A fragile upside
Growth in FY15 most certainly has an upside from where we stand today. According to CRISIL Research, GDP growth can rise to 6% in the base case this fiscal, assuming normal monsoons, a stable government and a widely anticipated global recovery. With elections concluding on a positive note for reforms and swift decision-making, the risk of a fragile mandate is out of the way. The general election results have bolstered confidence in the equity markets and raised expectations. Kick-starting the economy will, however, require much more than this. To top it all, since we began this fiscal, risks have started to build threatening to derail the economy off the path towards 6% growth.
A high-probability risk for this fiscal is of weak monsoons pulling down agriculture GDP growth and stoking inflation. The Indian Met estimates a 60% chance of an El Nio materialising this year. Data for the past two decades shows a 30% likelihood of an El Nio condition morphing into monsoon failure. If the monsoons are adversely affected, GDP growth can fall to 5.2% this year. This will call for immediate steps to cushion consumption spending, especially in rural India.
Turning the ship around
The governments top-priority should be to try and revive the economy. Unfortunately, the economy cannot be revived via short-term stabilisation tools such as interest rate cuts, and fiscal spendinginflation and fiscal deficit are outside the comfort zone. The government, therefore, needs to improve the business climate by hastening pending reforms, bringing in clarity on land acquisition and environmental clearances and working towards improving the ease of doing business in India in double quick time. The key imperatives are:
* Exercise fiscal discipline, boost growth: Fiscal consolidation should be achieved through reducing subsidy spending and adopting revenue-enhancing measures such as the goods & services tax (GST). On the other hand, to support growth, the government must increase productive spending. As per a recent Crisil Research report, in the last 2 yearsFY13 and FY14productive spending (capital expenditure and the revenue grants for capital creation) in critical areas such as public infrastructure, education and healthcare, among others, has been nearly R1.8 trillion lower than budgeted.
* Lower inflation to a sustainable level: For this, it is necessary to bring food inflation down. This requires an overhaul of the agriculture sector by focussing on growth, building supply chains, ensuring crop diversification and better management of food grain stocks by improving storage and distribution.
* Improve banks asset quality so they can finance growth: The banking sector lubricates the economy via smooth flow of funds. Currently, it is not in a position to do aggressively so as it is straddled with bad assets. We estimate the NPAs to remain over 4% of the GDP in FY15. Tiding over this situation will require a mix of sales of distressed assets as well as capital infusion.
* Focus on manufacturing from a medium-term perspective: The imperatives include improving productivity, providing uninterrupted access to energy, reforming the labour market, enhancing skills and creating employment opportunities in the sector.
Praying for rain
A weak monsoon can set back the policy correction by forcing the government into a fire-fight for offsetting income erosion, rising prices, farm indebtedness and shortage of drinking waterfactors that typically accompany a drought. In the past, years with drought have taken a toll on the governments finances, too. Data suggests food subsidy rose 34% in FY10. A fiscal expansion at this stage would not only fuel inflation and work at cross purposes with the tight monetary policy, but also restrict government spending for capital creation. In addition, with the growth and inflation dynamics being distorted, RBI will have lesser room to support growth and there might be an upward bias on interest rates in order to contain inflation.
The government can, however, mitigate some of this damage by pro-actively diverting resources towards management of drought/weak monsoon once the threat is apparent. To do this, the government must first take steps to create fiscal room. One way to do this is to cut fuel subsidy. The new government must not only re-endorse the process of increase in diesel prices, but also speed it up. Starting July, if the new government hikes diesel price by 50p on fortnightly rather than monthly basis, the diesel subsidy will get completely wiped off before December 2014 if they start now. This will mean close to R500 billion is freed up for drought relief provisions.
The way things stand, balancing the short-term risks and paving the way for higher, sustainable and more inclusive growth will be no mean challenge.
Dharmakirti Joshi, Dipti Deshpande & Sakshi Gupta
Joshi is chief economist, Deshpande, senior economist, and Gupta, junior economist, Crisil. Views are personal