The global economic and financial environment does not favour the Indian economy. India will face two external shocks. First, the tightening of US monetary policy. And second, the sharp increase in raw material prices.
The increase in US interest rates should trigger massive capital outflows and exert huge downward pressure on rupee, as it happened in 2013, 2014. But the risk resulting from the tightening of US monetary policy is expected to be less important than it was at the time. Indeed, Indian external accounts are much more stronger than they were in 2013, 2014. The current account deficit is much lower than it was at the time. Most importantly, foreign exchange reserves are much more important than they were. Today, foreign exchange reserves are enough to cover twice the country's short-term external financing needs. It was only one time in 2013. However, we've already seen huge movements of capital outflows from December to February. Even though the Indian Central Bank managed to stabilise the value of the rupee by intervening on the exchange market.
The second risk that weighs upon the Indian economy is the sharp increase in inflationary shocks in the context of the Ukrainian conflict. Even if India is not really directly impacted by the war in Ukraine, it won't be shielded from its consequences such as an increase in raw material prices. Regarding food prices, India produces and exports wheat so the impact of rising wheat prices won't be a real issue. However, it will be highly impacted by the sharp increase in vegetable oil prices, a product that is massively imported. That's also true for fertilizers. Unless the government decides to strongly increase its subsidies on fertilizers to lessen the impact on cereal prices.
The greater risk weighs on energy prices. India is a huge oil importer. And it won't be able to fully lessen the impact on its economy. The Central Bank considers that a 10% increase in oil prices would trigger a 20 basis point growth contraction, a 30 basis point increase in inflation and a 40 basis point increase of current account deficit. In other words, it could cause further downward pressure on the rupee.
The only way for the government to hold back this negative impact on its economy would be to strongly increase its subsidies on food prices, fertilizers or oil prices. But they have very limited budgetary leeway. The public finances have been heavily weakened by the COVID-19 pandemic. The government will have very few options given the fact that households have already been impoverished by the 2020 crisis.
