: CMIE and World Bank staff calculations The urban labor The urban labor market continues to improve in FY22/23; unemployment rates have market continues to declined further (Figure 2.4), while the worker-population ratio shows marginal improve in 2023, but improvement34. As per the data from the Periodic Labour Force Survey (PLFS), the at a slower pace for quarterly urban unemployment rates have steadily declined over the last year; between females Q4 FY21/22 and Q4 FY22/23, the urban unemployment rate declined from 8.2 to 6.8 percent, based on the current weekly status5 (CWS). Figure 2.5 shows that the decline was more significant for youth (15-29 years) and males, by 2.8 and 1.7 percentage points, respectively; particularly, the unemployment rate for youth has halved in Q4 FY22/23 from its peak of above 34 percent in Q1 FY20/21. In contrast, unemployment for females only decreased by 0.9 percentage points over the year (Box 2.1). 3 The labor force participation rate refers to the percentage of the working-age population (aged 15+) who are either employed or actively seeking work (unemployed); the worker-population ratio represents the proportion of the working-age population that is currently employed (workforce). 4 The PLFS and the International Labor Organization (ILO) treat forms of unpaid work differently in their definition of employment. As a result, national estimates of LFPR, WPR, and unemployment rates may differ from those based on latest ILO guidelines; details of ILO standards, see: https://ilostat.ilo.org/resources/concepts-and-definitions/forms-of-work/ 5 All estimates are based on national definitions and using current weekly status which uses a reference period of 7 days preceding the date of survey to determine the employment status. While PLFS provides estimates based on the current weekly status and the usual status approach, the latter using a reference period of one year. Figure 2.5: Unemployment rates declined more Figure 2.6: …and the increase in women’s worker significantly for males and youth… population ratio was driven by unpaid family work (Quarterly urban unemployment rate for males, females, and youth) (Quarterly urban worker population ratio) Male Female Youth Male Female Youth 40.0 80.0 35.0 34.7 70.0 67.9 69.1 30.0 60.0 56.9 25.0 50.0 22.7 20.0 21.1 40.0 17.3 32.6 15.0 20.7 30.0 30.1 11.7 24.4 10.0 20.0 20.6 9.2 16.5 15.5 5.0 6.0 10.0 0.0 0.0 Jul-Sep Jul-Sep Oct-Dec Jan-Mar Jan-Mar Jan-Mar Jul-Sep Jul-Sep Oct-Dec Jan-Mar Jan-Mar Jan-Mar 2017 2018 2019 2021 2022 2023 2017 2018 2019 2021 2022 2023 Source: Periodic Labour Force Survey, multiple years, World Bank Staff Calculations Box 2.1: Jobs for women and in the rural areas continue to lag jobs for men The urban worker population ratio (WPR) shows a marginal improvement relative to Q4 FY21/22; it increased by 1.4 and 2.3 percentage points for males and females, respectively. However, the increase in WPR for women is primarily driven by an increase in the share of women in unpaid work to 11.7 percent, a 1.5 percentage point increase since Q4 FY21/22. In Figure 2.6, we see that the WPR for males, females, and youths (15-29 years) have improved after a decline in 2020 and are now at their highest level since 2017. While the male labor force participation rate (LFPR) in urban areas has remained stagnant between Q4 FY21/22 and Q4 FY22/23 at 73.5 percent, female LFPR increased by 2 percentage points to 22.7 percent6. Furthermore, studies using cross-country data have found that high-income and low-income countries have the highest female LFPR, while middle-income countries have the lowest (Goldin, 1994). However, is significant variation in female labor force participation across Indian states, the relationship with per capita income is not fully consistent with U-shaped pattern (Figure 2.7). Hilly states like Himachal Pradesh, Meghalaya, and Nagaland have higher female LFPR relative to the per capita income, in contrast, more industrialized states such as Maharashtra, Gujarat, and Haryana have lower female LFPR despite their higher per capita income. Figure 2.7: Economic growth and women’s participation in the labor market in Indian states, 202 1-22 60.0 35 x 10000 Female labor force participation 30 Net State Domestic Product 50.0 Female LFPR per capita NSDP 40.0 25 20 30.0 15 20.0 rate (%) 10 10.0 5 0.0 0 Andaman &… Jammu & Kashmir-… Tripura Gujarat West Bengal Goa Telangana Madhya Pradesh Assam Manipur Uttar Pradesh Bihar Himachal Pradesh Meghalaya Tamil Nadu Mizoram Karnataka Kerala Uttarakhand Rajasthan Odisha Chandigarh Chhattisgarh Jharkhand Punjab Nagaland Haryana Delhi Sikkim Puducherry Arunachal Pradesh Maharashtra Andhra Pradesh Source: Periodic Labour Force Survey, and Ministry of Statistics and Programme Implementation Note: NSDP per capita in constant prices. 6 The estimates use international standards developed by the International Labor Organization; details see: https://ilostat.ilo.org/resources/concepts-and-definitions/forms-of-work/ Moreover, the quality of women’s jobs in India is much lower than that of men, and the share of regular salaried employment for women in urban areas is declining. According to data from PLFS (2021-22), women in India are almost three times less likely to be employed than men; even when they are employed, the average quality of their jobs is much lower their male counterparts. Based on the Job Quality Index (JQI) which rates regular salaried and casual-wage jobs from 0-4 based on income adequacy, employment benefits, written contracts, and job satisfaction parameters, jobs for women in the rural areas were rated at 1.0 between July 2021 and June 2022. In contrast, the JQI for rural men stood at 2.1, underscoring a substantial gender disparity in job quality in rural areas. In urban areas, the gender gap in JQI is less pronounced, with men’s having a JQI of 2.6 and women’s at 2.0 ( Figure 2.8). According to Q4 FY22/23 PLFS data for urban areas, a higher share of women workers (54.2 percent) is employed in regular salaried jobs than men (47.3 percent). However, regular salaried positions, offering benefits such as written contracts, health insurance, and social security benefits have remained stagnant between 2017 and 2023. In fact, between Q4 of FY21/22 and FY22/23, the share of men employed in regular salaried jobs increased by over a percentage point while women’s share declined by over two percentage points to 54.2 percent. In the past decade, real wages in rural areas have marginally declined for agricultural work and remained stagnant for non-agricultural work. The PLFS data for rural areas is released annually, the latest available data is for July 2021-June 2022 and does not allow for wage monitoring at the monthly level. However, data from the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) program indicates that the demand for these jobs in FY22/23 exceeded that of the pre-pandemic period. MGNREGA is often referred to as the employer of the last resort as it guarantees employment for those who cannot otherwise find work and at a wage lower than the prevailing market rates, effectively setting a wage floor. Furthermore, monthly wage data from the Labour Bureau indicates that the real daily wages of rural workers, both agricultural and non-agricultural, have remained unchanged since 2013 with some volatility (Figure 2.9). The high demand for MGNREGA jobs, and stagnant wages indicate a surplus of labor and a lack of employment opportunities in the rural sector. Figure 2.8: Job quality in rural and urban regions Figure 2.9: Daily wages of rural, male workers (Job Quality Index) (Real wages per day, INR) Female Male Agricultural Non-agricultural 3.0 2.6 250 2.5 240 2.1 2.0 230 2.0 220 1.5 210 1.0 200 1.0 190 0.5 180 Apr-20 Nov-13 Jun-14 Mar-16 Jul-18 Nov-20 Jun-21 Mar-23 May-17 Aug-15 Dec-17 Sep-19 Aug-22 Oct-16 Feb-19 Jan-15 Jan-22 0.0 Rural Urban Source: Periodic Labour Force Survey, 2021-22; Labour Bureau daily wages from DBIE-RBI, World Bank Staff Calculations. Note: Wages are deflated by rural state CPIs (2012=100). Inflation Headline Headline inflation averaged 5.3 percent y-o-y in April-July (from 6.6 percent during full-year inflation FY22/23, Figure 2.10). After remaining within the RBI’s tolerance range (of 2-6 percent) averaged for the first quarter of FY23/24, it spiked to 7.4 percent y-o-y in July before moderating to 5.3 percent 6.8 percent in August. The principal driver was a significant increase in food prices (which between account for nearly 46 percent of the consumer basket) due to unfavorable weather patterns April-July 2023 (Figure 2.11). To address price volatility, the government introduced several supply-side measures, including tariffs on onion exports, restrictions on stockpiling of certain crops as well as temporary bans on the export of several varieties of rice, wheat, and sugar. Overall inflation was contained by a moderation in fuel and energy inflation (averaging 4.4 percent y-o-y in April-August). The moderation in fuel and energy inflation reflected a high base (the prices of fuel and light grew 10.6 percent on average in April-August 2022 following a sharp rise in LPG and kerosene prices7 driven by rising global energy prices). Retail selling prices for petrol and diesel remained unchanged over the past 13 months (despite a fall in global crude oil prices). This was offset by higher electricity tariffs (up 13.8 percent and 13.5 percent y-o-y in July and August). Though food prices fell and inflation eased to 6.8 percent in August, risks remain from the monsoon deficiency and its evolving impacts on prices, El Niño phenomena, and global supply chain disruptions. Figure 2.10: Headline inflation spiked in July… Figure 2.11: …reflecting a sharp rise in food prices (percentage, y-o-y) (Contribution to headline inflation, percentage points) Food Tobacco etc Headline CPI 10 Clothing Housing 14 Core CPI Food & Beverages Fuel Miscellaneous Fuel & Light Headline CPI inflation 12 8 10 6 8 6 4 4 RBI's tolerance range (2-6 percent) 2 2 0 0 Apr-21 Apr-22 Apr-23 Aug-23 Aug-20 Aug-21 Aug-22 Dec-20 Jun-21 Dec-21 Jun-22 Dec-22 Jun-23 Oct-20 Feb-21 Oct-21 Feb-22 Oct-22 Feb-23 Aug-20 Apr-21 Apr-22 Apr-23 Aug-21 Aug-22 Aug-23 Dec-20 Jun-21 Dec-21 Jun-22 Dec-22 Jun-23 Oct-21 Oct-20 Feb-21 Feb-22 Oct-22 Feb-23 Source: CEIC and World Bank staff calculations. Note: Shaded portion Source: CEIC and World Bank staff calculations. represents the RBI’s tolerance range (2-6 percent) Core inflation Core inflation decelerated from 6.1 percent y-o-y in FY22/23 to 5 percent y-o-y—its lowest eased to level since April 2020 (Figure 2.12), thanks to modest growth in prices of transport and average communication. Prices of apparel, footwear, and household goods and services, also grew 5 percent in modestly, possibly reflecting stable transportation costs. Easing global commodity prices April-August since the beginning of 2022 kept WPI inflation subdued in April-August. The WPI fell 2023 2.1 percent over this period. The contraction in wholesale price inflation slowed in August, to 0.6 percent y-o-y (from 1.4 percent in July) due to an upswing in the wholesale prices for primary commodities, predominantly food which partially offset the continued contraction in the wholesale prices of fuel and manufactured items (Figure 2.13). 7The government started a targeted subsidy of INT 200 per 14.2 Kg cylinder for Pradhan Mantri Ujjwala Yojana (PMUY) beneficiaries for up to 12 refills a year for select households under PMUY. Figure 2.12: Core inflation moderated in H1 FY23/24 Figure 2.13: An uptick food prices offset overall wholesale before picking up slightly in July. price decline (Contribution, percentage, y-o-y) (Contribution, percentage, y-o-y) Others Primary articles Fuel & power Education and health 20 Transport & Communication Manufactured products WPI 6 Household G&S Housing 15 Core CPI 4 10 5 2 0 0 -5 Apr-21 Apr-22 Apr-23 Aug-20 Aug-21 Aug-22 Aug-23 Jun-22 Dec-22 Dec-20 Jun-21 Dec-21 Jun-23 Oct-20 Feb-21 Oct-21 Feb-22 Oct-22 Feb-23 Apr-21 Apr-22 Apr-23 Aug-23 Aug-20 Aug-21 Aug-22 Dec-20 Jun-21 Dec-21 Jun-22 Dec-22 Jun-23 Oct-21 Oct-20 Feb-21 Feb-22 Oct-22 Feb-23 Source: CEIC and World Bank staff calculations. Source: CEIC and World Bank staff calculations. Box 2.2: Government implemented measures to counter food inflation pressures Adverse weather conditions combined with geopolitical tensions raised food inflation. Uneven and scarce rainfall in July-August across large parts of the country impeded the sowing of staple crops like paddy and sugarcane, potentially affecting rice and sugar supplies. The discontinuation of the Black Sea Grain Initiative8 (which is expected to cause supply disruptions of wheat and sunflower oil), unfavorable weather in Canada and the USA (that might curtail soybean and rapeseed supplies), and dampened production in Malaysia have amplified global concerns regarding further spikes in wheat and vegetable oil prices. The government took steps to address supply shortages and mitigate price volatility. Further steps to compensate farmers adversely affected by export restrictions and adverse weather conditions may also be taken. Government response Applicable food Timeline items Increased procurement to raise buffer stocks of food items Tomatoes and onions To be continued till and supply in major consumption centers: government prices stabilize agencies (National Agricultural Cooperative Marketing Federation of India and National Cooperative Consumers' Federation of India Limited) were directed to increase the procurement of certain food items to increase government buffer stocks of the centralized procurement system (also known as the central pool). Increased supply through calibrated releases from the Pulses (tur, urad, To be continued till central pool: the government is expected to periodically moong, Masur and prices stabilize release food stocks in local markets to ensure continuous gram) and onions supplies of staple food items at affordable rates. Increased supply through the Open Market Sale scheme: Wheat and rice To be continued till Increased releases of food grains from the central pool by the prices stabilize Food Corporation of India to traders, bulk consumers and retail chains, to influence retail prices. 8The Black Sea Grain Initiative was an agreement between Russia, Ukraine, Turkey and the United Nations during the Russian invasion of Ukraine, effective for a year from July 2022 to July 2023, to allow the safe transportation of grain and food items from Ukrainian ports. The G20 held in New Delhi (9-10 September 2023) has called for revival of the Initiative. Hoarding prevention: Wholesale and retail stock limits Pulses (tur and urad) Till October 31st imposed on certain varieties of pulses and wheat under the Wheat 2023 (pulses) and Essential Commodities Act (1955). March 31st 2024, respectively (wheat) Bharat Dal Initiative: a new initiative to provide pulses (chana Pulses (chana) To be continued till dal) at subsidized rates. prices of chana stabilize Export duties and temporary export bans: The government Onions and non- Till December imposed a 40 percent duty on onion exports and banned basmati rice 31st2023 exports of non-basmati white rice (beginning July 20th). The government also imposed 20 percent duty on parboiled rice and placed a minimum export price of USD 1200 per ton on basmati rice. Removal of import duties: imports of certain pulses have Pulses (tur, urad and Till March 31st, 2024 been made temporarily duty free. masur) The government is expected to continue to take supply-side interventions to maintain food supply and contain price volatility. Food items contribute to roughly 46 percent of the Indian consumer basket— comparable to 53 percent in Indonesia, 49.8 percent in Vietnam and 36.7 percent in China. Given the high share of food in household expenditure, particularly in low-income households, food prices directly affect household welfare and also play a role informing inflation expectations and wage setting. As a result, several governments in the region have used fiscal instruments, such as cash transfers and income support to boost household purchasing power during crises. In the past, the Indian government also resorted to increased food distribution using the public distribution system to ensure food security and temporary trade restrictions to prevent supply shortages of staple food items. b. Monetary and financial sector The MPC kept the After hiking the policy rate by a total of 250 basis points (bps) between May 2022- policy rate February 2023, the MPC paused in April 2023 as inflation eased to near 4 percent – unchanged the mid-point of the RBI’s target range. The policy repo rate currently stands at 6.5 percent and the Standing Deposit Facility (SDF), the overnight deposits of commercial banks with the RBI, remains 25 bps below the repo rate (Figure 2.14). Despite an increase in inflation in June and in July due to a spike in food prices caused by supply chain disruptions and adverse conditions, the MPC has not changed the policy rate as it expects these developments to be transitory. RBI remains The RBI’s interventions to keep inflation within the target range has led to a moderation committed to mop- in liquidity in the banking system. In its third bi-monthly policy announcement of up surplus liquidity, FY23/24, on August 10, 2023, RBI introduced an incremental cash reserve ratio (I-CRR) resulting in of 10 percent to manage excess liquidity (partly caused by the return of the Rs. 2000 notes moderation in to the banking system following the decision to withdraw these notes from circulation in liquidity in the May). Banks have been mandated to maintain a I-CRR of 10 percent on incremental banking system deposits made between May 19 and July 28. Consequently, excess liquidity in the system has declined from an average of INR 2.2 trillion in the first half of August 2023 to INR 0.5 trillion in last week of August 2023 (Figure 2.15). Figure 2.14: After six successive rate hikes, the MPC Figure 2.15: Surplus liquidity in the banking system has maintained status quo in FY23/24 declined after the introduction of I-CRR (percent) (INR trillion) 7.0 liquidity deficit 0.5 100 6.5 90 0.0 80 6.0 70 5.5 -0.5 RBI 60 excess liquidity introduces 50 5.0 -1.0 I-CRR 40 4.5 Policy Repo Rate 30 Reverse Repo Rate -1.5 RBI withdraws Rs. 20 4.0 SDF Rate 2000 notes from 10 3.5 -2.0 circulation 0 13-May-23 1-Jan-23 14-Feb-23 31-Aug-23 23-Jan-23 8-Mar-23 4-Jun-23 30-Mar-23 21-Apr-23 26-Jun-23 9-Aug-23 18-Jul-23 3.0 Jul-22 Jun-18 Jun-19 Jun-20 May-17 Mar-21 Jul-21 Mar-22 Mar-23 May-16 Nov-21 Nov-22 Aug-23 Sep-16 Sep-17 Jan-16 Jan-17 Jan-18 Oct-18 Feb-19 Oct-19 Feb-20 Oct-20 Source: CEIC, RBI, World Bank staff calculations Note: Liquidity refers to 1-month rolling average of outstanding n net amount under RBI’s liquidity absorption facility. Source: RBI, World Bank staff calculations India’s financial The asset quality of Scheduled Commercial Banks (SCBs)9 continued to improve in sector remains FY 23/24 driven by higher loan growth, lower slippages, better recoveries and write- strong, with offs of bad loans. The gross non-performing assets (GNPA) ratio of SCBs reached its further lowest level in a decade (3.9 percent) in March 2023 (Figure 2.16). The improvement improvement in in asset quality has been broad based, with a steady decline in the stressed advances asset quality ratio across all major sectors. Asset quality also improved across all manufacturing sub- sectors. Asset quality in the large borrower portfolio improved significantly with the share of top 100 borrowers in SCBs’ GNPA declining from 6.8 percent in March 2022 to 1.6 percent in March 2023. Capital adequacy (the capital to risk weighted assets ratio) improved from 16 percent in September 2022 to 17.1 percent in March 2023. SCBs’ profit after tax grew 38.4 per cent (y-o-y) during 2022-23, with a strong increase in net interest income and lowering of provisions. Credit growth Credit growth remained buoyant, on the back of robust private consumption and sustained double- improvements in asset quality of banks. SCBs’ credit growth (y-o-y), which started digit growth in accelerating since early 2022, remained in double-digits in FY23/24, driven by services Q1FY23/24 and personal loans even as industrial credit slowed (Figure 2.17). Credit growth averaged 15.8 percent in Q1 FY23/24 compared to 12.0 percent in Q1 FY22/23. The personal loans segment grew 19.9 per cent (y-o-y) with all major segments registering robust expansion. Bank credit to the services sector grew by 23.3 percent in (y-o-y) primarily driven by non-banking finance companies. However, credit growth to industry remained solid at 8.1 percent in June 2023, though slowed down from its peak at 13.6 percent in October 2022 partially attributing to the end of the Emergency Credit Line Guarantee Scheme10. The availability of funds with SCBs to meet the credit demand continued to improve in FY23/24. Growth in outstanding deposits accelerated to 13 percent by June 2023 from 9.6 percent in March 2023. 9 Scheduled Commercial Banks refer to those commercial banks which have been included in the Second Schedule of the Reserve Bank of India (RBI) Act, 1934. These banks must have a paid-up capital and reserves of an aggregate value of not less than five lakh rupees. 10 The ECLGS was launched in May 2020 as a part of the central government's Covid-19 measures. Under the scheme, the central government provided 100 percent guarantee coverage to banks and NBFCs to enable them to extend emergency credit facilities to MSMEs to meet their additional term loan/ additional working capital requirement. Figure 2.16: Gross NPAs have fallen across all banks Figure 2.17: Credit growth in double-digits, with (percent) increased contribution of personal loans and services (Growth, y-o-y percent) Others Personal Loans 12.6 14 Services Industry 10.8 Agriculture and Allied Activities Total 12 18 9.5 9.3 10 8.4 7.6 7.5 8 13 5.9 5.2 5.1 6 4.8 3.9 3.7 3.7 8 3.0 4 2.8 2.4 2.3 2.2 1.9 2 3 0 Public Private Foreign All SCBs Banks -2 Apr-21 Jun-21 Apr-22 Jun-22 Apr-23 Jun-23 Aug-21 Aug-22 Dec-22 Dec-21 Oct-21 Feb-22 Oct-22 Feb-23 Mar-19 Mar-20 Mar-21 Mar-22 Mar-23 Source: RBI Source: RBI, World Bank staff calculations Various factors drove The benchmark yield on 10-year sovereign bonds declined sharply from 7.3 percent on the recent large April 3, 2023, to 7.0 percent by May 31, before jumping back to 7.2 percent by the end of movement in the August (Figure 2.18). The temporary softening of yield between April and May may be 10-year benchmark attributed to the pause of monetary policy rate hikes, easing of liquidity condition of the yield banking system, and the decline in US treasury yields. However, from June onwards, rising inflation, tightening of liquidity conditions, and growing expectations of the Fed increasing interest rates, pushed up the 10-year yields. The new condition also facilitated market expectations that the RBI is likely to hike interest rate, as reflected in the steepened yield curve, which calculates the difference in yields of securities with different maturities. India’s financial Equity markets have been performing strongly since the onset of FY 23/24 and scaled markets reached new new highs in July 2023, driven by robust corporate earnings, the moderation in inflation highs in July and easing global commodity prices. However, the market witnessed some correction in followed by some August, prompted by Fitch's US credit rating downgrade and poor economic outcomes in correction in August China and Europe (Figure 2.19). On balance, from April 1 to August 31, 2023, the Sensex and Nifty 50 surged by 9.9 percent and 10.9 percent respectively. The rally was spearheaded by sectors such as automobiles, oil and gas, insurance, banking, and capital goods. In contrast, sectors with deep global ties, including chemicals, IT, and metals, faced headwinds. Figure 2.18: Benchmark yield and short-term interest Figure 2.19: Financial markets have moderated after rates have trended upwards since June 2023 reaching historic highs in July 2023 (percent) (index) 1-year 10-year benchmark Sensex Nifty 50 (right axis) 9 70000 20000 60000 18000 8 16000 7 50000 14000 40000 12000 6 10000 30000 8000 5 20000 6000 4 4000 10000 2000 3 0 0 Mar-18 Mar-19 Jul-20 Apr-21 Jul-21 Mar-22 Apr-20 Jul-21 Mar-23 Jun-18 Dec-18 Aug-19 Nov-19 Dec-21 Jun-22 Nov-22 Aug-23 Jun-19 Nov-19 Dec-21 Aug-23 Sep-18 May-19 Sep-21 Sep-22 May-23 Sep-20 May-22 May-20 Jan-18 Feb-20 Oct-20 Jan-21 Feb-23 Feb-21 Oct-22 Jan-19 Source: RBI Source: Nifty and BSE Limited c. External sector The current account The current account deficit-to-GDP ratio widened to 1.1 percent in Q1 FY23/24 from a deficit widened to record low of 0.2 percent in the previous quarter (Q4 FY22/23). However, the deficit 1.1 percent in remained below the pre-pandemic (FY16/17-FY19/20) average of 1.4 percent of GDP Q1 FY23/24 but (Figure 2.20). Services export growth was robust, particularly for IT, professional and remains below the management services, and bolstered the services trade surplus in Q1(Figure 2.21). In pre-pandemic contrast, India’s merchandise exports fell sharply reflecting the weakening external average demand, and the goods trade deficit widened to 6.6 percent of GDP in Q1 FY23/24 (+0.6ppt from Q4 FY22/23). Resilient inflows of workers’ remittances boosted income receipts (both primary and secondary) in both Q4 FY22/23 and Q1 FY23/24. Figure 2.20: The current account deficit widened in Figure 2.21: …primarily due to a widening merchandise Q1 FY23/24… trade deficit (Percentage of GDP) (Percentage of GDP) 6 Current Account Balance 15 Goods balance, excl. gold Average, FY19/20 Non-monetary gold balance Services balance Average, FY20/21 Primary income balance 4 Average, FY21/22 10 Secondary income balance Average, FY22/23 Current Account Balance 2 1.20 5 0 0 -0.87 -1.14 -1.07 -2 -5 -2.00 -4 -10 Q1-FY20 Q2-FY20 Q3-FY20 Q4-FY20 Q1-FY21 Q2-FY21 Q3-FY21 Q4-FY21 Q1-FY22 Q2-FY22 Q3-FY22 Q4-FY22 Q1-FY23 Q2-FY23 Q3-FY23 Q4-FY23 Q1-FY24 Q1-FY20 Q2-FY20 Q3-FY20 Q4-FY20 Q1-FY21 Q2-FY21 Q3-FY21 Q4-FY21 Q1-FY22 Q2-FY22 Q3-FY22 Q4-FY22 Q1-FY23 Q2-FY23 Q3-FY23 Q4-FY23 Q1-FY24 Source: CEIC, RBI, World Bank staff calculations Note: The shaded part is the WB estimate based on the monthly data on trade in goods and services. Source: CEIC, RBI, World Bank staff calculations Weak external India’s merchandise exports declined in Q1 FY23/24 primarily due to a 29 percent y-o-y demand caused the contraction in refinery petroleum exports – in contrast to a 12 percent y-o-y increase in goods trade deficit to Q4 FY22/23 (Figure 2.22). This downturn reflected mainly the steep decline in global oil widen in Q1 FY23/24 prices for refinery oil exports in Q1 FY23/24 (-31 percent y-o-y), which was barely offset by a 2 percent y-o-y increase in volume of petroleum exports. Other key exports – farm and allied products, chemicals, base metals, and textiles – collectively accounting for more than a third of India’s total goods exports, also contracted in Q1 FY23/24. Weak demand from India’s key export destinations – the US, the EU, ASEAN economies and China – has weighed on merchandise exports. In contrast, exports of a few high technology goods– electronics, machinery, and transport equipment – grew and contributed positively to export growth. The share of these goods has steadily increased in India’s total exports during the last decade (Box 2.3). Meanwhile, merchandise imports declined in Q1 FY23/24 due to a sharp fall in commodity prices – primarily driven down by sluggish global demand – impacted the import value of minerals and ores, gems and petroleum, which account for half of India’s merchandise imports. This notable resilience in the domestic demand also contributed to an uptick in the import of electronics, machinery and metals, though at a lesser extent to offset the overall decline in merchandise imports. Figure 2.22: Export growth has collapsed across major Figure 2.23: The downtrend in merchandise import categories of goods, except for high-technology goods growth has been driven by lower commodity prices (contribution to growth y-o-y, percentage points) (contribution to growth y-o-y, percentage points) 90 Farm & allied products High 120 Minerals Gems 80 Chemicals technology Chemicals Base metals Base Metals 100 Electronics Machinery 70 goods Petroleum Others Electronics contributed 80 60 Total imports, y-o-y Machinery a positive 50 Transport equipment 60 2.1ppts to 40 Textiles export 40 30 Petroleum growth 20 Others 20 10 Total exports, y-o-y 0 0 -10 -20 -20 -30 -40 -40 -60 Q1-FY20 Q2-FY20 Q3-FY20 Q4-FY20 Q1-FY21 Q2-FY21 Q3-FY21 Q4-FY21 Q1-FY22 Q2-FY22 Q3-FY22 Q4-FY22 Q1-FY23 Q2-FY23 Q3-FY23 Q4-FY23 Q1-FY24 Q1-FY20 Q2-FY20 Q3-FY20 Q4-FY20 Q1-FY21 Q2-FY21 Q3-FY21 Q4-FY21 Q1-FY22 Q2-FY22 Q3-FY22 Q4-FY22 Q1-FY23 Q2-FY23 Q3-FY23 Q4-FY23 Q1-FY24 Source: CEIC, Ministry of Commerce and Industry, World Bank staff calculations Foreign portfolio Net portfolio investment flows into India’s equity markets surged to levels last observed flows have been in Q3 FY20/21 (Figure 2.24). With the US Federal Reserve holding off on policy rate resilient and net FDI hikes, foreign investors have sought to maximize risk-adjusted returns in emerging inflows, while still economies. In this context, India’s elevated interest rates, last this high in 2018, along with below the pre- strong fundamentals have made its financial market attractive. Meanwhile, net FDI inflows pandemic average, bounced-back in Q1 FY23/24, doubling from a low of USD 1.7 billion in Q3 FY22/23 were strong in (Figure 2.25). Notwithstanding the recent increase, net FDI inflows as a percentage of Q1 FY23/24 GDP have remained below the pre-pandemic (FY18-FY20) average for the past four consecutive quarters. Figure 2.24: FPI inflows surged in Q1 FY23/24 as Figure 2.25: FDI inflows have rebounded but remain foreign investors sought higher risk-adjusted returns below the pre-pandemic average in India (USD billions, left axis); (Percentage of GDP, right axis) (USD billions) 25 Debt Equity 30 Net FDI 4.5 20 4.0 25 As % of GDP (RHS) Hybrid Total FPI 3.5 15 20 Average net FDI as % of 3.0 10 GDP, FY18-FY20 (RHS) 15 2.5 5 2.0 0 10 1.5 -5 5 1.0 -10 0.5 0 -15 0.0 -5 -0.5 -20 Q1-FY20 Q2-FY20 Q3-FY20 Q4-FY20 Q1-FY21 Q2-FY21 Q3-FY21 Q4-FY21 Q1-FY22 Q2-FY22 Q3-FY22 Q4-FY22 Q1-FY23 Q2-FY23 Q3-FY23 Q4-FY23 Q1-FY24 Q1-FY20 Q2-FY20 Q3-FY20 Q4-FY20 Q1-FY21 Q2-FY21 Q3-FY21 Q4-FY21 Q1-FY22 Q2-FY22 Q3-FY22 Q4-FY22 Q1-FY23 Q2-FY23 Q3-FY23 Q4-FY23 Q1-FY24 Source: CEIC, RBI, World Bank staff calculations Source: CEIC, RBI, World Bank staff calculations The rupee The rupee appreciated marginally against the USD in Q1 FY23/24. This was primarily appreciated slightly influenced by a decline in imports – in turn driven by softening global commodity but has remained prices – and a surge in portfolio capital inflows from Q4 FY22/23 (Figure 2.26). stable this year Additionally, relative to the previous year, exchange rate volatility diminished considerably, compared to last and the rupee moved in a narrow range of 82-83 INR/USD. This was partly thanks to the year’s volatility RBI’s intervention in the FX market: the RBI has been a net buyer of US dollars this year due to which India’s stock of foreign exchange reserves increased to USD 595 billion at end-August 2023 from about 561 billion at the beginning of 2023 (Figure 2.27). In Q1 FY23/24, the real effective exchange rate (REER) appreciated slightly. This was largely driven relatively higher domestic inflation compared to India’s major trade partners (such as the US and UK). Figure 2.26: The Indian rupee appreciated marginally Figure 2.27: Foreign exchange reserves have been against the USD on the back of capital inflows and increasing on the back of the RBI’s FX intervention lower imports (LHS & RHS: USD billion) (INR/USD) REER 20 800 115 85 NEER INR/USD (RHS) 110 80 10 600 105 75 100 70 0 400 95 65 -10 Net Spot sales or purchase by the 200 RBI 90 60 FX Reserves, USD (RHS) 85 55 -20 0 Jun-18 Jun-19 Jun-20 Jun-21 Jun-22 Jun-23 Oct-21 Oct-18 Feb-19 Oct-19 Feb-20 Oct-20 Feb-21 Feb-22 Oct-22 Feb-23 Apr-16 Apr-17 Apr-18 Apr-19 Apr-20 Apr-21 Apr-22 Apr-23 Oct-16 Oct-17 Oct-18 Oct-19 Oct-20 Oct-21 Oct-22 Source: Haver, IMF, World Bank staff calculations Source: CEIC, RBI, World Bank staff calculations Box 2.3: The composition of India’s exports is shifting from medium-low technology towards higher technology goods The share of high and medium-high (HMH) technology manufactured exports in India’s total goods exports has risen by almost 10 percentage points between 2012 and 2022. The technology intensity of manufactured goods exports has important implications for an economy’s growth, with higher technology exports generating greater gains for productivity through efficiency gains, technology and knowledge spillovers, than trade in less sophisticated activities (Cuaresma and Wörz, 2005). Meanwhile, the share of low technology goods has remained unchanged over the last decade, but the share of medium-low technology goods has declined, from 48 percent in 2012 to 42 percent in 2022 (Figure 2.28) and HMH exports now account for a third of the total. HMH technology exports have been the fastest growing category over the last decade (Figure 2.29). While exports of low technology goods grew marginally and that of medium-low technology goods contracted during 2013-17, HMH goods exports expanded by 3.1 percentage. Within this category, exports from sectors such as railway transport, inorganic and organic chemicals, chemical products, electrical machinery and equipment, plastics, as well as nuclear reactors, boilers and generators have performed particularly well. Consequently, India’s share in global high technology exports increased from 0.6 to 0.8 percent over 2012-19. Exports of both medium-low and low technology goods have been extremely volatile over the last decade. Although medium-low technology exports have had a large contribution to total export growth, due to a higher share, the growth has been volatile (Figure 2.30a). This volatility has stemmed from the resource- based products like minerals and ores and precious stones, which are subject to fluctuations in global commodity prices. India still has a “revealed comparative advantage” in low and medium-low technology exports. The revealed comparative advantage11 (RCA) of most low and medium-low technology products has declined over 2010-20 (Figure 2.30b), but India still maintains a comparative advantage in several low and medium-low technology goods. Therefore, India still has the potential to increase its global market share in these goods as supply chains for relatively low technology goods are gradually shifting out of China. Figure 2.28: India’s share of HMH technology Figure 2.29: HMH technology exports have grown manufacturing exports has risen robustly over the last decade (Share in total merchandise exports, percent) (Growth, y-o-y percent) 100% 15 2013-17 2018-22 2013-22 90% 80% 70% 10 60% 7.2 50% 4.5 5 3.9 40% 30% 20% 0 10% 0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 -5 Low Medium Low HMH Others Low Medium-low HMH 11 The RCA index of country I for product j is measured by the product’s share in the country’s exports in relation to its share in world trade. If the index exceeds one, the country is said to have a revealed comparative advantage in the product. Figure 2.30a: The contribution of medium low Figure 2.30b: India still has a comparative advantage technology is substantial but volatile in low and medium-low technology exports, although (Contribution to merchandise export growth, y-o-y percentage it has declined points) (RCA of goods with RCA>1 in 2020) 60 Low Medium Low 6 HMH others 5 40 Growth 4 3 2 20 1 0 Animal Minerals Vegetable Hides and Skins Chemicals Metals Textiles and Footwear Stone and Glass Clothing 0 -20 Low Medium low HMH 2010 2020 Source: Ministry of Commerce and Industry, WITS, and WB Staff calculations Note: Category of goods (low, medium-low, high and medium-high technology) are based on Hatzichronoglou, T. (1997) d. Fiscal sector and debt sustainability The general The general government fiscal deficit -the combined deficit of the center and states- government fiscal declined from 9.6 percent of GDP in FY21/22 to 9.0 percent in FY22/23 (Figure 2.31). deficit declined in Expenditures declined as some post-pandemic welfare measures were withdrawn, but FY22/23 along with revenues also declined as fuel tax cuts were introduced to soften the impact of high global the public-debt-to- crude oil prices on domestic inflation (Figure 2.32). Public debt also declined from GDP ratio 87.6 percent of GDP in FY20/21 to 82.9 percent in FY22/23, as the primary deficit narrowed and growth-interest rate dynamics remained favorable, with strong nominal GDP growth. Figure 2.31: The general government fiscal deficit Figure 2.32: Both expenditures and revenues declined as declined in FY22/23, as did the debt/GDP ratio a share of GDP in FY22/23 (percent of GDP) (percent of GDP) Public debt (right axis) Fiscal deficit Revenue Expenditure (right axis) 14 95 22.0 32 12 90 21.5 31 10 85 21.0 30 20.5 8 80 29 20.0 6 75 28 19.5 4 70 19.0 27 2 65 18.5 26 0 60 18.0 25 Note: *Based on provisional accounts for the central government and the states. Source: CEIC, RBI, CSO and WB staff calculations The government The targeted consolidation from 6.4 percent of GDP in FY22/23 to 5.9 percent in targets a fiscal deficit FY23/24 is expected to be driven mainly by continued consolidation of recurrent of 5.9 percent of spending through the withdrawal of all pandemic-related welfare measures. the GDP for FY23/24 improvement in revenue collection also contributes to the narrowing deficits: the GST collection is expected to pick up benefiting from the pre-pandemic reforms; the corporate income tax is projected to remain buoyant owing to an improved bank balance sheet. Since then, an The central government cut the price for liquified petroleum gas (LPG) cylinders, which additional subsidy are primarily used for cooking, by INR 200/cylinder and increased the subsidy for eligible on cooking gas has households by a similar amount. While the cost of the price cut will be absorbed by the been announced… state-owned oil marketing companies, the cost of the increased subsidy (around 0.3 percent of GDP) will be borne by the central government. The government has also responded to the sharp increase in food prices in July by imposing several restrictions on vegetable and cereal exports but it has, so far, refrained from additional welfare measures in the form of increased subsidies or cash transfers to support vulnerable households. …and revenue In the four-month period (April-July) for which data is available, the central government’s growth improved in gross tax revenues only increased by 2.8 percent y-o-y. The government had only achieved August and 28 percent of its budgeted target for tax revenues compared with over 30 percent of the September after a budget estimate on the expenditure side (as capital spending was front-loaded at the start slow start of the year) (Figure 2.33). As a result, the fiscal deficit reached 34 percent of the budget estimate or 2.0 percent of GDP (Figure 2.34). However, growth in GST revenue and direct tax collections showed a marked improvement in August and September. Figure 2.33: Front-loaded spending caused the fiscal Figure 2.34: GST collection has continued to grow at a deficit to increase in the first half of the fiscal year robust pace (fiscal deficit, percent of FY22/23 budget estimates) (GST collection, INR billion) 40 2000 FY22/23 35 FY23/24 30 Receipts 1500 Expenditure 25 20 1000 GST collection 15 Average for FY19/20 10 500 Average for FY20/21 Average for FY21/22 5 Average FY22/23 0 0 Apr-19 Apr-20 Apr-21 Apr-22 Apr-23 Jul-19 Oct-19 Jan-20 Jul-20 Oct-20 Jan-21 Jul-21 Oct-21 Jan-22 Jul-22 Oct-22 Jan-23 Jul-23 April May August June July Source: CEIC, Ministry of Finance, and WB staff calculations State governments According to budget estimates, the combined fiscal deficit for the states is projected to have budgeted for a be 3.1 percent of GDP in FY23/24, somewhat above the provisional estimate of fiscal deficit around 2.7 percent in FY22/23. Revenue growth is expected to reach 11.6 percent y-o-y, in line 3 percent in FY23/24 with the budgeted growth in central government tax revenues, while expenditure growth and capital spending is projected to be around 9.2 percent. Capital spending is projected to increase by has increased 18 percent, buoyed by 50-year interest-free loans from the central government. Monthly fiscal data for April-July for 16 major states show that capital spending increased by over 50 percent y-o-y, indicating front-loaded capex also at the state level particularly sharply in Madhya Pradesh, Telangana and Rajasthan. Public debt According to quarterly public debt data published by the central government, the decreased to central government’s total liabilities fell from 61.5 percent of GDP in FY20/21 to 82.9 percent of GDP 57.1 percent by the end of FY22/23, mainly thanks to rapid nominal GDP growth and in FY22/23 a decline in the primary deficit. At the state level, the combined debt/GSDP ratio remained stable around 27 percent of GDP, though some states are observing higher public debt levels. Box 2.4: Relatively high public debt levels and cost of borrowing impose a high debt servicing burden India’s debt ratio is higher than that of most other emerging market and middle-income countries. Among 34 emerging market and middle-income countries, only 4 countries had a debt-to-GDP ratio higher than India’s. As a result, India’s debt-servicing costs are also much higher at over 5 percent of GDP, compared with the combined average of around 2 percent for all emerging market countries. Although public borrowings help boost economic development, the associated significantly higher debt servicing burden reduces the overall level of savings in the economy and consumes government resources that could be directed towards other productive purposes. Although India’s debt is significant, sustainability risks are low. Nearly all of India’s public debt is rupee- denominated, with external borrowings (form bilateral and multilateral sources) only accounting for about 3 percent of GDP. Domestically issued debt, largely in the form of government bonds, is mostly medium or long- term and domestically held, with a weighted average maturity of over 11 years for central government debt. Thus, rollover risk is low and exposure to volatility in exchange rates or external interest rates is limited. The cost of borrowing is relatively high but it has been declining. The effective interest rate for public debt is around 6.2 percent, higher than for most other EMEs. However, it has fallen gradually from a peak of around 7.1 percent in 2013. This is due in part to the gradual linking of interest rates on small savings instruments to market interest rates. The spread between the yield on Indian government securities and US government securities has also narrowed over the past 10 years, as relatively stable macroeconomic performance in terms of moderate inflation, fiscal discipline and steady growth has contributed to a lower risk premium. Figure 2.35: India’s debt and interest payments are Figure 2.36: …and the effective cost of borrowing is higher than most other countries… also relatively high (X-axis: interest payments, percent of GDP, Y-axis: debt, percent (effective interest rate, percent) of GDP) 120 8 7 100 INDIA 6 80 5 60 4 3 40 2 20 1 0 0 0 1 2 3 4 5 6 7 UKR HUN COL KAZ DOM IDN IND RUS ZAR MEX UAE ALG ARG URY MYS MAR PHL PER BEL THA IRN POL TUR ROM OMN ECU BRA EGY CHN SLK AGO SAU QAT PAK Source: IMF Fiscal Monitor, WB staff calculations 3. Outlook Real GDP India’s growth is expected to moderate to 6.3 percent in FY23/24 from 7.2 percent in growth is FY22/23, but it will remain one of the fastest growing major economies in the world. The expected to expected slowdown is mainly due to waning base effects, slowing global growth, and moderate in domestic price pressures. Private consumption growth is likely to slow as the post-pandemic FY23/24 catch up fades, and external demand for India’s exports will be affected by slowing growth in major trading partners, including the EU. (Table 3. 1). However, activity will be supported by strong investment, driven by a continued increase in public investment in infrastructure. Strong Growth of domestic demand is expected to remain robust, albeit at a slower pace investment will (Figure 3.1). Despite the sharp increase in lending rates since early-2022, conditions remain drive growth but conducive for private investment: balance sheets of banks and the corporate sector have consumption improved, capacity utilization has increased, and the government has stepped up capital growth will spending on infrastructure. Private consumption growth is likely to taper off as post- moderate pandemic pent-up demand fades and high food price inflation constrains demand, particularly for low-income households. Meanwhile government consumption is expected to grow slowly, in line with the central government’s efforts to lower the share of current spending. Rising food Headline inflation is expected to average 5.9 percent in FY23/24. Abnormal rainfall during prices will keep the monsoon months caused a sharp increase in food prices in July 2023. Though eased in headline August, it is expected to continue to weigh on headline inflation through the rest of the inflation fiscal year. While oil prices have moderated from their peak in 2022 and will help stabilize elevated inflation, they are expected to remain elevated than the pre-pandemic levels. The RBI’s policy of withdrawing accommodation and raising the policy interest rate over the last year has helped rein-in core inflation, which is expected to continue to decelerate gradually. The CAD will The current account deficit (CAD) is projected to narrow to 1.4 percent of GDP in FY23/24 narrow as driven by a decline in the merchandise trade deficit (Figure 3.2). The merchandise import commodity bill will be lower than in FY22/23, on account of lower global commodity prices, that should prices ease more than offset the decline in merchandise exports from slower global growth. Meanwhile India’s services trade surplus from exports of IT and professional services and, stable remittances and FDI inflows are expected to buoy the CAD. The direction of foreign portfolio investment flows is likely to reverse with net inflows as India remains one of the fastest growing emerging market economies. The fiscal deficit The general government deficit is expected to decline to 8.7 percent in FY23/24 from should continue 9.0 percent of GDP in FY22/23. Fiscal consolidation is likely to be led by modest growth to decline in recurrent spending and buoyant revenue growth, making room for investment. Although gradually fiscal intervention has been limited so far, fiscal consolidation could be delayed by subsidy programs to limit the impact of high food prices on vulnerable households ahead of the general elections in 2024. Debt to GDP Public debt should stabilize around 83 percent of GDP, only falling to 82.4 percent by remains FY25/26. Nonetheless, debt remains sustainable with gradual fiscal consolidation12 and elevated, but the double-digit nominal GDP growth supporting a negative interest-rate growth differential. level of debt is Most of the debt is held by domestic investors and the rollover risk is low. The weighted average maturity of market borrowings of the central and state governments is over 11 years 12The fiscal deficit is expected to narrow 7.9 percent of GDP by FY25/26, which is lower than the 8.2 percent forecast in the previous edition of the World Bank’s Macro Poverty Outlook. sustainable with and 8 years respectively and has increased in recent years. However, the elevated level of low rollover risk debt does impose a significant debt-servicing burden and a meaningful reduction in debt as a share of GDP would require the government to reduce the primary deficit even more. Figure 3.1: Investment will continue to drive real GDP Figure 3.2: Current account deficit will narrow on the growth in FY23/24 back of a smaller merchandise trade deficit (Contribution to growth, percentage point) (percentage share of GDP) Others 1.5 Current Account Balance/ GDP 15 Net Exports Forecast GFCF 1.0 Government Consumption Private consumption 0.5 10 GDP, y-o-y 0.0 -0.5 5 -1.0 -1.4 -1.5 0 -2.0 -2.0 -2.5 -5 FY22 FY23 FY24 FY25 FY26 Source: CEIC and World Bank Staff calculations Note: The shaded portion reflects the World Bank projections Table 3. 1: World Bank macroeconomic outlook indicators Indicator FY20/21 FY21/22 FY22/23 FY23/24 FY24/25 FY25/26 (percent y-o-y growth, unless otherwise specified) Real GDP Growth, at constant market prices -5.8 9.1 7.2 6.3 6.4 6.5 Private Consumption -5.2 11.2 7.5 5.9 6.0 6.4 Government Consumption -0.9 6.6 0.1 4.1 5.1 5.8 Gross Fixed Capital Formation -7.3 14.6 11.4 8.9 7.8 7.3 Exports, Goods and Services -9.1 29.3 13.6 0.9 6.7 8.2 Imports, Goods and Services -13.7 21.8 17.1 3.0 7.2 8.7 Real GDP Growth, at constant factor prices -4.2 8.8 7.0 6.3 6.4 6.5 Agriculture 4.1 3.5 4.0 3.5 3.6 3.7 Industry -0.9 11.6 4.4 5.7 6.4 6.4 Services -8.2 8.8 9.5 7.4 7.2 7.3 Inflation (Consumer Price Index) 6.2 5.5 6.7 5.9 4.7 4.1 Current Account Balance (percent of GDP) 0.9 -1.2 -2.0 -1.4 -1.2 -1.6 Net Foreign Direct Investment (percent of GDP) 1.6 1.2 0.8 1.1 1.4 1.5 Fiscal Balance (percent of GDP) -12.6 -9.6 -9.0 -8.7 -8.1 -7.9 Debt (percent of GDP) 89.3 84.8 82.9 82.9 82.5 82.4 Primary Balance (percent of GDP) -7.2 -4.4 -3.9 -3.3 -2.7 -2.5 Source: CEIC and World Bank Staff calculations Note: (i) Shaded columns are WB forecasts References Goldin, C. 1994. 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