Eco survey: promises and pitfalls

The word “decoupling” first entered the Indian lexicon during the global financial crisis of 2007-08, when it seemed that the country had escaped the adverse fall-outs of the mortgage-linked US housing crisis that was fast engulfing the developed world. Its success was attributed to the steady policies of the Reserve Bank of India - like refusing the banks to undertake risky credit swaps that had landed the world in trouble. Today, Arvind Subramanian, the government’s chief economic adviser, brought the word back in circulation with the Economic Survey of 2017-18.

He used the word to explain the strange divide in the Indian growth story in the financial year 2017-18. Subramanian described the events of the first half of this fiscal as ‘decoupling’ from the synchronised global recovery - the best since 2010 - and in the second half, aligning with it.

India's growth slowed to 5.7 % in the June quarter and 6.3% in the September, while the advanced nations have reported better growth since the financial crisis. The reason for such ‘decoupling’ lies in diverging monetary policies among the developed world and India, resulting in a divergence in economic activities. While the industrialized world and the US Federal Reserve, brought down its interest rates, the RBI continued to hike rates. For instance, while the Federal Reserve brought US policy rates by 1 percentage point between July and December 2016, interest rates in India went up by 2.5 percentage points.

“Not only did it depress consumption and investment, but also attracted capital inflows, especially in debt instruments, which caused the rupee to strengthen thereby dampening exports. The rupee, in fact, appreciated by another 9% between early 2016 and November2017 against a basket of currencies,” says the survey.

Domestic policy measures like demonetization and the implementation of the goods and services tax (GST) did not help matters either. Even before the shock of sudden demonetization, which temporarily reduced demand and hampered production in the cash-only informal sector could subside, the new indirect tax was introduced. This led to supply chain disruptions and spelt misery for small and medium-sized industries. Many of had to shut shop because of the difficulty in complying with the paperwork, resulting in large-scale job losses. Bigger manufacturers had little choice but to import goods, which in turn impacted the country’s import bill, something that hadn't happened in the developed world.

The twin balance sheet problem — growing non-performing assets (NPAs) of banks and the mounting debts of the corporate sector — not only impaired the bank’s ability to lend but also reduced India Inc’s willingness to borrow thereby hampering private investment in the country to a four-year low.

Higher oil prices -- 18% increase in the first three quarters of 2017-18 over the same period last year-- too had its adverse impact on the Indian economy by not just raising the country’s import bill but also reducing the excise duty collection. As the Survey points out: “Every $10 per barrel increase in the price of oil reduces growth by 0.2-0.3 percentage points, increases wholesale price index inflation by about 1.7 percentage points and worsens the current account deficit by $9 to $ 10 billion."

But a host of factors are now helping India to synchronise India’s growth with those of the advanced nations. As the effect of GST and demonetisation is receding, export growth has started to pick up registering a 13.6% increase in the third quarter of fiscal 2017-18 vis-a-vis a 13.1% slowdown in imports in the same period last year. Besides, there has also been an uptick in remittances from the Gulf region as a result of high oil prices, continuing boom in stock markets and record-high levels of foreign exchange reserves which topped $432 billion. An infusion of Rs 2.1 lakh crore for recapitalization of public sector over 2017-18 and 2018-19, too can go a long way in not just solving the NPA issue but also providing an exit route to bankrupt corporates.

And that’s not all. The current account deficit (CAD) is well below the 3% GDP mark, and the initial dip in GST collection seems to be picking up again. It touched nearly Rs 86,703 crore in December 2017 up from nearly Rs 80,000 crore a month before and direct tax collection has risen to a record high of 2.3% of the GDP in fiscal 2017-18 compared to 2% in fiscal 2014-15. Similarly, lending by non-banking financial institutions have grown by 43% in April to December 2017 and rural demand, as evident from growth in motor cycle and auto sales. No wonder then, the Economic survey is already predicting a 6.75% growth in FY 18, slightly above the 6.5% projected by the Central Statistics Office. The survey predicts growth will be between 7% and 7.5% in FY 19 reinstating India as the world’s fastest growing major economy.

So what is the Economy Survey’s medium-term outlook for the Indian economy? Subramanian believes that the country can touch at least 8% GDP growth in the medium-term. However, he also warns of greater vigilance with regard to the challenges ahead. The recent upswing in inflation—it crossed the RBI’s target of 4% in November 2017—from rising global oil prices, unseasonal increases in prices of fruits and vegetables, adverse impact of the Seventh Pay Commission—may not come down substantially. “If higher oil prices require tighter monetary policy to meet the inflation target, real interest rates could exert a drag on consumption,’’ says the Survey. It will have a serious impact on the economy because consumption has been holding up the Indian growth story.

The CAD too is expected to widen to 1.5% to 2% of the GDP in fiscal 2017-18 compared to 0.7% last year. The fiscal deficit for the first eight months reached 112% of the total year, reflecting a shortfall in non-tax revenue, reduced dividends from government agencies and enterprises, and higher expenditure. Again, any stock price correction, which is already at a record high, could trigger capital outflows, especially if monetary policy unwinds faster than expected in the advanced countries and if oil prices remain high. “Policy might then have to respond with higher interest rates, which could choke off the nascent recovery. The classic emerging market dilemma of reconciling the trade-off between macro-stability and growth could play itself out,’’ says the survey.

A key determinant of growth will be the proper implementation of the Insolvency and Bankruptcy Code 2017. The greater the delays in the early cases, the greater the risk that uncertainty will shroud the entire IBC process. “It is also possible that expeditious resolution may require the government to provide more resources to public sector banks, especially if haircuts required are greater than previously expected," the survey says.

There are also geo-political and geo-economic risks like a fear of war in the Korean peninsula; political upheaval in the Middle East, aggressive crude output cuts by Saudi Arabia and Russia in advance of the planned listing of Saudi Arabian Oil Company Aramco; trade tensions that can spiral out of hand, and unprecedented credit growth in China.

Moreover, if interest rates rise suddenly in the advanced nations it could have some damaging consequences for India as well. For one, a large decline in wealth would force advanced country consumers to cut back on their spending, which in turn would lead firms to curtail their investments. “And the political implications of yet another decline in asset prices, the second in decade, could also be significant, with effects that are difficult to imagine,’’ argues the report.

So the question emerges - what needs to be done in the near and medium term to put India back on the track as the fastest growing economy in the world? As the report points out that over the coming year, the government will need to focus on the 4 R's; ensuring that the process of resolving the major indebted cases and recapitalisation of PSBs is carried out to its successful conclusion, credible shrink the unviable ones and signal greater private sector participation in the future, stabilize GST implementation remove uncertainty for exporters, privatise Air India and stave off threats to macro-economic stability.

As for the medium term it is all about employment, education, agriculture, private investments and exports. It is about finding good jobs for young and burgeoning workforce, especially for women. Creating an educated and healthy labour force to meet the challenges of technological changes while raising farm productivity and strengthening agricultural resilience to take care of rural distress is imperative. Above all, India must continue improving the climate for rapid economic growth on the strength of the only two sustainable engines—private investments and exports.