India's Economic Landscape Amidst Global Conflicts
India is grappling with uncertainties from the US-Israel-Iran conflict. While economic buffers are in place, macroeconomic vulnerabilities persist, necessitating more investments and innovation to balance growth.
Markets, Flows, and Regulations
- India is managing a persistent external imbalance with a core external deficit of $38 billion in FY25, increasing to $40-45 billion in FY26, and potentially reaching $50 billion in FY27.
- The Reserve Bank of India (RBI) has $585 billion in foreign currency reserves, providing a buffer for adjustment.
- From FY25 to FY26, the RBI net supplied $195 billion of foreign exchange, exceeding the estimated core deficit of $80 billion.
- About $115 billion in demand was driven by hedging and speculation rather than core deficits, influenced by the offshore rupee non-deliverable forward (NDF) market.
Despite capital account restrictions, domestic participants face limitations in currency market speculation that are not applicable offshore. The RBI's measures to limit arbitrage between onshore and offshore markets aim to stabilize the rupee, which has weakened from 107 to around 92 in trade-weighted real effective exchange rate terms.
Macroeconomic Vulnerabilities
- India's current account deficit (CAD) could rise to $50-60 billion in FY27, posing challenges in attracting capital flows.
- State governments may understate deficits, leading to a potential higher fiscal deficit by 1.0-1.5% of GDP.
- Rising energy input prices add fiscal pressure, potentially necessitating retail price increases or risking inflation and slower growth.
- Supply chain disruptions, El Nino, and fertilizer shortages threaten growth and inflation, with AI's impact on employment and software services also a concern.
Policy choices may be delayed, with the government potentially bearing energy price burdens and monetary policy remaining accommodative. However, relying on hope for falling energy prices or resuming capital flows is not sustainable.
Way Forward
- India requires innovation and investment through appropriate fiscal and regulatory policies to ensure balanced growth.
- Reducing financial repression is crucial, as large RBI bond purchases and low interest rates may hinder debt markets.
- Market-determined interest rates could stabilize currency, attract more flows into debt, and foster fiscal accountability.
- India's taxation framework needs reform towards a residence-based model for capital gains tax, aligning with global standards.
- Offering trusted funds passporting across asset classes, like European UCITS, could simplify access to Indian markets.
Although India has buffers, complacency is not an option. Policies must shift from managing volatility to enabling investment and balanced growth.
Note: The views expressed are personal and do not necessarily reflect the opinions of Business Standard or its affiliates.
