Towards Goldilocks Fy23?

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Oct. 14, 2021

If consensus expectation (based on RBI’s latest Professional Forecaster’s Survey, released last week) is to be believed, India is heading for Goldilocks next year. Consider the following: 


Summary of Current Consensus Estimates 








Real GDP Growth 







CPI Inflation 







Combined Fiscal Deficit (% of GDP) 







Current Account Balance 







3mth Sovereign Yield (end of period) 







Source: CSO, RBI, Ministry of Finance, CAG. Note: Estimates for FY22 & FY23 as per RBI’s Professional Forecaster’s Survey  


Growth to return to pre-Covid rate: India’s economy is expected to grow by 6.8% next year. While this is slower than the 9.4% growth this year, the growth this year is on the back of a -7.5% growth last year. The low base is thus aiding the growth this year which is not the case next year. In the 12 quarters before the pandemic (calendar years 2017, 2018 and 2019), India’s GDP had grown at an average rate of 6.1%. The economy is thus expected to return to slightly above pre-covid growth rate next year on a normalized base. Yes, some will argue that this is only to be expected given that there has been some element of output loss due to the pandemic which will not be fully recouped in the current year. That is a reasonable argument. But the current estimates imply that that is indeed what the current consensus expectation is. 


Inflation to decelerate: Even as growth is expected to return to the pre-Covid trajectory, inflation is expected to decelerate. CPI Inflation which averaged 6.2% last year and 5.3% in the first 6 months of this year is expected to decelerate an average of 4.7% next year. Inflation is thus expected to be close to RBI’s target of 4% and well below the upper end of the inflation threshold of 6% through the course of the entire next year.  


Interest rates to rise, but modestly: The current level of interest rates in the economy is low by historical standards. For example, the current effective policy rate (the overnight inter-bank call rate) is the lowest in over a decade. And despite the MPC having an explicit inflation mandate, the Monetary Policy Committee’s current guidance on interest rates is growth-centric. The MPC has committed to keeping interest rates low as long as necessary to ‘revive and sustain growth on a durable basis.’ 


With GDP growth recovering to the pre-covid level next year, that objective is broadly achieved. It is thus natural to expect the MPC to start normalizing monetary policy. However, with inflation expected to remain low, there would be no urgency on the part of the MPC to normalize monetary policy. And thus, the consensus expectation is for only an 80bps increase in short-term rates (3mth treasury bill yield) by the end of next year – almost 18 months out. And despite this 80bps increase, short-term interest rates would be almost 200bps below the pre-pandemic average. Interest rates are thus expected to remain low and monetary policy growth supportive, even 18 months from now.  


Fiscal Consolidation more than halfway through: The government’s fiscal deficit expanded last year due to the pandemic related fiscal stimulus expenditure and lower revenues. However, the fiscal deficit is expected to shrink in the current year and the next. From 13% of GDP in FY21, the combined fiscal deficit of the Central and all the State Governments is expected to decline to 9% in FY23 – a decline of 400bps in 2 years. The combined fiscal deficit had averaged 6% just before the pandemic and thus more than half the downward adjustment in fiscal deficit would have already happened by the end of FY23 - just 2 years.  


External environment to remain benign: On the external front, India’s current account is expected to return to a deficit this year as well as the next. But at 0.7% of GDP this year and 1.1% of GDP in FY23, the current account deficit is expected to remain modest by historical standards. For reference, between FY16-20 India’s current account deficit had averaged 1.3% of GDP. Capital flows are expected to comfortably exceed this modest deficit and thus India is expected to accrue a BoP surplus in both years and further build its FX reserves. Not surprisingly then the expectation is for the Rupee to remain stable against the US Dollar over the next 12 months.  


There are two points from the above discussion. First, if the anticipated scenario materializes, it will indeed be positive. It will set the stage for a much stronger upcycle. Which economy (and all the economic agents in the country) will not want to return to pre-crisis growth levels even as inflation moderates allowing interest rates to remain low for an extended period? Fiscal consolidation to happen in a calibrated manner? Global environment to remain benign allowing exchange rate stability and build-up of FX reserves?  


But markets are supposed to price in expectations and thus it is logical to expect that consensus expectation about the economy is what is reflected in the various asset prices. What matters for financial markets is what will be the deviation from the current consensus estimates (which are already reflected in prices). Will something go wrong and the economic outlook for the economy be less rosy than anticipated or will we have a ‘Goldier Goldilocks’ in FY23? 


The evidence generally is that consensus estimates on balance tend to surprise on the negative as estimates generally suffer from ‘optimism’ bias. And because macroeconomic variables are interlinked, it is seldom just one variable that moves against expectation. For example, if Oil prices continue to rise, it will impact the current account balance and thus the rupee, inflation and thus interest rates, and consequently growth. Similarly, if Oil prices drop sharply, it will positively impact several economic variables. 


So, will something go wrong, relative to current expectations, next year? Or will next year be one of those years in which analysts turn out to be less optimistic than they ought to have been?


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