Key takeaways from the RBI report on State of the Economy

20 Aug 2023 , 09:09 AM

The Reserve Bank of India publishes the monthly RBI Bulletin around the middle of the month, giving a comprehensive analysis of the key macro events and indicators of the previous month; both domestica and global. The RBI report begins with a review of the state of the economy and here are the major takeaways from the State of the Economy Report for July 2023.

What we read from the RBI State of the Economy Report for July 2023?

The report begins on a positive note in that the quarterly results and the macro growth numbers have been positive despite the global headwinds. On the high frequency indicators, most of them are positive, although the momentum of the high frequency indicators has been faltering in the last couple of month. Here is what we read from the RBI State of the Economy Report.

1. Global headwinds have continued almost unabated. Even as the global economy was recovering from the banking crisis in the US and in Europe, the latest crisis came in the form of a sovereign debt downgrade of the US economy by Fitch. The rating agency had pinned the blame on rising fiscal risks for the US economy as well as weak governance, especially in the matter of the debt ceiling expansion. This was further exacerbated when Moody’s also joined the fray and downgraded US banks. Amidst all these headwinds at a global level, the US Fed continues to remain hawkish, which has raised the spectre of a US recession all over again. The impact on the Indian exports of goods and services is already visible due to fears of a slowdown.

    

2. Ironically, even as the US debt was downgraded by Fitch, the US Treasuries and the US dollar emerged as safe haven alternatives in an uncertain economy. This has led to a surge in portfolio flows into the US markets as well as a persistent strengthening of the dollar. These two factors have combined to cause weak FPI flows into India. After all, when the dollar is strong and the rupee is weak, foreign investors stand to lose in terms of dollar returns. Even before the global recession hits the Indian economy, the downgrade is already leading to risk-off flows away from emerging markets like India.

    

3. The big concern for the Indian economy has been the spike in inflation. In May, India had reported consumer inflation at 4.25%, just 25 bps above the target of 4%. By June, the consumer inflation had risen to 4.81% and in July it spiked to 7.44%. The spike in headline inflation in India was largely triggered by a surge in food inflation to above 11%. That is largely on account of the delayed monsoons, followed by a deluge in some parts. The worse impacted has been the price of vegetables with the vegetable inflation alone in July standing at over 37%. In addition, cereals, pulses, and milk also saw a spike in inflation and with a 50% weight in the CPI index, food had an inordinate impact on the headline inflation.

    

4. The spike in inflation in India also raises a policy dilemma for the RBI. The last rate hike that India had implemented was way back in February 2023 with the RBI pausing on rates in April, June, and August. However, with the inflation bouncing to 7.44%, the RBI may be impelled to hike the interest rates by at least 25 bps. In fact, looking at the spike in inflation, it looks very likely that the RBI may not wait till October and may instead implement a rate hike earlier itself. After all, Indian real rates are already in the negative at the current rate of inflation. Also, the US is just about 120 bps away from its inflation target while India is now a full 344 basis points away. For the RBI, the inflation for Q2 and for FY24 is very likely to overshoot the RBI estimates.

    

5. For the Indian economy, still heavily depending on the Kharif and Rabi output, there are several risks arising from global warming and from the El Nino effect. For this year, the global average temperatures stood at 16.9%, which his nearly 30% higher than the previous record set in 2019. It has already triggered deadly heatwaves in North America and Europe, something unprecedented. Due to the El Nino effect, the warm months may continue right into 2024 and that could have an impact on the level of reservoirs in India as well as the Rabi output, which starts in the last quarter of the calendar year. Food inflation is the most likely outcome of global heat waves. 

    

6. The gist of the Q1FY24 results shows some important trends in the corporate numbers in India. The entire outperformance is tilted towards a handful of large companies in a selected few sectors. At a macro level, there has been flattening of revenues while the profit growth has come largely from a sharp fall in input costs in sync with falling commodity prices. Oil marketing companies gained from lower crude prices while banks gained from wider net interest margins. Autos, capital goods and FMCG saw healthy growth in profits on account of sharply lower input costs. However, IT remained under pressure due to weak tech spending and pricing pressures. In addition, metals and chemicals also saw a tepid performance in the quarter.

    

7. From a macro perspective, two key takeaways in July were the weakening of the Indian rupee vis-à-vis the dollar and the strengthening of crude oil. Let us focus on crude first. Crude touched a high of $87/bbl before tapering to $84/bbl during the week on account of unwinding of long positions in crude oil futures. Also, there have been concerns that the global demand may not support very high prices. In the last few weeks, the crude prices in the Brent market have rallied from $71/bbl to $87/bbl due to supply cuts by the OPEC and Russia as well as the US inventories of oil falling sharply. The oil prices have been a key reason for the weakening of the INR, but that is also partially caused by a spike in the dollar index (DXY) as global investors get more risk-off and prefer to invest in safe havens like the US Dollar assets in general and US treasuries in particular.

    

8. One of the positive factors has been that the Index of Supply Chain Pressures for India (ISPI) has been hovering well below its historical averages. That could be an indication that the supply chain pressures, which began during the pandemic, is finally coming to an end. This should automatically bring down the structural inflation or core inflation, that has been a major bane for policy makers in India. In India, the core inflation has continued to hover above the 5% mark and this easing of supply chain constraints should directly help the inflation moderate in the months ahead.

How do the major lead indicators look like?

Lead indicators are the advancing signals that the economy gets from macro variables that have strong externalities. Here are how the lead indicators are looking in July 2023.

• E-way bills, the basis for GST action, has not only picked up sequentially in July, but has shown double-digit growth on a yoy basis. This is a classic lead indicators of good traction in trade activity. Toll collections have also been higher on a yoy basis, although the monsoons have resulted in some moderation on a sequential basis.

   

• There has been a contraction in automobile sales and the main hit has come from weak international sales and very tepid rural sales. The delayed monsoons and the high level of rural inflation is likely to keep the auto demand under pressure. Two-wheelers contracted for the first time in 16 months and rural sales and macroeconomic uncertainty were the key reasons. PV dispatches are up but registrations are down.

   

• FMCG sales are also an important lead indicator as they hint at the direction of consumer demand. July saw sequential improvement in FMCG demand as traders prepared themselves for the festive season which starts around September and extends all the way to December. This is an important lead indicator, not only of consumer willingness to spend but also affordability in the light of rising inflation.

   

• The unemployment rate fell to 7.95% in July, and while there was contraction in jobs created by the services sector, there more jobs being created in the manufacturing sector and also in the rural areas. However, with the Kharif sowing picking up late, the demand for jobs under the MGNREGS has fallen sharply. However, the MGNREGS job creation is still higher on a yoy basis.

   

• Nearly two-thirds of the items in the export basket saw contraction in demand leading to exports falling on yoy basis for the sixth month in a row. However, the contraction in exports was also supported by a contraction in imports, combined with the lower commodity prices. This has ensured that the merchandise trade deficit has either remained constant or has fallen over the last few months.

   

• There are some concerns on the revenue front, which is not as robust as it was last year. Direct tax collections contracted by 1.8% in July 2023, but this was more due to lower corporate tax collections even as the individual tax collections have gone up in the month. While excise duties have contracted under indirect taxes, the GST has seen a sharp surge. Amidst all these constraints, what stands out is the government showing aggression in capital spending.

In the last few years, the debate has been whether India will slip into stagflation mode. That is a situation of rising inflation but faltering or flat growth. For now, the RBI Bulleting is quite emphatic that while inflation may take longer to be reined in, the growth engines are unlikely to be impacted. That is the good news.