Budget 2018: Yesterday’s budget appears to have been crafted against a narrative that blames current economic slowdown on bad timing: as the global economy entered its strongest synchronised lift since 2010, India was beset by the unintended consequences of demonetisation, GST teething problems, and the restructuring of bad bank debt that combined to temporarily slow growth and tax collection.It is only a matter of time before these disruptions are repaired and, once that happens, India will ride the global tide to higher eco growth. Ergo, fiscal policy should provide temporary relief to ease the burden of adjustment from near-term pain to medium-term prosperity, even though it means sacrificing macroeconomic stability for growth. However, this logic may have little to do with reality. While global growth has been surging, underlying this cyclical bounce is a global economy mired in structural malaise. Measured productivity almost everywhere has declined since the global financial crisis. Even the much-touted tax reform in the US will likely only boost near-term demand without increasing medium-term supply. With capacity increasingly strained after eight years of expansion and productivity flagging, sooner rather than later, wages will rise, pushing up inflation, forcing central banks to tighten more aggressively, and eventually strangling corporate profitability, which has been the lifeblood of this expansion.
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Turning to India, much has been blamed on demonetisation, GST, and bad debt as the culprits behind the slowdown. While it is undeniable that they have been disruptive, perhaps even more than appreciated today, it is hard to pin all the blame on them. The reason should be obvious: India’s growth has been sliding since the second quarter of 2016, six months before demonetisation and a year before the introduction of GST. While the bad debt problem hit headlines in 2016, overleverage began to tighten bank lending in 2014. The tightening of credit has had no discernible impact on corporate investment: It collapsed from its high of 17% of GDP way back in 2009 and has since flat lined at 12%. Instead, in the last few years, private housing and SME investment have contracted nearly five percentage points of GDP. While there has been a marked improvement in business sentiment and several reforms implemented, the 70% decline in global oil prices from June 2014 to January 2016 and their subsequent doubling quantitatively explains almost all of India’s growth dynamics since mid-2014.
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The budget ignored these facts, instead choosing to justify accommodating a 0.3% of GDP breach of the FY18 deficit target and postponing the commitment made in the last budget to a 3% of GDP deficit target for FY19 on the bad-timing hypothesis. This would be the fourth consecutive year the government has postponed the promised consolidation target to the following year. The bond market has not been reacting well to fears of such a breach since last September and sold off once again yesterday, reacting to the size of the deficit outturn in this fiscal year and the optimistic belief that the teething problems of GST will go away next year.
The cost of this breach so far has been 1 to 1.25ppt of higher interest rates on government and private sector borrowing. With oil prices now threatening to rise even further and India’s current account deficit widening (from an outturn of 1% of GDP a year ago to a projected 2.7% of GDP in FY19), chances are that the RBI could well start hiking policy rate, too. So, will sacrificing macroeconomic stability be worth it? Whatever growth support the government might think it is providing could well be more than offset by the unwarranted rise in interest cost. Could the government have done anything different? Yes. Both spending priorities and revenue sources could have been restructured to meet the new challenges of the post-crisis global economy and the true drivers of India’s growth. And even the outsized rise in interest rates could have been muted if the government had raised the foreign bond-holding limit in a systematic manner to create a larger sustainable and more diversified source of demand for its bonds. But it didn’t. Instead, it pinned the budget on the hope that all that ails India will just fade away. Events in FY19 may well turn out to be very different. Every time India has played with macroeconomic stability, it has eventually ended in tears.
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