‘Emerging Markets Were More Nimble': CRISIL's Chief Economist DK Joshi On Developments of 2023

India’s retail inflation shot up sharply in November to 5.55%, thanks to rising food prices. Food inflation in the same month was 8.70%, according to government data. While inflation has remained a concern, the country’s gross domestic product (GDP) growth has managed to keep the spirits high. According to GDP data at the end of November, India’s economy grew 7.6% in the July-September quarter, making it the fastest-growing major economy in the world.

“Overall GDP numbers have surprised on the upside, despite all the global stress and shocks that we saw and unknown events happening, I think they haven’t impacted us to that extent,” said DK Joshi, chief economist at credit rating agency CRISIL. The primary driver of growth has been the government, as private consumption remained slow. “Because they are pushing investments up, and also because government consumption is also rising. Private consumption appears to be a little weak,” he said. “But my sense is [that] we’ll see some pickup as the second half data becomes available soon.”

On the inflation front, Joshi said that food inflation was the only problem. “If you look at fuel, it is negative right now. And if you look at core inflation, it’s also coming down,” he said, adding that food inflation cannot be ignored. “...When the shocks become persistent, as they are becoming, recently – we’ve seen cereals, pulses, spices, everything is in double digits — as a consequence of that because the rest of the economy is doing well, it can transmit quickly to the rest of the economy. So that is why the central bank has to be a little cautious on the inflation side,” he said.

The central bank will have to reassess how it looks at inflation and that monetary policy setting is key, he said. “The monetary policy in general is at a very delicate point. If you tighten too much, you end up with a recession. And if you tighten a little lower than that is needed, then inflation becomes entrenched,” he said.

In 2024, he said that the fiscal policy stimulus, which was being fed into the economy post-Covid, might continue. “But simultaneously the very high interest rates will also start impacting some segments. So there is a general slowdown which is expected,” he said. Joshi also said that the ongoing Israel conflict, and the attacks on commercial vessels in the Red Sea area, are affecting trade. “If it becomes a bigger conflict, the transportation costs, etc. will rise and that will create supply-side issues. Again, I think the cost will rise and that does hurt trade,” he added.

In The Core Report: Special Edition, financial journalist Govindraj Ethiraj and CRISIL’s DK Joshi talked about key events or factors that occurred in 2023, that could set the stage for what will likely happen in 2024, and lessons and insights to carry forward into the next year.

Edited excerpts:

Let’s start in a very broad sense. There is the internal economy, there’s the external economy. And I would rather leave it to you to prioritise what were the most significant macroeconomic developments of 2023, which in some ways I’ll try and link to, or ask you to link to what could happen or set the stage for 2024.

I think the number one event from a macro perspective is the monetary policy setting. I think globally, there is a realisation now that the monetary policy needs to be more proactive, and that’s more in the advanced part of the world. The emerging markets this time were more nimble. The central banks were more proactive. And the guys who faltered were the guys whose models we used to follow. So the US Fed went consistently wrong in predicting inflation time after time.

Earlier they were expecting inflation to touch 2%, which is their target, by the beginning of 2023. Now that has moved to the end of ‘25. So what that has done is it has induced a certain amount of caution into the central banks. You went wrong in predicting the upside of inflation. Will you be right in predicting the downside? So the monetary policy in general is at a very delicate point. If you tighten too much, you end up with a recession. And if you tighten a little lower than what is needed, then inflation becomes entrenched. And you can see that what the Fed most recently did was it turned dovish…where they were giving very hawkish commentary before that but it’s because I think they need to keep adjusting to the changing times.

But the lesson here is that the central bank will have to reassess how it looks at inflation. Why did it miss the boat? And I think more proactiveness is needed from the Western Central Banks now because they have a bigger problem at hand.

That’s an interesting point. What I’d like to know is why did they miss the boat?

Well, I think it’s because you have had low inflation for a very long time. It seems …they forgot that fiscal policy works. The fiscal stimulus that was being injected post-Covid was huge and fiscal policy actually worked and it created a huge amount of demand. That is why I think the unemployment rate is also low in the US.

I think the fiscal policy stimulus continues to feed into the economy and may continue to feed even in 2024. But simultaneously the very high interest rates will also start impacting some segments. So there is a general slowdown which is expected. Received wisdom is that it will be a soft landing, but whether it will be soft or will it be hard, I think time will tell. I think the past experience is not very good as far as the forecasts are concerned.

But when you mentioned the United States and the Federal Reserve and its dovish stance right now. So when we look at, let’s say, prices of gold, we look at the rupee, we look at oil, and of course stock market flows themselves, everything seems to be linked to what the Federal Reserve is doing or has done. Now, this has obviously been the case somewhat over the years, but one would have thought, or maybe expected that we would have decoupled to some extent and that doesn’t seem to be the case. Would you agree with that?

Well, I think as far as the economies are concerned, we are not decoupled in the cycles…as far as cycles are concerned. The cycles are correlated because we are more interconnected. But the trend is decoupled… so long term and the monetary policy, etc, I think these are part of the cycle, so they do impact. However if you notice what happened to the 10-year bonds, the day the Fed turned dovish, the 10-year bonds fell. There was no action from the RBI. So it was purely external factors.

And then there are countries like Indonesia which have raised interest rates not because their inflation is high, but because the US Fed is keeping interest rates high and that is impacting their currency, it’s impacting capital flows. So there is an impact of systemically important central banks in the world, on emerging markets. And on top of the pile is the US Federal Reserve.

Having said that, what we might see now in the coming year is that the emerging markets will not wait for the Fed to cut rates. I think some of them, which had started raising interest rates much before, I think the inflation became a problem there, I think they can cut rates earlier also. And the quantity of rate hikes by the Fed or quantum is much, much higher than what the Indian Central Bank, for instance, has done. So I think it’s not a one-to-one relationship. That’s what I wanted to point out. But directionally, I think both. You can’t ignore what the Fed is doing, by the way. It’s not only about raising interest rates. They’re also shrinking their balance sheets. If you take the debate back to 2009-10, we used to say that the Fed is expanding its balance sheet. So a lot of money is coming into the system. Dollars are flowing, so if they are shrinking their balance sheet, the reverse should happen. So the dollar flow globally should also be restricted because of quantitative tightening now.

Let’s look at India now. Obviously, in India, we are used to higher interest rates. We are used to higher inflation compared to many of these countries. The interesting thing that seemed to have happened in ‘23 and maybe ‘22 as well is that interest rates and inflation numbers in India almost seem to mirror the West and vice versa. But if we were to put that aside, how would you say India has managed its interstate environment and its inflation environment in a very broad sense from 2023?

Well, I think we’ve done reasonably well. I would say the only problem has been food inflation. If you look at fuel, it is negative right now. And if you look at core inflation, it’s also coming down. Core is when you take food and fuel out of the overall inflation basket. The reason why it is coming down is, that input costs are low, so companies are managing to protect their margins and also they are passing on some of the benefits to the consumer. So that’s why core inflation is low. Fuel inflation is low purely because the gas prices are controlled. Also, the recent reduction in cooking gas created a base effect. So fuel inflation became negative.

Now, food is the biggest problem. Although central banks do not control food inflation through monetary policy, when the shocks become persistent, as they are becoming, recently, I think we’ve seen cereals, pulses, spices, everything is in double digits. As a consequence of that, because the rest of the economy is doing well, it can transmit quickly to the rest of the economy. So that is why the central bank has to be a little cautious on the inflation side. They cannot ignore what’s happening on the food front.

But can central banks do anything about food inflation in general and in specific in India?

No. They can’t control food inflation, or even for that matter, fuel inflation. What they can do is that they slow down the economy, then the transmission slows down. So they can only slow the transmission of the shock from food to the rest of the economy. That is how it works. But they can’t bring the food inflation per se down.

And I’m going to come to overall GDP and growth and so on. But when you look at the way we’ve managed our monetary policy, when we’ve raised interest rates and we’ve lowered interest rates, you feel that we are following our own trajectory, or is there some connection now, or continues to, do we still see a connection with what’s happening in the rest of the world right now?

Yeah, we do see. I think particularly the Fed actions do have an impact, but the dominant role of monetary policy is domestic conditions. That is why, as I said earlier, we did not have to raise interest rates as much as the US and Europe had to raise. So I think if you look at the central bank policy, there’s a large section on what’s happening globally. So they do take into account what’s happening globally. Domestic inflation is the primary driver of monetary policy. But on the periphery, what happens in the global economy does influence that.

So let’s come to GDP now. So if you were to look at growth in 2023 and before we come to 2024, firstly, how would you describe it when we look at the numbers? Suppose we say, okay, GDP grew 7.6%. That obviously sounds very good, but it’s in relation to something else, which in turn is in relation to maybe the number that we saw in Covid. So, firstly, are we out of that base effect? And to the extent that we are or not, where are we today?

Well, I think if you compare the size of the economy to the pre-Covid, yeah, we are much higher than that. I think there’s no doubt. But different parts have recovered differently. I think the fastest recovery has been in investments. So investment has caught up with the trend level. I mean, if there were no Covid, we would still be there as far as investments are concerned. But for other parts, I think we may not be that.

As far as trade is concerned, I think we are above the trend because trade did very well after the pandemic. So overall, I think the economy, if I take the case that there was no pandemic and the economy would have moved in a particular direction, I think it is still below the level where it would have been without the pandemic. But some parts have recovered faster than others.

So in absolute numbers or gross value added, where are we today compared to what we were pre-pandemic?

Well, I think we would be. I don’t have the number on the top of my head, I think seven, or eight, maybe I can confirm that number later, but we are much higher than what we were at the pre-pandemic level. But as far as the trend level is concerned, we are below that.

If you were to look at the numbers that we’ve been seeing most recently, to what extent is that reflecting, let’s say, a much stronger economy, or are we still on base effect?

No, I think it’s reflecting a stronger economy because if you see the components, you will see agriculture hasn’t done well. I think the latest data showed 1.2%. Just for reference, in the last ten years, the average growth in agriculture has been 4.4% per year, which is above the trend. So I think agriculture has markedly slowed down.

Despite agriculture slowing, if you are doing well, that means the other parts of the economy are doing better. And there, I think construction and manufacturing are staging some sort of a comeback. Let’s get a historical perspective on this. After the pandemic, you could not consume services because immediately after the pandemic struck, but you could consume manufactured goods. You can order them… XYZ. So manufacturing did well at that time, but the moment you opened the economy up and Covid was down, you rushed towards services. And now the pent-up demand in services is coming down. So manufacturing will again move up.

And this is exactly what is reflected in the GDP data that we saw. So overall GDP numbers have surprised us on the upside, despite all the global stress and shocks that we saw and unknown events happening, I think they haven’t impacted us to that extent. Having said that, in the last quarter, the primary drivers have been the government, because they are pushing investments up, and also because government consumption is also rising. Private consumption appears to be a little weak. But my sense is, I think we’ll see some pickup as the second half data becomes available soon.

If we were to look at GDP and break it down a little bit, one is of course, what we produce and consume within the country, and the other is what we export. How does that set the stage for what we are likely to see in 2024?

It’s a very interesting scenario that is likely to play out, and there are two factors there. One is what is the expectation on global trade next year? What really struck me was that whether you look at the Organisation for Economic Co-operation and Development (OECD) forecast or the International Monetary Fund (IMF) forecast or the World Trade Organisation (WTO) forecast, everybody is predicting a pickup in goods exports. Goods exports did not do well in 2023.

They only grew by something like volume growth was 0.9% and that is expected to grow at 3%. One of the reasons is that from services you’ll move towards goods. So if you consume more goods, you will trade more goods. The catch for India is that our trade exposure has been rising to the US and Europe, and the US is expected to slow down next year. So how that impacts us, I think will be a key monitorable.

Second, I think is what we are seeing in the Red Sea area. If it becomes a bigger conflict, I think the transportation costs, et cetera, will rise and that will create supply-side issues. Again, I think the cost will rise and I think that will hurt trade. The other point that I’ve been making for the last couple of quarters is that our trade exposure to Asia has slowed. And this is the part of the world which is growing very well. And by the way, it’s not only India that is doing well. There are other Asian countries that are domestically driven, like Indonesia, Philippines, etc. They are also recording reasonably healthy growth rates. Trade is, you have to observe how, whether the prediction of OECD etc for global trade does come true or not.

If it comes true, then how do we shape up vis-a-vis the slowdown in the US?

So I think overall I would say that a sharp slowdown in goods trade is not expected in the coming year because of these development projections.

Now a more conceptual question. To what extent will we grow as an economy, or to what extent will we add growth to our economy because of exports? And conversely, do we need strong exports to really boost the economy? Or could we do well even if things are as they are today?

Well, I think this year, if you see exports, it’s minus 6% cumulative growth. So exports haven’t done that well, but still growth has, which is telling you that domestic demand is what is firing growth. You need exports because I think if exports rise, domestic activity also picks up in accordance with that. I mean, if you are exporting more manufacturing products, you are also producing more manufacturing products. It’s helping you create more jobs, etc.

It is also making you more competitive if you are able to, you’re providing better stuff at home also apart from exporting. So exports are a very critical part of ensuring that if your exports grow, particularly in more complex areas, then your supply chains are becoming more efficient. I think I would say that exports are a very important part. It’s not just the growth, but it has many other implications. And right now, I think the scenario is a little tougher in general for exports because countries are turning inwards.

So if you were to look at, let’s say, some of the targets that we have as a country, a $5 trillion economy, or even beyond that, what is the role that exports can play, will have to play in helping us get that additional growth? Or the converse is that we really, I mean, it’s good as long as it’s there, but it’s not going to make a difference in the kicker.

Well, I think what goes into the demand side GDP calculation is C-consumption plus I-investment plus G which is government spending, exports minus imports. Our imports are still higher than exports. So the trade is not adding to the GDP. It may be adding less at points sometimes and it may be more negative at some other points in time. It’s not just pushing the growth up, it’s doing a variety of things. It’s ensuring that you are becoming more efficient, etcetera. I think we can become a $5 trillion economy even without exports growing much more than they have previously.

Or becoming like China, which is usually what people are thinking of.

It’s a different environment. When China was growing, when East Asia was growing, the countries were opening up. Now they are setting up their own industrial hubs. They are promoting industrial policy, whether it’s the Inflation Act or the Chips Act. So there is a move to move production inwards…tariffs are being used to discriminate against your geopolitical rivals, etc. India will benefit because I think trade is shifting and we might benefit a little bit from that. But so far I think we haven’t seen much benefit coming from the supply chain shift. The benefit in Asia has gone to Vietnam and Thailand, I mean, more than anybody else.

Let’s stay within the economy now or within the country now. So there’s government spending, which obviously is very high. There is private investment, which has not been so high. And there is private consumption. So these are only the three things that I’m guessing we can talk about. So tell us about how each of these three strands is looking as you look at 2024 and what could grow more on this.

I think the government is committed to a fiscal deficit path and fiscal consolidation is important for three reasons. Number one is India is triple B Minus, which is just investment grade. And it has the highest debt in the peer group of triple B minus.

The third reason why I think fiscal policy is into focus is also because you are entering the JP Morgan index next year and you’re subject to a little more fiscal scrutiny. So I think if you put all these three things together, there needs to be fiscal consolidation. So the government has been pushing investments, the I component, and now it’s time for the private sector to take the baton from the government.

The issue is that the government cannot adhere to fiscal consolidation targets by creating infrastructure or spending on infrastructure, even though it is good the way it has been doing in the last two years. So it will have to slow down. So as far as the private sector is concerned, I think there are three, or four reasons why the private sector is in a position to invest. One is capacity utilisation in manufacturing above 76%... the second is the government investment itself has propped up your segments like steel, cement, etc. So there is some spillover from there.

Then, the industrial policy of the government is supporting investment right now in less capital-intensive sectors like electronics and pharma but going ahead, we’ll see specialties, steel, solar panels, and auto. These are next in line. And then the balance sheet of the corporates is still quite good.

Their leverage is low, so they are in a position to borrow and expand. And then India also has the opportunity to latch on to the global supply chain shifts by accelerating the process of attracting them. So it’s a very good time to push private investors. So you have to identify what is holding it back, apart from the uncertainty, which you can’t control, global uncertainty. But whatever the bottlenecks are, if you address them, the transition from government investment to private investment will be smoother and it will lead to more sustainable growth. So that is the investment part.

Government consumption. I think you have committed expenditures on interest rates because your debt is high. You have committed expenditure on subsidies, which is food subsidy, which has been extended to five years. So you’ll have to focus on revenue collections and plug as many holes as you can in the revenue.

What I mean is some part of government consumption expenditure is fixed. But the other part I think you can still address and at the same time raise your revenue so that it doesn’t become a fiscal burden. So this is consumption. And then finally, is the private investment part, which is the consumption from the households. Household consumption got skewed. I think there is a clear premiumisation happening there. The consumption items of lower income classes are not doing well, but the upper-income classes are doing well. The average size of the automobile, and the average price of the automobile that is being sold have become much bigger.

Here I think the only solution is creating better job opportunities so that people do not have to depend on food subsidies, etc. They can generate their income over time, but that will take time. So private consumption will be a mixed bag. You will see certain elements, newer areas, newer modes of consumption, more technology-related consumption, digital content, all these things. I think they are also part of consumption. Unfortunately, we don’t measure them well. It doesn’t show up properly in GDP because the base is 11-12. I think the consumption pattern in 11-12 and today is very different. So you need to rebase your GDP calculations also. And I think that’s happening pretty soon. I think they are looking for a normal year to do that

To come back to, or rather to go to the individual now who is at the center of all of this, what’s your sense? I get the point that there is a k-shaped recovery, or there was a k-shaped recovery, and therefore there is k-shaped consumption today. So this is not a happy state. Governments have to think of everyone, not just those who can buy higher-end cars or bigger houses or whatever. So how is this likely to pan out, at least from an economic point of view?

We are coming out of a phase that has been quite disruptive. Covid itself was disruptive. It has shaken manufacturing, and services, depending on which phase you were in. And going ahead, my sense is the next phase is going to be because of the changing behaviour, whether it is your consumption, you want to consume certain things quickly. You don’t want to give up on premium stuff, even if you can’t afford it.

So all these considerations are important for the individual and also for the corporates. But coming back to your primary question, the only way I see it is job creation, more meaningful job creation, so to say, which is a very big challenge because when you promote efficiency, I think you become more capital intensive also at times. So how do you promote labour-intensive segments is a big challenge. That is the reason why the government has to take care of people who can’t benefit from the growth process completely by providing either free food or maybe health insurance.

But there’s always, I think, a conflict between equity and efficiency. When you are trying to push growth up trying to push efficiency up, sometimes the equity part gets neglected. It becomes the duty of the government to ensure that.

If we were to flip that aside, we talked about private investment or consumers. If we were to look at it from a business point of view, how should business leaders or businesses be looking at all of this going into 2024?

Well, I think they have to be very nimble. That’s all I can say. Given the speed with which I think technology is transforming. I think for businesses, a very critical question would be, how do you manage the office space? What proportion of people will be willing to come or not? all those assessments are going into the calculation of businessmen.

The other thing is, that they have benefited a lot this year, profit margins from lower input costs, etc. So they have to be very mindful of where the energy price is going, or for that matter, the commodity price is going. Looks like there’s not much upside to it. The profit margin issue, I think to manage that, they have to manage their risks better.

I think they have to focus more on resilience. You need to keep cash reserves because you are in a volatile environment. Having a good balance sheet helps you, because it does two things. One, it cushions you when there is a shock. Second, it allows you to take up more investments because you have low leverage if the opportunity is there. So I think it’s a good situation for mid and large-size corporates.

And the other thing which I mentioned earlier, was the switch from services to manufacturing, which we are seeing in data. If that happens, if your manufacturing or non-service sector does better, then you have to be positioned accordingly.

So when you say the data showing a switch, I mean, what’s the kind of switch that we see?

You see manufacturing growth at 13%. Construction growth is extremely strong.

But construction is driving manufacturing, or is it?

Both are, both are separately measured. I think the value-added now, I think if you move beyond that and then start looking at services, services growth is strong, but it is slowing. I mean, the pace with which it is increasing is slowing. And as I said globally, the good sector is expected to do well. So it kind of ties up with that story. So this transition from super high growth in services or pent-up demand-led growth in services could be towards the manufacturing goods sector. So the corporates will accordingly benefit or lose.

But at a consumer level, you’re saying that people who, let’s say, splurged on experiences will maybe now go back to splurging on goods.

They may not splurge on goods, depending…now services will slow and the manufacturing goods segment will be more back in fashion, I think.

And that’s an important trend to look out for.

For, I’m not sure whether it will play out, but I’m drawing from what the global multilaterals are saying about the goods trade, and Indian data also kind of maps to that. It will be an interesting trend to watch if it plays out that way.

I asked you about how business leaders should be looking at 2024 in terms of opportunities and risks and so on. Obviously, climate is going to play an important role here. And this, I’m sure, comes out even in your own interactions with businesses and companies. So what does that whole area look like?

Well, I think 2023 was a flashpoint in some sense because it is expected, or rather projected to be the hottest year in recorded history and we’ve seen disruptions happening. So you will have to focus both on mitigating and adaptation.

Mitigating is like reducing your carbon footprint. Adaptation is like what we have done for cyclones, etc. I think they’re coming, but they’re not hitting the economy that badly, or they are not killing that many people.

Both these have become important considerations for businesses, and for governments, because even for a business, it’s not only where you are situated. If you are situated in a climatically fragile zone, I think that has a bearing on your profits. It has a bearing on the perception. If you are sourcing your material from areas that can be disrupted by climate, again, you are exposing yourself to newer risks.

All these considerations will have to be addressed and companies have to start thinking ahead because this is a shock. You have to make yourself more resilient, just as you are trying to make new crops that can withstand heat and cold much more than the usual crops. Similarly, businesses will also have to plan for their transition.

And you are seeing many businesses put a number to this and say, okay, this is the amount of resources I have to devote to.

They are thinking about it now. Even investments will become climate-sensitive. That’s the other part. Green investments, all those things are also there. Very much so. For a country like India the ecosystem has to focus more on adaptation, I would say, because the mitigation would mean in some sense reducing your carbon footprint, which we should be doing, but we can’t do it as fast as the rich countries. So making sure that you adapt to the changing climate and become more resilient is a consideration for most businesses and they are also aware of how much carbon footprint you are creating.

If in your own wish list of things that you would like to foster, let’s say a more stable economy or a stable to growth economy and so on, what would it be?

Well, there’s no solution from a short-term perspective. You need health, and education, these are things that you need to focus on for long-term sustainable growth. And then skilling people is very important because there is a skill mismatch also. It’s not only that people are not finding employment, some of the employees are not finding people. And there are areas where if you are talking of AI, etc, you need to focus on enough manpower in that segment because it’s very different from the IT service that you were doing earlier.

Global players will come to India and GCCs are already known capability centres and they’ll become more attractive if you can supply the required manpower. Because services exports, in total exports, the share is only rising in the last two decades. It’s 42% share of services exports now. So that is one part.

And second is there is the infra and other things which you are growing, make sure enough manpower is available to deliver on that.

The second item would be if you want to pass the baton to the private sector, address their bottlenecks…Think I gave you four or five reasons why the private sector can invest and if those conditions are met, you could have a very sustainable investment cycle pickup.

Also Read : ‘Risks Largely External’: Crisil’s DK Joshi On Decoding Global And Domestic Macro Signals