Transiting from 2024 to 2025 will have its uncertainties

Looking inwards, a good monsoon also meant that worries on the farm front were minimal. The general elections, however, caused some disruption as government spending got deferred, which in turn affected private investment decisions. Against this background, how has the Indian economy performed?

On the positive side, growth has been rather stable, and while forecasts for FY25 have been pruned to less than 7%, the foundations appear to be fairly resilient. 

Data for the second quarter reveal steady performance of services and agriculture, which continue to be the bedrock of the growth process.

Second, agricultural production is expected to be robust, with both kharif and rabi benefiting from the good monsoon and high reservoir levels. 

Third, rural demand has revived as seen in consumer sales since October, which bodes well for demand. Fourth, the banking system has grown stronger in terms of asset quality and capital availability, and is well placed to meet the challenge of rising credit. 

Fifth, exports have turned around, albeit mildly, from negative growth to around 2% for the first eight months, which is a comfort. Sixth, FDI (foreign direct investment) continues to be buoyant at $42 billion in the first half of the year as investors continued to repose faith in the fastest growing economy. 

Seventh, the RBI (Reserve Bank of India) did send signals for a pivot in interest rate in October with a change in stance to neutral. While the repo rate remained unchanged in the December policy, bond yields softened to an extent in anticipation. 

Eighth, private sector investment has shown some signs of an increase since July as seen by higher investment intentions. 

And last, the stock markets mimicked global trends and stood out even as corporate profits remained under pressure in both the quarters of the year. Clearly, the India story spoke better than what could be called temporary hiccups.

The rather sanguine story has had only one major shadow, which was inflation. High inflation has been a concern for the larger part of the year. With food inflation being particularly high, it did come in the way of discretionary spending as was revealed by some companies that spoke of urban stress. 

This contributed to higher input costs, which affected both growth in sales and profits, and got reflected in the low growth in manufacturing within the GDP (gross domestic product) numbers. The good monsoon should change this scene in the coming months.

The other unsettling factor that added to volatility in the forex market was the whimsical nature of FPIs (foreign portfolio investors). While debt flows did benefit from the inclusion of Indian bonds in global indices, equity outflows dented overall flows, which cumulated to just around $7 billion this year. 

This added to the constant pressure on the rupee as the market watched for continued RBI intervention to prevent the currency from sliding. 

After crossing a high of $700 billion, forex reserves have slipped by around $50 billion in the past few months. This got reflected in the rupee, which slid in the past two months my almost ₹2 per dollar.

Looking ahead, in 2025, there is certainly optimism on the domestic front as lower inflation and interest rates should help revive investment. Interest rates are likely to be lowered in February provided inflation remains within an acceptable range and the cycle could involve up to 75 bps cut in the calendar year. This would be good news for the bond market, too. 

Assuming a normal monsoon, growth for FY26 should be above 7%. On its part, the government would be well placed to lower the fiscal deficit further to probably less than 4.5% of GDP for FY26 as revenue collections may be expected to be buoyant. Further, it may be expected that capex would continue in an uninterrupted manner next year.

The unknown factor will be developments in the far west when Donald Trump takes over as the US president. His economic agenda articulated during the election campaign was quite straightforward. 

It included increasing customs tariffs, curbing migrants and lowering corporate tax rates. The potential impact on higher deficits and borrowing cannot be missed and this would also have an influence over the future direction of interest rates given the potential inflation.

China, on the other hand, would need to take some countervailing action, which can mean subsidizing production to the extent that exports could have a dumping proclivity. Therefore, one has to be extra alert on imports.

But for sure there would be volatility in the forex market and the RBI may have to be active once again to prevent the slide in the currency. Alternatively, an approach could be to allow for further slide of the rupee to keep abreast with competition. It will once again be the year of the RBI on both interest rates and currency.

Madan Sabnavis is chief economist, Bank of Baroda and author of Corporate Quirks: The darker side of the sun. Views are personal.