India: GDP growth, inflation, and Russia-Ukraine fallout

The GDP numbers for the 4Q21 (third quarter FY22) disappointed.
Radhika Rao01 Mar 2022
  • The Indian economy expanded at a slower pace of 5.4% yoy in Oct-Dec21
  • We lower FY22 GDP growth forecast to reflect past data revisions and slowing momentum
  • Inflation is a dominant concern
  • The Russia-Ukraine conflict will be felt through energy and trade channels
Photo credit: Unsplash

Growth disappoints

The GDP numbers for the 4Q21 (third quarter FY22) disappointed. Growth was expected to slow due to fading base effects, but the extent of slowdown turned out to be steeper than anticipated. Oct-Dec21 (3QFY22) real GDP growth rose by a slower 5.4% yoy vs revised 8.5% in 2QFY. The supply-side measure, Gross Value added (GVA) growth also moderated to 4.7% vs 8.4% in the quarter before. Besides unfavourable base effects, internals were mixed - firm consumption, but moderation in investments, manufacturing, and construction activity. For the full year, the official GDP growth estimate now stands 8.9% yoy vs 9.2% provided in the first estimate. A good part of this downward adjustment owes to the upward revision in the base year numbers for FY21, where a smaller decline of -6.6% was seen vs -7.3% earlier.

Data highlights

• Under GVA, despite normalisation in the second Covid wave, vaccination rollout, festive tailwind and service sector reopening, underperformance was led by industry – manufacturing (0.2% vs 5.6% in 3Q (2QFY)), construction (-2.8% vs 8.2%) – as well as services led by trade, hotels transport up 6.1% vs 9.5% the quarter before. Farm and allied sector output rose by the slowest pace in over two years, much of which owed to a high base as production had risen sharply in late-2021. Most sub-sectors barring trade, hotels, and transport, have returned to pre-pandemic levels. Delayed recovery in the latter sector which is labour intensive underscores the scarring impact of the pandemic on incomes and purchasing power. 

Core GVA i.e., GVA excluding public administration and agricultural output, which is a barometer of private sector activity, slowed to 3% yoy from 7.3% quarter before.

• Under expenditure, private and government consumption rose on sequential basis, benefiting from normalisation in the pandemic situation, but fixed asset investments slowed sharply on qoq and annualised basis to 2% yoy from 14.6% quarter before. The latter partly owed to base effects but was also reflective of subdued private sector interests likely due to margin compression and tepid capex interests.

Net exports remained a drag for a fifth successive quarter, and this is likely to deepen further in the Mar22 quarter due to further increase in the commodity import bill. Most segments have returned to pre-pandemic levels (Dec19) but investments lost momentum.

• Nominal GDP in 4Q21 (3QFY) remained relatively strong at 15.7% yoy, lifted by double-digit deflator reading (third consecutive month of double-digit reading).

• Annual growth numbers show GDP at 8.9% in FY22 vs a revised -6.6% in FY21, whilst GVA stands at 8.3% vs -4.8% in FY21. The sharper fall in net taxes on products in FY21 in midst of the pandemic corrected in FY22 thereby resulting in a smaller GDP-GVA spread. The breakdown reveals that for the full year, the share of private and government consumption expenditure % of GDP moderated in FY22 whilst that of fixed capital formation rose. Nominal GDP for the year was a strong 19.4%, underpinned by a double-digit deflator, tracking WPI inflation closely. As it stands, the FY22 fiscal deficit will also be on a firmer footing, with wider nominal GDP to lower the deficit by 20bps compared to the revised -6.9% of GDP.


In early 1Q22 (4QFY22), onset of the third Covid wave necessitated temporary localised curbs, which have since been lifted, allowing normalcy to return. Our DBS Weekly Activity Gauge (WAG) which captures high frequency prints pointed to a shallow and short-lived impact of the third wave.

February was off a firmer start, with an eye on potential supply-side fallout of geopolitical tensions and further pressure on corporate margins owing to a sharp rally in commodity prices. The DBS Nowcast model points to further slowdown in Jan-Mar22 growth to below 4% yoy, magnified by adverse base effects. We revise down the FY22 real GDP forecast to 8.5% yoy (vs 9.5% previously) vs -6.6% in FY21, factoring in a higher FY21 base, and loss of momentum in 2H.

Beyond the Mar22 quarter and as base effects driven volatility evens out, the economy will require durable growth boosters to regain momentum. There are positives (easier financial conditions, reopening normalisation, budget capex push) and negatives (tighter global financial conditions, labour market scars, weak real incomes and subdued private sector appetite) in the mix. To reflect this mix and revisions to FY22 base, we revise up FY23 to 7.5% vs 7% earlier. We build in assumptions of a manageable pandemic situation, gradual recovery in consumption and higher private sector participation. Private sector players are expected to draw confidence from demand visibility and deleveraged books to step-up capex spending, as supply-side catalysts fall into place by way of asset monetisation program, National infra pipeline, bad bank, government’s capex push, and PLI manufacturing push, which are expected to also lift the aggregate capacity utilisation levels.

Inflation a dominant risk

Jan-Mar22 inflation is likely to average ~6% yoy vs Oct-Dec21’s 5%, at the upper end of the RBI’s target range, due to non-food pressures and base effects. High 1Q22 inflation will not move the needle for the policy bias as the monetary policy committee had planned to look through this temporary spike. The chart below points to a pickup in the headline inflation momentum.

The central bank draws comfort from its FY23 inflation forecast at 4.5% yoy, closer to the mid-point of the target range. However, risks are building up for the FY23 price outlook.

Base effects notwithstanding, there are upside risks to this forecast on account of:

a) retail fuel prices remain unchanged since Dec21 but we expect sharp revisions once state polls end in early-March;

b) RBI’s October policy review carried oil assumptions at US$75pb, whilst prevailing levels are around US$95-100, suggesting inflation forecasts carry an upside bias;

c) service sector operating at full potential and price revisions;

d) pass through of higher gas prices onto fertiliser prices, apart from edible oils, factoring in the fallout of the Russia-Ukraine fallout (more below);

e) producers’ passing higher input costs to retain margins;

f) generalised price pressures as incomes benefit from post-pandemic normalisation.

Our FY23 inflation forecast stands revised to 5.0% yoy, from ~5.4% in FY22. Sustained high oil prices pose 20-40bps upside risk to our forecast.

On policy, the central bank might cite weak growth prints and need for administration measures to contain the spillover from higher oil/gas onto inflation, backstopping their dovish bias. Nonetheless, given risks to the price outlook and tighter global financial conditions, we expect them to lay the ground for a gradual exit from their accommodative stance and adjust benchmark rates to pre-pandemic levels in FY23.

Fallout of the Russia-Ukraine conflict

As the Russia-Ukraine conflict rages on, Western nations have unveiled fresh sanctions to penalise Russia’s financial system and economy. We discuss the fallout of the conflict:

Risk channel

At the start of Russia’s invasion attempt, a broad shift to safe havens, pushed greenback higher, US yields lower, and triggered a correction in global equities. Indian markets corrected sharply, with the benchmark index Sensex marking the largest single day fall since early-2020. Since then, the bourse has stabilised, but foreign interests remain on jittery terrain, extending their selling streak since Oct21. Equities have witnessed US$13.7bn outflows in the past five months, besides $1.4bn offloaded in debt.

Dollar strength and a sharp rise in oil prices have hurt the currency, leading the rupee to be amongst the regional underperformers on ytd basis. As a pre-emptive move to manage liquidity, the RBI announced a sell/buy USD/INR swap worth US$5bn (INR375bn) to be undertaken on March 8, i.e., sell dollars and mop-up INR liquidity through a forex swap, entering into a contract to buy the dollars back after two years (see note).

Despite geopolitical risks, our inhouse view is for the US Fed to stay on course to deliver five rate hikes this year on inflation worries, backing our expectation for dollar strength and official preference for a weaker currency to see USDINR head towards 77 this year. Bond yields are likely to be capped heading into quarter end, before supply worries dominate (see note).

Energy commodity price channel

The rally in global oil prices has taken the Indian crude oil basket up 32% compared to late-2021 levels, back to 2014 levels. Domestic retail fuel prices, by contrast, remain unchanged since early-December (usually revised daily), marking the longest freeze since the daily revisions were introduced in mid-2017. Post state elections, retail prices are likely to be incrementally hiked by a cumulative INR8-15/bl, alongside the monthly review to increase unsubsidised LPG/cooking gas prices, besides allied varieties including CNG, etc. To cushion the adverse impact of purchasing power, excise duty cuts might be considered, with every Rs 1 cut in the excise duty costs ~INR130bn to the exchequer. Separately, authorities are mulling over plans to draw from strategic stockpiles – Vishakhapatnam, Mangaluru, Padur – which stood at 5.3mn metric tonnes as of FY20; these might bring short-term relief but reverse out if supply shortages kick in.

On a broader note, sustained high oil prices are a risk for the broader macro health of the economy, as every US$10 increase in oil prices lifts CPI inflation by 20-25bps, widens the current account gap by 0.3% of GDP and poses a ~15bps downside risk to growth. In addition, given the pass through of higher oil and sunflower oil (refined oils have 1.3% weight in the inflation basket; and spillover to larger universe of edible oils), FY23 inflation faces upside risks. We expect the RBI to gradually hike rates from 3Q22 onwards.

Trade channel

Besides being major energy exporters, Russia and Ukraine are also major exporters of agriculture (wheat, corn, barley), and metals (nickel, copper, platinum), besides crucial gases (neon etc) for chip making, disruptions in which might impact supply chains for auto, chip manufacturing, etc. at the margin. Most global semiconductor manufacturers have, however, assuaged concerns saying their direct exposure to these two countries is limited.

For India, the non-defence trade exposure to Russia & Ukraine is modest as c1% of India’s exports head to the two countries and imports make 2% of total purchases. Supply disruptions might provide an opportunity for India’s wheat and/ manufactured goods shipments. Nonetheless, sector-specific pain points remain e.g., sunflower oil supplies. Of the 2.2mt consumed, Ukraine accounted for 1.7mt in FY21, followed by Russia and Argentina. Suspension in air or port movements are likely to add to the recent buoyancy in prices.

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Radhika Rao

Senior Economist – Eurozone, India, Indonesia

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