MS flags stagflation risk for India, cuts FY23 GDP growth forecast

American brokerage firm Morgan Stanley on Thursday sharply cut its India FY23 real GDP growth estimate to 7.9 per cent, mainly due to the impact of the Russia-Ukraine conflict on oil prices.

Analysts at the brokerage also raised their inflation forecast to 6 per cent - the upper end of the tolerance band for the RBI - and flagged stagflation risks because of the ongoing events.

"We believe that the ongoing geopolitical tensions exacerbate external risks and impart a stagflationary impulse to the economy," they said.

It can be noted that stagflation involves a stagnancy in output or growth, coupled with high inflation.

The analysts said they expect the cyclical recovery trend to continue, but the same will be in a softer mode.

They also specified that India is impacted in multiple ways by the geopolitical tensions, including hardening of oil and other commodities prices, a possible dip in trade and also tighter financial conditions because of the dent to sentiments.

Many watchers have been worried about the possible impact on GDP growth as a result of Russia's war against Ukraine. Interestingly, the downward revision in the estimate by the brokerage comes on a day when leading domestic credit rating agency Crisil stuck to its 7.8 per cent expansion for FY23.

The American brokerage firm expects the current account deficit to widen to a ten-year high of 3 per cent as a result of the ongoing crisis, which has pushed oil prices to over USD 140 per barrel.

"The key channel of impact for the economy will be higher cost-push inflation, feeding into broader price pressures, which will weigh on all economic agents i.e. households, business, and government," it said.

Macro-stability indicators are expected to "worsen" in India, but lack of domestic imbalances and focus on improving the productivity dynamic will help to mitigate risks, it said, adding there is no need for either the government or the RBI to tighten disruptively as a result of the crisis at hand.

However, the analysts advanced their expectation of a rate hike by the RBI to the April policy review from June earlier, which will also kick off the post-pandemic policy normalisation process.

"If the RBI were to delay its normalisation process, the risk of disruptive policy rate hikes would rise. We see less room for fiscal policy stimulus to support growth given high deficit and debt levels we see a possibility of a modest fuel tax cut and reliance on the national rural employment programme as an automatic stabiliser," it said.

There is also a risk of fiscal slippage of 0.50 per cent to the budgetary target of 6.4 per cent of the GDP, it added.