7.8% GDP Growth in Q1 FY27 Sparks Intense Debate

 

As is the norm, on the last day of August, the Ministry of Statistics and Program Implementation (MoSPI) released the economic output data for the first quarter of the current financial year, reporting GDP growth of 7.8 per cent.  This growth rate presents India as the fastest-growing economy. Still, it is lower than the 8.6 per cent recorded in the previous quarter and, of course, higher than the 6.9 per cent growth in the corresponding quarter of 2025-26. This stronger-than-expected performance beats the RBI’s 7 per cent forecast, despite heightened global uncertainties that have pushed up energy prices, stoked inflationary pressures and weakened external demand.  

Interestingly, this 7.8% real-growth estimate for the first quarter of fiscal 2027 is accompanied by an impressive rise in real GVA that stood at 8.2%, supported by strong performance in manufacturing and financial/professional-services. This surge in GVA, many economists opined, acts as a cleaner, more reliable indicator of core economic momentum, for it filters out distortions from volatile net taxation and product subsidies.

Yet, it has triggered intense debate. Subhash Chandra Garg, the former financial secretary, commented that the first quarter real GDP growth is not 7.8 per cent but just 2.6 per cent. He argued that it was the revision of the earlier estimate of Q1 FY 26 GDP from Rs 86 lakh crore to 80 lakh crore that made the year-on-year comparison look much stronger. He further stated that comparing Q1 FY27 nominal GDP of Rs 88.27 lakh crore with the former, unrevised Q1 FY26 figure of Rs 86 lakh crore would imply nominal growth of only about 2.6%, rather than the officially reported 10.3%. He further contended that after accounting for inflation of about 2-2.5%, the real growth might be near zero. His contention is primarily based on the scale and consequences of the revision made to the base-period estimate.

The wider criticism that the revised data attracted from some quarters squarely rests on: one, the substantial revision of past GDP estimates calls for fuller disclosure and closer scrutiny; two, the gap between reported real GVA growth (9.2%) and nominal GVA growth (7.7%) yielding an implicit GVA deflator of minus 1.5%; three, whether the new deflators and double-deflation procedure could make real manufacturing growth appear unusually strong when input-price and output-price movements diverge; and four, the most pertinent question: whether a strong GDP figure adequately reflects employment, investment quality and distributional outcomes.   

The MoSPI rejected Garg’s 2.6% calculation because it compares estimates from different statistical series: Q1 FY27 is measured under the revised 2022–23-base framework, while Garg’s denominator is an older, unrevised estimate based on the base year of 2011-12. They say a valid year-on-year growth calculation must compare the revised Q1 FY27 figure with the correspondingly revised Q1 FY26 figure.

The ministry further stated that the revision resulted from updated sources and methods—such as more extensive GST and digitally generated data—not from a discretionary reduction of last year’s GDP to enhance the current year’s growth rate. On double deflation, it maintains that a negative implicit manufacturing GVA deflator does not mean manufacturing prices fell; it reflects output and intermediate inputs being deflated separately, not because of a 1.5% fall in all manufacturing prices.

Here, one must bear in mind that double deflation measures real value added; of course, the resulting growth estimate may be higher or lower in any particular quarter depending on the data on output, inputs and their respective prices, while a single deflator can distort the volume estimate when commodity, energy and component costs move differently from the prices manufacturers receive for finished goods. Indeed, this switch aligns India’s national accounts more closely with internationally used statistical practice and, as asserted by the Ministry, is not meant to generate a higher GDP figure. There is also a strong argument that economies that grow fast, particularly with a very large informal component, need to reset their base and methodology periodically to capture new information, which may revise overall GDP numbers up or down.

The overall assertion of economists is that there is no playing politics with the data to present a higher GDP number. They argue that if the government were interested in inflating growth, it could have simply tried to push the consumption numbers higher – a figure difficult to measure/verify – but the consumption number was at a lower rate than in the old data. The rise in GDP is also to be understood alongside the growth in investment, imports and import prices.   

That said, it must also be admitted that the GDP growth figures fail to address the concerns about jobs, inequality, or the durability of growth. Nor does it address the higher tariffs on imported goods such as polyester, etc. Surajit Bhalla, in one of his current discussions on GDP, questioned the growing influence of the “deep State” on policymaking. As former finance secretary, SC Garg observed, the sharp downward revision of the corresponding quarter of the previous year calls for far more transparency. His demand to publish the “income leg” of national accounts – revealing how value-added is divided among labour, corporations and government – will certainly clarify how wealth is distributed. Ironically, no such practice was in vogue when he was the Finance Secretary. But in a democracy, these systemic questions matter just as much as GDP growth, if not more.   

The Overdue New CPI Series

 

The Ministry of Statistics & Programme Implementation has finally released the new Consumer Price Index (CPI) on 12 February 2026, updating the base year from 2012 to 2024=100. The new CPI is pegged to consumption patterns from the household consumption expenditure survey 2023-24. The previous series had 2012 as its base year and was based on consumption patterns of 2011-12.

As the Chief Economic Adviser, Anantha Nageswaran observed, India has changed significantly over the last decade, both in terms of consumption behaviours and the composition of household expenditure. For instance, 80 crore households are now receiving free foodgrain under the Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY). This obviously reduces the amount spent on food. That aside, many new service offerings, such as over-the-top video streaming, gaming & metaverse Services, online market means, etc., have emerged. The lifestyle of the common man has thus drastically changed over the last decade.

The new CPI series addresses these changes commendably. The weightage of food and beverages in the overall CPI has been reduced to 36.75% from 45.86% in the earlier CPI. This is indeed a significant move, for food prices hitherto have a far greater influence on the overall inflation rate, despite their shrinking share in households’ monthly expenditures. Over it, food prices in India are notoriously volatile, for they quickly reflect supply bottlenecks caused mostly by the vagaries of weather. Indeed, this adjustment also captures the fact of reduction in the proportion of income spent on food by households owing to their rising living standards across the geography and thereby presents a more reliable inflation data for the policymakers.

Secondly, as India’s service economy is growing faster than the economy’s average growth rate, price levels in the sector will have a significant impact on the inflation behaviour. In order to capture this growing phenomenon, the new index covered many new items from this sector, which is likely to improve the quality and representativeness of the index.  For the first time, the index included the data collected from 12 ecommerce platforms, in addition to the data collected from more marketplaces across the country.  This inclusion of price information from digital channels may enable the policymakers at the state level to better distinguish the inflation dynamics prevailing in urban and rural areas and initiate necessary measures to counter the so emerging challenges.   

One noteworthy feature of the new index is its adoption of the international Classification of Individual Consumption by Purpose (COICOP) 2018 framework for grouping household consumption expenditure on goods and services. It offers several key benefits: granular dissemination of data, improved accuracy on modern consumption, precise classification by usage, global comparability and importantly, allows policymakers to identify specific inflationary pressures in modern service sectors.

The importance of more accurate inflation data for macroeconomic stability hardly needs to be stressed here, for it plays a pivotal role in orchestrating fiscal and monetary policies.  It is in that context that assigning a realistic weightage for food items in the new index augurs well in making the index more stable. Similarly, increase in the number of weighted items in the basket to 358 from the existing 299 and within this, goods have risen to 308 from 259 and services from 40 to 50, inclusion of rural housing, online media, etc., is certain to improve the strength of the index. All this, in turn, shall enhance the scope for predicting budget allocations, for some aspects of the budget, such as inflation-linked dearness allowances and dearness relief, are linked to the CPI.

Similarly, the well-constructed new CPI will aid the Reserve Bank of India, particularly its Monetary Policy Committee, in framing various policy interest rates by providing an accurate estimate of the prevailing inflation rate. This shall enable the RBI to focus more on aggregate demand pressures rather than manoeuvring the supply-induced inflation through a demand-sensitive variable like the interest rate. The new CPI is likely to improve the assessment of poverty levels as well.

According to the new CPI, the inflation rate increased to 2.75% in January as against 1.33% in December (under the old CPI). Although the Ministry of Statistics & Programme Implementation provided the back-series data, some experts opined that the conversion is largely mechanical, for it applied the ‘linking-factor’ to previous data rather than reconstructing the entire old basket to mirror the new, updated consumption patterns, which would have facilitated easy comparative analysis. 

The Ministry has indeed delivered an updated, digitally supported and analytically stronger CPI. The new index portraying methodological rigour and practical relevance, reflects international alignment.   Nevertheless, the ministry should engage in reviewing the index once in every five years with greater coverage, accuracy and offer without fail a representative index of India’s fast changing consumption landscape.

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India-EU FTA: A Challenging Opportunity!

 

After nearly two decades of intermittent negotiations, India and the European Union have finally signed the much-awaited Free Trade Agreement (FTA) – hailed by both sides as the “Mother of All Deeds” – on January 27. This deal is more than a trade agreement: It heralds that India has come of age, for it has shown the courage to enter into a trade agreement with 27 countries that are far ahead of India technologically and economically.

This agreement also showcases India’s confidence, maturity and negotiating skills in dealing with a powerful counterparty. Piyush Goyal, Commerce minister, nicely reflects this while describing the scale and intent of the agreement, thus: “This mother is neither going to be very strict nor lenient. This mother is going to be compassionate … going to be loving, …going to make sure that … the 27 nations of Europe and India, all 28 … will enjoy the fruits of this free trade agreement.”

This deal is pretty ambitious. The EU is India’s third-largest trading partner. During 2024-25, India exported goods worth $75.85 billion to the EU and imported goods worth $60.68 bn. Under the deal, the EU will drop tariffs on 99.5 % of goods imported in terms of value from India. Similarly, India has agreed to liberalise duties on over 92 per cent of tariff lines. India has agreed to bring down tariffs to zero on 30% of trade by value as soon as the agreement comes into force. Thus, Europe will get access to a vast Indian market of 1.4 bn consumers. Similarly, Indian manufacturers in the textiles, leather, engineering goods, and gems and jewellery sectors can now compete on an equal footing with countries like Turkiye, Vietnam, etc.

Credit goes to both parties for accommodating each other’s sensitive issues that seemed intractable previously. India could manage to ensure that its strategic agricultural sectors and dairy were excluded from the deal. Similarly, the EU managed to exclude several of its sensitive agricultural sectors from the deal. That aside, the workable solution to tackle automobile exports to India stands out. The quota-based system, limited to higher-end vehicles, designed to protect the interests of India’s domestic manufacturers at the lower-end of the price band, will offer a big opportunity for European luxury carmakers to export to India. Similarly, quota-based wine tariffs open the Indian market for French wine-makers while offering a semblance of protection to domestic producers.

This FTA is not just about tariffs. It also aims at rebalancing geopolitical interests. India, by deepening its ties with Europe, can hedge against the US trade unpredictability. In a similar vein, for the EU, the deal is a hedge against authoritarian supply chains. Indeed, several other agreements covering mobility, technology and defence and security were also signed to increase cooperation and strengthen relations between India and the EU. This newfound understanding shall lay the foundation for a broader India-EU strategic realignment.

Of course, in any such agreements, there is bound to be dissatisfaction among some quarters. The Samyukta Kisan Morcha (SKM) – an umbrella body of farmers’ organisations – fears that opening the processed food market to the EU will have a disastrous impact on domestic agriculture production and small farmers. But what one must bear in mind here is that while negotiating, one cannot expect all the benefits to be one-sided—there has to be a give-and-take approach. It is only when negotiations result in a win-win outcome that execution of a deal becomes smooth. Now that we understand our FTA-related challenges, we need to strengthen our competitiveness with targeted policy support to overcome the challenges.

That said, there are some real concerns: India could not obtain any concessions under the Carbon Border Adjustment Mechanism (CABM). Though as of date tariffs apply to only six carbon-intensive products, the deal is designed to include all industrial goods in the coming years. This is a big challenge. The only saving grace is that this tariff is applicable to all countries equally. India has, of course, succeeded in making the EU agree that any concession granted to any other country will be extended to India as well. Nonetheless, this is an opportunity for Indian firms to modernise quickly and enhance their credibility across global markets.

Similarly, the calibrated automobile liberalisation is likely to challenge India’s market dynamics. Unless policy measures to strengthen the domestic component ecosystem, MSME suppliers and R&D capabilities are implemented soon, we risk becoming a high-value import market. Similarly, despite tariff liberalisation, agri-exports will face a formidable challenge due to the EU’s stringent sanitary and phytosanitary standards, residue limits, carbon footprint compliance, and sustainability certifications. Secondly, the EU’s agricultural sector is highly subsidised and unless our farmers produce at scale and competitive costs, exports may not gain momentum.  

This FTA is a great opportunity. It offers India unprecedented access to European markets— one of the world’s most demanding regulatory blocs. To capitalise on the deal, domestic manufacturers, particularly MSMEs, which are the backbone of employment, need policy and financial support to upgrade their skills and technology. Thus, success rests on the execution of the deal. That is the big challenge!

2026: A New Dawn of Hope!

 

The year that saw wild swings in global financial markets— defence stocks riding over geopolitical tensions, AI mania; gold hitting record highs as investors searched for safety beyond the dollar, silver’s competing sprint; and bond markets, crypto craziness, and greedy carry-trades that saw wild gains and spectacular wipeouts amid shifting political tensions— has come to an end.

American stock markets were at an all-time high—the stock market index reached a record high of 6952.84 in December 2025. Conversely, the Indian equity market declined in the first quarter of 2025, owing to record selling by Foreign Institutional Investors amounting to over Rs 1 lakh crore. This trend did not reverse as they remained net sellers of Indian equities throughout the year. Indeed, they sold equities worth Rs 1.6 lakh crore over the course of the year. One reason cited for such a sell-off by FIIs was the high price-to-earnings ratio of Indian equities, which is considered as one of the most expensive in the world.  

Country-specific tariffs unveiled by the US have created substantial trade tensions. After hectic negotiations, tariffs have, of course, substantially receded from their highs in the case of the European Union and some other countries, such as Vietnam, Indonesia, etc., while China and India are still bearing the brunt. In fact, Indian businesses in copper, steel, aluminium, automobiles, gems and jewellery, textiles, and marine products are reeling under the 50% tariff imposed by the US on their exports.  According to the Commerce Ministry, shipments to the US dropped by 15% during the second quarter of 2025-26. Persistent trade barriers and a fragile global environment are bound to hurt not only India’s exports but also private investment and employment generation.

Amid this turbulent global scenario, it is heartening to note that the Indian economy continues to grow strongly, driven by robust domestic demand. Yet, the financial system, as the RBI observed, is likely to face near-term risks such as “increased exchange rate volatility, dampened trade, reduced corporate earnings, lower foreign investment and tightened financial conditions” owing to the spill overs from external uncertainties. However, the outlook for growth will become clearer once the tariff negotiations with the US come to a logical conclusion.

As international trade has become more fragmented and politicised, Indian exporters are now diversifying exports to markets outside the US, which rose by 5.5% between May and November 2025. The already signed Comprehensive Economic and Trade Agreement with the UK shall further support this attempt in 2026. Indeed, the government is actively negotiating free trade agreements with various countries to secure predictable and reasonable trade terms.

The recently concluded negotiations with New Zealand on a free trade agreement that emphasises services and labour mobility, areas in which India enjoys a comparative advantage, are expected to aid growth in 2026. The trade deal with the European Union, which is at an advanced stage of negotiations, is likely to come into force in the new year.  Similarly, talks with the US on a bilateral agreement on tariffs are expected to come to a logical end in 2026. Thus, the Indian economy appears well-positioned to weather the shocks of 2025.

The real challenge now is to ensure that the FTAs work to drive export growth. This obviously calls for strengthening domestic production capacity by developing robust component ecosystems and better design and tooling processes. In short, we must move beyond the assembly stage to build manufacturing capacities.  

Encouragingly, inflation, despite the rupee depreciating sharply, remained well below the targeted rate of the Reserve Bank. Thus, the growth-inflation trade-off remaining mild, a low-interest-rate scenario is likely to continue. This will help corporations exhibit improved performance. Once the corporate earnings become visible, FIIs are likely to return in the new year. The rupee, having already adjusted to the US tariffs, should stabilise with the return of FIIs in 2026. 

The growing wave of anti-Indian sentiment on US social media and the heightened scrutiny of H-1B visas pose mobility risks for Indian tech talent. However, investments committed recently by companies such as Google, Meta, Microsoft, and Amazon, totalling US $ 67.58 bn to establish data centres in India, and the growing interest of multinationals in establishing GCCs – 110 new centres by late 2025 – offer counterbalancing employment opportunities for technical personnel in the country.

That aside, RBI affirms that “strong domestic growth drivers, sizable foreign exchange reserves, and adequate capital and liquidity buffers across the financial system and corporate sector should help the economy withstand adverse shocks.” Thus, 2026 promises accelerated growth through resilient policies and investments – a positive divergence from 2025.  Nevertheless, challenges remain.  

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US Tariffs: A Wake-Up Call for India?

On August 27, the United States Department of Homeland Security released a notification imposing additional 25% tariffs on Indian imports, which will raise the total levy to 50%. This move is viewed by many in India as a form of tariff weaponization to penalize India for continuing to import oil from Russia. 

This sharp escalation in tariffs, which made India one of the worst-affected countries in Donald Trump’s tariff war, has rattled Indian exporters, particularly exporters from small and medium sectors such as textile exporters, auto parts manufacturers, gems and jewellery exporters, seafood exporters, etc., who now expect a steep decline in shipments, rushed to the government for immediate support to overcome the threat to their businesses. 

The stock market, too, reflected this anxiety. On the day of the announcement, the BSE Sensex plummeted 849.37 points to close at 80,786.54, while the NSE Nifty 50 dropped by 255.70 points to end at 24,712.05—the biggest loss in the last three months. 

Economists opine that if the 50% tariff persists, India’s gross domestic product (GDP) growth during the current fiscal could slip to or even below 6%. This elevated tariff is feared to hurt India’s relative competitiveness, dampen export momentum, erode investor sentiment, and potentially slow foreign direct investments. Cumulatively, these factors could impact the current account deficit, and eventually, build pressure for a sharper depreciation of the rupee. The rupee has already dropped to an all-time low of 88.31 to the US dollar. 

That aside, companies from several key export sectors that have become victims of high tariffs vis-à-vis exporters from countries like Vietnam, South Korea, Taiwan, etc., fear falling capacity utilization and job losses. Indeed, Crisil has already projected a 50% drop in the revenue growth of readymade garment makers, suggesting significant job losses in the sector.  

Yet, not all is bleak. Some analysts, including government agencies, believe that rising domestic demand, aided by the recent GST rationalization, low inflation, and falling interest rates, could soften the impact. Moreover, as India’s overall export dependence on the US is relatively limited—$86.5 bn during FY 2025—the broader economy might still avoid a deep shock. Rick Rossow of Center for Strategic and International Studies, Washington, also opined that as the tariffs targeted goods and manufacturing remained a relatively small share of India’s economy—around 14%—the impact on the “real economy will be limited”. 

Interestingly, in a recent public address, Prime Minister Narendra Modi said, “I appeal to the citizens of our country to prioritize purchasing goods that are made in India. Whether it is decorative items or gifts, let us choose products manufactured within our own nation.” Such a spirit, if it prevails among all citizens, could not only enable us to absorb the threat of tariffs but also keep India’s growth ambitions intact. 

Nonetheless, these high tariffs, which the government observed as “unfair, unjustified and unreasonable”, are not in the interest of the nation. Deteriorating access to the largest export market of the world at this critical juncture, when we are actively prioritizing manufacturing under “Make in India” policies, and also working towards placing ourselves as the alternative manufacturing hub for what is currently being made in China, may stifle our economy.  

That being the reality, India, as it has handled the issue of tariffs and the rhetoric surrounding it so far with maturity and pragmatism, may have to keep pushing the negotiations for a favorable accommodation with the US. Intriguingly, there is also an argument that Russian oil is not that cheap today compared to the prevailing global prices, and the benefits so accrued are not that encouraging even vis-à-vis the costs that it has to absorb by losing the US exports. So, keeping these facts in view, India has to play its cards deftly and navigate through the impasse with diplomatic finesse for a win-win outcome. 

Simultaneously, affected exporters must be helped to explore alternative markets by providing liquidity support in the meantime to sustain their operations. Indeed, it is a wake-up call for India not to rely on a single market to keep export business intact. 

Over and above all this, there is an urgent need to launch reforms to radically improve the ease of doing business in India. A fully functional single-window clearance system must be created to speedily clear investment proposals. Also, lower levies to make exports globally competitive. The immense potential offered by tourism must be exploited by launching necessary reforms that encourage tourist flows.  

Now is the time for Indians to act rationally, and as R C Bhargava, Chairman, MSIL, observed, to do their best and stand by the government in overcoming the hurdles and keep growing.

 

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Is the Rupee Overly Depreciated?

 

The rupee has been in a kind of free fall: it hit 85 to the US dollar on December 19, 2024, slipped to 86.62 on January 13, 2025, despite large-scale interventions by the Reserve Bank of India (RBI), and then touched a historic low of 87.1850 on February 3, a drop of 0.67 against the dollar.  

The Indian currency remained volatile throughout January 2025 as foreign portfolio investors sold stocks worth $6.7 bn and repatriated the proceeds during January alone. The two key market indices, Nifty 50 and BSE Sensex, which peaked on September 27, 2024, were down 11% by January 13, 2025, partly due to the relentless selling by foreign institutional investors during this period.

The depreciation of the rupee is not a new phenomenon; it has been depreciating by around 3.4% annually since 2005. However, the recent fall in the currency is largely attributed to the fear surrounding the tariff plans of US President Donald Trump, and the uncertainty that accompanied them. This was evident on February 3, when the Trump administration imposed tariffs on Mexico, China, and Canada, sparking a wave of risk aversion in emerging markets. As a result, the rupee touched a low of 87.28 at one point on that day.

 In response to tariff increases, the US dollar index—the value of the dollar relative to a basket of six currencies—rose from 107.8 on January 31 to 109.8 on February 3. The imposition of 25% tariffs on Mexico and Canada and 10% on China by the Trump administration indeed hammered markets globally. Tracking the global stock sell-off, the benchmark Sensex closed down 0.4% at 77,187, while the broader Nifty 50 index declined 0.5% to 232,61. Indeed, it was the intermittent intervention of the RBI in the dollar/rupee spot market that helped contain some losses.

Persistent outflows from the capital market and the demand for dollars from oil companies are putting continuous pressure on the rupee. As the impact of the US tariffs deepens, the rupee is likely to face even more pressure.  That aside, economic theory suggests that the tariffs imposed by Trump are expected to strengthen the dollar. If he proceeds with re-imposing the paused tariffs on Canada and Mexico, the dollar could further strengthen significantly.  The rupee is already one of the worst-performing Asian currencies. Furthermore, if the RBI, as anticipated by India Inc., cuts interest rates by 25 basis points, analysts fear that the rupee could soon hit the 88-per-dollar mark. 

Amidst this evolving scenario, analysts who once advocated for the RBI to let the rupee depreciate are now calling for it to defend the rupee. They fear that further depreciation of the rupee will increase the cost of commodity imports, which could, in turn, fuel persistent inflation. Exchange rate volatility also raises risk premia, which typically exceeds the actual depreciation in emerging markets. Indeed, such volatility harms the real sector as well. Over it, if depreciation continues at a faster pace, it may even affect the foreign investor sentiment. Given all this, some analysts are urging the RBI to intervene in the market to maintain a flexible nominal exchange rate that minimizes volatility. 

Raghuram Rajan, the former RBI Governor, stated that the central bank need not intervene in the market to protect the rupee, citing several reasons. He pointed out that the rupee is not the only currency depreciating against the dollar and that there is still room for the rupee to depreciate further. He believes that the rupee remains overvalued in real terms when compared to its peers. In fact, an estimate by the Bank of Baroda suggests that under ceteris paribus conditions—where only external factors are considered—there is still room for the rupee to depreciate.

In the last few months, foreign exchange reserves with the RBI have fallen from $705 bn to $635 bn as it sold dollars to protect the rupee from sharply depreciating. As a result, the appetite for further intervention has naturally diminished. Secondly, during the recent fall in the rupee against the dollar, the rupee has appreciated relative to the currencies of other trading partners. Therefore, exports to countries whose currencies have depreciated not only against the dollar but also against the rupee, and which are denominated in those currencies, are becoming less competitive. This may be another reason for the RBI’s recent muted intervention in the forex market.

That aside, managing both the exchange rate and inflation simultaneously is a challenging task for the RBI. Nevertheless, in the context of growing global uncertainty and weaponization of tariffs, RBI should use its reserves to reduce excess volatility in the exchange market, for reserves can be rebuilt over time.   

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Indian Economy: An Approach to the Trump Era ...

 

Intriguingly, European Central Bank Chief Christine Lagarde, in her first interview since Donald Trump won his second term to enter the Oval Office as the 47th President of the US, advised Europe’s political leaders “not to retaliate, but to negotiate” with the President-elect who asserted that he would impose tariffs between 10% to 20% on all non-Chinese imports into his country. 

She also warned that a “trade war at large” is “in nobody’s interest” for it would lead to “a global reduction of GDP”. Indeed deviating from her earlier stance, Lagarde advised European leaders to navigate through Trump’s second term by adopting a “cheque-book strategy”, they may “buy certain things from the US” such as liquefied natural gas, defense equipment, etc. For, it would signal a willingness to cooperate with the US, which in turn could aid both sides to de-escalate the conflict further. 

This advice given by Lagarde to EU nations perhaps merits consideration by India, for the country’s economy too is unlikely to remain unaffected by Trump’s vow to hike tariffs. Although many opine that for now India has been spared, one cannot afford to ignore what Trump said during his first term: “India has high tariffs”, citing its 100% tariff on Harley-Davidson motorcycles and 150% on American whisky, even labeled India the “tariff king”. 

So, it wouldn’t be surprising if Trump this time round pressurizes India for reduction in tariffs on American goods, particularly on agricultural produce, dairy, and animal products, despite the fact they are well within the WTO norms. Indeed, he aired similar comments in his recent press meet in Florida. Besides, US being the top trading partner with more than $190 bn in trade, and 80% of IT sector exports relying on US, India cannot afford to ignore these probabilities. 

That aside, as the BCG India Chairman Janmejaya Sinha observed, it is no guarantee that the pain, if any, inflicted by the proposed tariffs by Trump on China will automatically leads to a gain for India. For, to compete with China in production what a country needs to offer to the global corporates’ investment is not merely the reduction in cost but stability—stability in policy framework, the persistence of which China continues to offer till date, in many ways. 

Another big challenge is scale. Even though large industrial houses have of late started investing heavily in sectors such as electronics and semiconductors duly supported by the government scheme to offer tens of billions of dollars in the form of production-linked incentives, it is no match for what China did. There is a fear that unlike in China, there is a great problem relating to not only scale but also procurement of raw materials in India. 

Over and above all this, to realize the ambition of India becoming the electronics manufacturing hub, the country has to penetrate deeper into the supply chain by increasing the domestic value addition from the current 18%-20% to 40% in the immediate future. In view of all these hurdles, one wonders if the proposed hike in tariffs on Chinese goods by the Trump regime may not necessarily divert massive investments away from China. In fact, there are already reports indicating that US companies have put a pause on making further investments in India. Analysts even say that today from an investing perspective, America has zero interest in international markets. 

Speaking at the Global Economic Policy Forum 2024, World Bank Chief Economist Indermit Gill made two very important observations which demand India’s attention: one, global economic growth has been decelerating, with the potential growth rate in advanced economies halving over the past two decades; and two, even emerging markets and developing economies are seeing a decline in potential growth rates due to ongoing geopolitical tensions, trade fragmentation, policy uncertainty, and persistent inflation. Further, observing that the “changes needed are not happening quickly enough” in India, he urged policymakers to leverage the economy’s strength by accelerating structural reforms. 

Amidst all these hurdles coupled with consistently high inflation for the past two years, if India has to pursue its Viksit Bharat objective, it must continue to grow at least above 7-8% annually. Here, it is pertinent to remember that India ranks 153 against South Korea’s 44 and Taiwan’s 35 in the per capita export data generated by the World Bank and UNCTAD for about 200 countries. Even in service exports, India ranks 89 out of 114 countries trailing behind Malaysia, Turkey, Thailand, etc. Secondly, according to best-selling authors Gary W Keller and Jay Papasan, the one thing that could drive economic success is climbing the global value chain and thereby accomplishing sustained double-digit export performance. And, if this has to happen, we may have to follow the advice given by Lagarde: Adopt a cheque-book strategy while navigating through the Trump era and strengthen the ties with the US by leveraging on the friendly chord already struck as a participant of QUAD dialogue. 

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Why Some Countries are Rich while Others are Poor?

Traditionally, economic models emphasize that economic growth rests on the accumulation of factors of production, namely, labor, capital, and technology that enhance productivity and efficiency. In other words, the greater the capital stock per worker and the more productive and efficient its use, the richer a country would be. The obvious question that it raises is: Why did some countries accumulate more of these factors of production and grow richer than others?

This year’s winners of the Sveriges Riksbank Prize in Economic Sciences, awarded in memory of Alfred Nobel, “for studies of how institutions are formed and affect prosperity”—Daron Acemoglu, Professor at MIT, Cambridge, US; Simon Johnson, Professor at MIT, Cambridge, US, and James A Robinson Professor at University of Chicago, US—argue that accumulation of factors of production in a country depends on the quality of its institutions/government.  

In 2001, these three Laureates published a paper, “The Colonial Origins of Comparative Development: An Empirical Investigation”, that became one of the most cited papers in economics. This paper examined the long-lasting effects of colonialism on the economic development of countries. Employing a range of empirical methods, including regression analysis, and analysing the colonial experiences of various countries and their current economic performance using historical data, the authors have shown a clear correlation between the type of institutional patterns established during colonialism and present-day economic outcomes. 

According to them, colonizers had established two kinds of institutions in the colonies: One, extractive institutions, and the other inclusive institutions. Extractive institutions are designed to exploit the resources and labor of a colony such as Congo, etc., for the benefit of the small elite, i.e., the colonizers. Such institutions helped colonizers retain control and thereby enjoy short-term gains. On the other hand, inclusive institutions promoted broad participation including locals in the economic process and provided secure property rights, which ultimately fostered investment and innovation. This kind of institutional pattern had a lasting impact on the economic prosperity of the colonies such as North America, Canada, Australia, and New Zealand, leading to flourishing economic growth. 

This phenomenon of establishing different institutions in different colonies gave the Laureates a “natural experiment” to analyze and unearth the underlying criteria for the creation of different institutions in different colonies. The authors hypothesized that the said colonization strategy was in part determined by the feasibility of European settlement in the colonies. In support of this argument, they, cleverly using the historical data about the mortality rates of settlers in different colonies, inferred that those countries with low mortality rates had become attractive for colonizers to stay for long, and as a result, they built inclusive institutions allowing the colonized to share in the wealth produced through private property and free markets. 

Contrarily, in colonies such as in Africa and South America, where mortality rates of Europeans were high, colonizers tended to develop extractive institutions, for they had less incentive to settle there for long and build lasting governance structures. They finally concluded that these institutions by virtue of their persistence to the present continue to impact their economic performance. Their results also indicate that “reducing expropriation risk would result in significant gains in income per capita but do not point out what concrete steps would lead to an improvement in these institutions”. 

Some economists, however, argue that the data for the key variable, namely, “settler mortality” on which their very argument rests is flawed and selectively chosen to flatter their hypothesis and hence their empirical findings are not robust. They also commented that their style of inferring causation is debatable, for it cannot distinguish between the places that the colonizers went to and the human capital they brought along with them.  

Nevertheless, this paper was found to have greatly influenced several disciplines such as economic development, political science, economic history, institutional studies, etc. It also highlights the importance of historical specificity in understanding economic growth, and in that sense, it moved development economics away from traditional growth models.

Interestingly, way back in 1997, Jared Diamond argued in his trans-disciplinary non-fiction book Guns, Germes, and Steel: The Fates of Human Societies that it was the geography of European countries that led to early economic growth. Moving a bit beyond Diamond’s assertion, current year’s Nobel Laureates in economics, argued that it was the kind of institutions built by the colonizers in colonies—defined by mortality rates linked to the region’s geography—that ultimately influenced economic growth.

Indeed, two of the Laurates, Acemoglu and Robinson, taking the chain of causation one step further, argued in their best-selling book, Why Nations Fail, that political institutions as determinants of economic institutions led to long-run development. This argument, however, fails to explain how China with that kind of political institutions could grow economically so well, while India despite its democratic setup could not grow that well.

Nonetheless, the Nobel Laureates’ exploration to find an answer to the question as to why some countries are rich and others poor, has certainly laid a foundation for later generations of economists to build fresh knowledge over it. That aside, their paper also suggests strengthening property rights, encouraging political inclusivity, and promoting good governance for fostering economic development in post-colonial countries. Simply put, the Nobel Laurates argue for a genuine commitment of governments of the erstwhile colonies to build institutions that promote inclusive economic growth.   

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India-EFTA Trade Deal: Will It Serve India’s Interests?

It is after 21 rounds of negotiations spreading over 16 long years that India and the European Free Trade Association (EFTA) comprising Switzerland, Norway, Iceland, and Liechtenstein could at last sign the Trade and Economic Partnership Agreement (TEPA) on March 10. EFTA terms it a significant milestone in the relationship between EFTA and India and also claims that it reflects a deeper economic partnership. This agreement however comes into effect only after the member countries ratify the accord. 

The EFTA block is India’s fifth largest trading partner after the EU, China, US, and UK. Its member countries are not part of the EU. It is an intergovernmental organization meant to promote and intensify trade. It is neither a politically integrated bloc nor a customs union. They have one of the largest networks of free trade agreements (FTAs) spanning over 60 countries and territories. That reveals the growing importance of trade agreements for growth in international trade in a globalized world. 

The present agreement between these four small countries of EFTA and India is likely to open the doors of economic cooperation, knowledge sharing and job creation both in India and EFTA countries provided they work collaboratively and resolve every obstacle that pops up in the way strategically and move forward with faith in each other to implement the accord effectively. 

Theoretically speaking, a free trade agreement is a pact between two or more nations to reduce barriers to imports and exports among them. Under an FTA, goods and services can be bought and sold across international borders with little or no governmental tariffs, quotas, or subsidies. Free trade has indeed allowed many countries to attain rapid economic growth. It enables countries to capitalize on the principle of Ricardo’s ‘comparative advantage’ —focusing on producing such goods that a country can produce with cheap labour, and sell in the global market at a lower price and thereby garner the market. 

For the first time ever in the history of FTAs, the EFTA member nations have committed to invest $100 bn excluding foreign portfolio investment and help create a million jobs in India over the coming 15 years. The investment flow is however predicated on India’s GDP growing at a nominal rate of 9.5% over 15 years. There is, of course, an option in the agreement that enables India to revoke its trade concessions if there is any shortfall in the proposed investment but only in proportion to the extent of the shortfall in the said investment. This again could be undertaken only after a review which could take about three years, which means such revocation is possible only after 18-20 years of the agreement coming into force. It has also offered 92.2% of its tariff which covers 99.6% of India’s exports. The EFTA’s market access offer covers 100% of non-agri products and tariff concession on processed agricultural products. 

Now the question is: Whether India stand to gain market access, particularly to Switzerland? According to the Global Trade Research Initiative, 98% of India’s exports to Switzerland are industrial products and the duties on these products are now brought down to zero from the existing 1.3%. Thus, there appears to be no real gain. But the government hopes that the TEPA would stimulate our service exports in sectors where we are considered strong globally such as IT services, business services, personal, cultural, sporting and recreational services, audio-visual services, etc. Our IT companies such as TCS, Infosys and HCL already have their offices in EFTA countries but the free movement of IT professionals across these nations could only result in gains for India. Norway has, of course, said that there would be ‘no capping’ on the entry of Indian IT professionals, but there are no such explicit concessions in the agreement. In light of these realities, one has to wait and watch how the EFTA countries handle the entry of Indian professionals. 

In return, India offered to lift or partially remove very high customs duties on 95.3% of industrial imports, of course, excluding gold, in a phased manner over varying periods. Sectors such as dairy, soya, coal and sensitive agricultural products are excluded from the said list. Nevertheless, the reduction in tariffs is likely to expand the trade deficit that stood at $18.6 with EFTA countries. That aside, there are already more than 300 Swiss companies such as Nestlé, Holcim, Novartis, Sulzer and banks such as UBS operating in India. Switzerland, which already has a trade surplus of over $12 bn with India could now increase its export of electrical machinery, engineering products, wine, watches, medical devices and pharmaceuticals to India. 

Over it, Switzerland, the largest partner in the EFTA, has a thriving FTA with China. Recently, they have even upgraded their trade relationship. This posits a challenge: Will Chinese goods find an easy way into India via Switzerland? Of course, there are rules of origin in the agreement but one is not sure if they cannot be circumvented as it happened under the ASEAN FTA route. Incidentally, Switzerland is currently working towards resetting its ties with the EU. In case it enters the EU by adopting the ‘Carbon Border Adjustment Mechanism’ and other related conditions imposed by the EU, it may pose a new challenge to India. A vigil over these challenges is likely to keep gains in good stead.

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India in the Global Bond Index: What Next?

 

At last, India has made its entry into JP Morgan’s global bond market index. This will of course happen over a period of 10 months, starting from June 28, 2024, with a weight that is expected to reach 10% at an incremental of 1% per month by March 2025 in the GBI-Em Global Diversified Index. That aside, India is also likely to be included in other indices under the GBI-EM suite, with total assets of $236 bn under its management. 

With Russia out of the index after being ostracized post-Ukraine invasion, there emerged a free slot for another country to fill it and India with a fully accessible route for investment in the Government Securities (G-Secs) market that offers 23 government bonds with a notional value of Rs. 27 lakh cr equivalent to $330 bn, fit the bill quite well. 

Obviously, when G-Secs are included in a global index, the Indian bond market is certain to get a fillip, for foreign funds are likely to invest in G-Secs in larger quantities than what they are currently doing. The very inclusion in the global index affords a kind of gold standard to our bonds due to which foreign funds will be encouraged to invest. Even through passive investments of fund houses in a bond index, we are likely to get about $20-30 bn by way of our share of 10% in the index. In addition to that we may also get additional inflows by way of direct investment in our bonds as they offer higher interest vis-à-vis global rates. All this cumulatively leads to an increase in foreign portfolio investment (FPIs) in the debt market. 

One may now pose a question: Isn’t this happening today? True, FPIs do invest in G-Secs, but the limits prescribed for FPIs are not being fully utilized. The debt utilization statistics reveal that FPI holdings in G-Secs stood at 23.51% for general foreign investors and for long-term foreign investors it was about 5.59%. 

In such a scenario, the inclusion of our bonds in the index will be a game-changer: it is certain to widen our investor base, besides bringing down the cost of capital. Secondly, at a later stage, lured by the favorable yield on these indices, investors may even show security-specific interest, which means a still wider investor base.  Thirdly, it may even lead to the inclusion of corporate bonds at an opportune time. Finally, all this results in large capital inflows, which means not only a stronger rupee but also a strong surplus balance of payments position despite a widening current account deficit. 

Over and above all this, funding of the government deficit by FPIs, eases pressure on domestic banks for funds. This in turn will pave the way for banks to allocate more resources for lending to the private sector, resulting in economic expansion. 

However, there is a flip-side to this hunky-dory scenario. The inclusion of Indian bonds in the global indices exposes our bond markets to the repercussions due to exogenous forces. For instance, a phenomenon like the 2008 Global Financial Crisis would lead to a sell-off across markets and once our bonds are a part of the indices, it would result in capital flight. Such capital flight can destabilize not only the bond market but also exchange rates. In such situations, the intervention of Reserve Bank of India (RBI) assumes paramount importance in stabilizing both the forex and bond markets.  

At times, FPIs can induce volatility in domestic markets through their responses to exogenous reasons. For instance, when the US Federal Reserve raises interest rates dollar gets strengthened automatically, and this would simply trigger capital flight. This creates volatility in the forex market calling for RBI intervention. Such outflows create a cost for the central bank. Similarly, country rating plays an important role in the trading patterns of fund managers. Any change in rating outlook can also affect the investment patterns of funds, which can cause volatility. 

Today, RBI is in a position to successfully regulate excess volatility in the bond market by affecting liquidity. Thus, it has all the while managed to keep yields from G-Secs range-bound. This has helped the government in keeping its cost of borrowing moderate and stable. But once the FPIs start playing actively in the G-Secs market, the scene will change. Similarly, high foreign holding of debt exposes our markets not only to external macroeconomic shocks but also to geo-political risks. That aside, it subjects our fiscal situation to greater scrutiny. To sum up, on the positive, there will be an influx of foreign funds but the market and the RBI must be ready to manage external shocks and volatility with alacrity.

Is Inflation Getting Entrenched?

“Inflation is taking too long to get back to target,” told Gita Gopinath, first deputy managing director of IMF to the ECB’s annual forum in Sintra, Portugal, which, according to her, warrants that “central banks, including the ECB, must remain committed to fighting inflation even if that means risking weaker growth or much more cooling in the labor market”. 

She even feared that structural factors such as redesigning global supply chains, geopolitical tensions, and climate change may further prolong inflation. Obviously, all this points to the risk of “inflation getting entrenched” and thus the scope for returning to the ultra-low interest rates that prevailed during the pre-pandemic is less likely.  

Recalling the experiences of the high inflation period of the 1970s, she, while addressing the annual conference of the Central Bank of Brazil, also cautioned that “Central banks must remain resolute in keeping policies tight and recognize that insufficient monetary tightening now may necessitate even more painful actions down the road”. 

It is needless to say here that fiscal restraint will go a long way in aiding central banks’ fight against inflation. For, in an environment where the growth outlook is uncertain and the rates of interest are likely to stay higher for longer, there is every need to observe fiscal restraint. Else, there is a danger of financial market instability.  

As against these happenings in the developed world, emerging market economies, aided by well-orchestrated monetary policies and reforms, are reported to have maintained growth in recent years. Nevertheless, owing to the tightening of monetary policies by the developed countries, emerging economies may still face “considerable downside risks” that may worsen the conditions. 

Against this global scenario, Indian consumers are continuing to struggle to cope with a sharp rise in the prices of kitchen essentials such as vegetables, rice, pulses, etc. This overall rise in prices across a wider food basket is perceived by a few analysts as a reflection of the unsettling build-up of underlying inflationary pressure in the economy.  

The retail inflation data released by the government for May reveals that prices of pulses have reached a 31-month high of 6.56%. And the stock limits imposed by the government on traders of lentils appear to have had little or no impact on their price behavior. Similarly, there is also an increase of 19% in the price of rice. Of course, there is always the element of seasonality of crop arrivals to market playing a role of its own in determining the prices of agricultural produce.   

It is in this context that the announcement of the India Meteorological Department (IMD) revealing a 23% deficit in the all-India rainfall in the month of June is causing concern. For, it has impacted the Kharif sowings:  the acreage under paddy is reported to have come down by 5.6% vis-à-vis last year’s level, while in maize and cotton, the shortfall stood at 2% and 4.6%, respectively. 

Added to it, as El Nino is in play this year, it is feared that owing to the fact of the accompanying negative Indian Ocean Dipole (IOD)—also known as the Indian Niño—conditions remaining neutral so far, there is a likelihood of a sub-par monsoon this year. If the conditions turn negative, it could cause severe drought across the country. And history is replete with instances where IMD’s long-range forecasts issued in the months of April and May turned out to be overestimates. Should this happen again, it is certain to pose upside inflation risks. 

Furthermore, given the critical impact of monsoon rains on the Indian economy, delayed arrival of the monsoon and the forecasted deficiency in rainfall is certain to pose a threat not only to prices of food products but also to the growth estimates as spatial patterns and distribution of rainfall assume utmost significance. Therefore, policymakers must keep a constant vigil on the evolving IOD conditions as commented by IMD from time to time, and be ready with appropriate policy measures to counter the drought-driven spike in food prices. 

In a nutshell, all this calls for a close monitoring of liquidity in the system and its agile and flexible management. Of course, the Reserve Bank and its monetary authorities are well seized of the matter as is revealed by their proclamation that the monetary policy shall firmly stay focussed on maintaining price stability. Equally important is the management of fiscal deficit, for that is what ultimately matters in managing the inflation-growth dynamic.

It is however worth remembering here that experiences of the past suggest that even a small amount of sticky underlying inflation makes the task of taming it more difficult!   

Transition from LIBOR to … …

The London Interbank Offered Rate (LIBOR) was originally considered as a very systematic and well-managed international benchmark interest rate for a large volume and variety of financial products and contracts including derivative products, syndicated corporate loans, sovereign bonds, etc.

LIBOR was earlier calculated by adopting a polling method. At a specified time quotations were gathered by the Intercontinental Exchange (ICE) from about 16 to 18 major banks that have a significant role in the London market for their charge rates if they were to lend money in five major currencies—US dollar, Euro, British pound, Japanese yen, and Swiss franc—for seven different maturities: overnight/spot next, one week, and one, two, three, six and 12 months. The extreme rates were removed and the remaining rates were averaged to determine a median borrowing rate. This was announced each morning as LIBOR, at around 11.55 am by the ICE Benchmark Administration.

This procedure went on well for quite some time. But with the eruption of the LIBOR scandal of 2012 that sent shockwaves across the global financial markets, the flaw in arriving at the LIBOR rate came to light. It was revealed that major bank players—Citi Bank, HSBC, Barclays Bank, Deutsch Bank, and JP Morgan— colluded amongst themselves for garnering benefit by quoting mutually decided rates to the market officials. Once this manipulation came to light, market-participants lost their confidence in this widely used benchmark rate.

This string of LIBOR-related scandals made market players feel like going for a new alternative benchmark rate. But replacing LIBOR turned out to be not that easy, for almost all of the then-existing loans were benchmarked against LIBOR. However, in 2017, the US Federal Reserve introduced the Secured Overnight Financing Rate (SOFR) as an alternative to LIBOR. In the same year, the LIBOR regulator announced that LIBOR would be discontinued by December 2021. As a sequel to this, the Reserve Bank of India issued instructions to banks and other RBI-regulated entities to stop entering into new contracts that use LIBOR as a reference rate (as soon as possible) and latest by December 31, 2021.

This had, of course, created a lot of commotion in the market. For, this entailed two challenges: one, it called for banks to ensure that existing contracts in which LIBOR was the reference rate and the contracts fall due after the date on which LIBOR ceases to be effective contain Fall-back Clauses; and two, in the event of its absence banks to ensure that a new benchmark rate is identified, financial risks thereof are mapped along with identification of legal risks involved post the adoption of the new benchmark. Coming to the new contracts, banks have by and large adopted SOFR—a benchmark interest rate for dollar-denominated derivatives and loans arrived at based on observable repo rates—as a replacement for LIBOR.

Simultaneously, the use of LIBOR-based Mumbai Interbank Forward Offer Rate (MIFOR) was restricted to certain specific purposes such as transactions executed to support risk-management activities such as hedging, market-making in support of client activities, etc. They were also to assess the risk emanating out of LIBOR-linked contracts and place a framework in force to handle risks arising from such exposures. Banks are also required to create the necessary infrastructure to offer financial products linked to ARR. All this is a real challenge, which the banks are navigating through with the advisories offered by RBI.

Against this backdrop, and expecting that banks have developed the necessary wherewithal to manage the complete transition away from LIBOR, RBI issued a circular on May 12 asking banks and other financial institutions “to ensure that no new transaction undertaken by them or their customers rely on or are priced using the US $ LIBOR or the Mumbai Interbank Forward Outright Rate (MIFOR)” from July 1, 2023. They were also advised “to take all necessary steps to ensure insertion of fallbacks in all remaining legacy financial contracts that reference US$ LIBOR (including transactions that reference MIFOR)”.  

This complete move to alternative benchmark rates from LIBOR will take a while for banks to settle on the alternatives. Although SOFR is less likely to be manipulated since the treasury repo market is one of the most liquid markets, it is “backward-looking”. Secondly, there is an argument against Term SOFR that it lags in a rising rate environment. Of course, it is also true that the reverse happens in a decreasing rate environment and thus some argue that over a period of a few years, this difference might average out. Nevertheless, navigating through these nuances is a big challenge for Indian banks.

 

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