An uncertain world: India needs to improve its economic growth potential

There is considerable anxiety around the world regarding economic outcomes this year. Much will depend on policy shifts in the United States as Donald Trump begins his second term as President. Both the International Monetary Fund (IMF) and the World Bank released their economic assessments last week, signalling uncertainty, but they extend beyond the policy changes in the US. Both multilateral institutions expect global growth to be steady during the year, though projections differ. The IMF expects the world economy to grow at 3.3 per cent in 2025, while the World Bank expects the growth rate to be 2.7 per cent. However, as the IMF has been highlighting in its assessments, the growth rate will be lower than the average of the first two decades of this century.

 

Further, the World Bank’s medium-term assessment, particularly that of emerging markets and developing economies (EMDEs), presents a more sobering picture and should worry policymakers. The report notes that EMDEs, which drive 60 per cent of global growth, are entering the second quarter of the 21st century with per capita income on a trajectory that will lead to a slower catchup with the developed economies as against earlier estimates. Slower global growth over the medium term will have a bearing on growth outcomes in India. The Indian economy, according to the first advance estimate of the National Statistics Office, will grow at 6.4 per cent this financial year, a significant deceleration from the growth rate of 8.2 per cent achieved last financial year. Economists have argued that the Indian economy has returned to its trend growth after a sharp recovery from the pandemic-induced disruption. Thus, the policy focus will need to be on increasing the medium-term growth potential.

 

Although the medium-term growth outlook poses challenges, there are significant risks in the near term as well. As the IMF has pointed out: “An intensification of protectionist policies… in the form of a new wave of tariffs, could exacerbate trade tensions, lower investment, reduce market efficiency, distort trade flows, and again disrupt supply chains.” Consequently, growth could suffer in both the medium and near term. Protectionist policies in the US, along with loose fiscal policy, as expected from the Trump administration, could lift the US growth rate in the near term. However, large fiscal- and monetary-policy adjustments as a result could significantly impact global fund flows and the strength of the dollar. An adjustment in the US Federal Reserve’s projections reflecting a slower pace of rate cuts has pushed up bond yields worldwide. Although not many are talking about a reversal in the Fed’s stance, a sharp increase in US tariffs along with loose fiscal policy could potentially force the Fed to reevaluate its position. Any possibility of rate increases could lead to significant volatility in the global financial market.

 

The challenge for policymakers in India is to protect financial stability and find ways to increase growth potential at a time when global growth is likely to be below trend. The currency-market movements have been in focus over the past few months and are being widely debated, including on these pages. The Reserve Bank of India (RBI), for instance, spent $20 billion in November to support the rupee. As things stand, there could be continued pressure on the currency because of policy action in the US. The RBI must allow the currency to depreciate and only intervene to smooth the process. A fairly valued rupee will help India deal with near- to medium-term external growth headwinds.