Sure, demonetisation and GST caused disruptions, but that’s par for any reforms course, where the payoffs happen only over the medium to long run, while headaches begin right away.
The year 2017 was a year of repair, reforms and disruptions. A long-pending, much-touted and seminal reform, the goods and services tax (GST), finally saw the light of day after arduous non-partisan debates and compromises, and public sector banks have been promised a huge recapitalisation hand from the government. Sure, demonetisation and GST caused disruptions, but that’s par for any reforms course, where the payoffs happen only over the medium to long run, while headaches begin right away.As a result, India’s GDP growth slipped to 6% in the first half of fiscal 2018. As the creases get ironed out, we expect growth in the second half lifting overall GDP growth to 6.8% this fiscal. But the upside will be limited if GST-related glitches take time to resolve and the government cuts capital expenditure in response to rising fiscal stress, particularly at the state level. These risks create a downward bias to our growth projection.
Looking back, 2017 was one of those rare years when India could not take advantage of the well-balanced global recovery where investment, consumption and trade did well. The International Monetary Fund expects global merchandise exports, which were decelerating in the past three years, to grow 4.2% in 2017, or 60 basis points (bps) faster than global GDP growth. The trade intensity of global growth has already risen to a six-year high.
India did not benefit much from this because of the disruptions. But 2018 promises to be better because the effect of demonetisation has almost faded and GST bottlenecks are getting ironed out on priority.
Front-loaded recapitalisation of public sector banks will also improve their ability to lend when the economy gathers pace. That, and the low-base effect of this fiscal and a step-up in world growth (S&P Global expects world GDP to grow 10 bps to 3.7% in 2018), can lift India’s boat to 7.6% next fiscal.
We foresee growth being largely inside-out, or rural-led, with the government trying to make agriculture remunerative and increasing investments in hinterland infrastructure.
That’s because this fiscal has seen farmer realisations drop, particularly in pulses and coarse cereals, with many of them selling below cost of production or minimum support prices. Clearly, they did not benefit from two consecutive spells of adequate monsoon and healthy farm output.
It is critical to reverse this trend. The February Union Budget will tell us whether the government proposes to do this in a fiscally-responsible way or succumb to the incipient political cycle and go for populism.
The good part is that real rural wages have already risen 4.8% in April-July 2017, the fastest pace in four years, which augurs well for consumption.
But the fiscal 2019 outlook is not without risks. The key external ones are a spike in crude prices and asymmetry in monetary policy in advanced
countries, while continuing GST glitches and mounting fiscal stress are the domestic risks.
Crude oil prices have been simmering for over a year now. In this fiscal so far (April-November 2017) Brent crude price is up an average 15.9%. Low oil prices had helped India rein in its twin deficits (current account and fiscal), tame inflation and boost GDP growth. Crude prices crossing $70 per barrel will start having a material impact on all these parameters.
Another risk lurking is the spillover from normalisation of extraordinary monetary stimulus in advanced countries. While growth today is quite synchronised, the unwinding of monetary policy won’t be so. The divergence will be due to two reasons. The first is the length of recovery in the US versus Europe and Japan. While the US has been growing steadily for over seven years now, Europe has turned around only in the past 2-3 years. This
has a bearing on interest rate dynamics. Secondly, despite ‘above-potential’ growth in Europe, inflation could very well be the dog that did not bark.
So, while the US Federal Reserve has started to trim its balance sheet and raise interest rates, Eurozone and Japan are likely to see accommodative policies for a longer period.
S&P Global expects the European Central Bank to announce a slowdown in asset purchases in the first half of 2018 with a view to unwinding completely by early 2019. Therefore, interest rates in the Eurozone are unlikely to rise before 2019.
Such divergent monetary policies and the consequent widening of interest rate differential between the US and Europe will mean capital flowing into the US, which would strengthen the dollar.
That has implications for capital flows into India, particularly foreign portfolio investments into bonds. Additionally, a stronger dollar can put pressure on local yields as global portfolios rebalance towards safe haven. How quickly that happens will be a function of how swiftly the Fed tightens.
The complicated structure of GST has raised administrative and compliance costs for the government and business, respectively. Any fresh delay
in sorting these out will curb thedomestic drivers of growth and restrict India’s ability to benefit from the global upturn.