Political certainty, achieved after the BJP won a majority in the general elections earlier this year, had raised the hope of the Indian economy getting back on track fairly quickly. Although early signs of economic recovery is visible, everything in not hunky dory on the economic front.
Some of the macroeconomic data points that have come lately are not very encouraging. Industrial output growth, as measured by the Index of Industrial Production (IIP), after showing signs of recovery during the first two months of this fiscal, has again collapsed. Manufacturing growth is the pivot of overall industrial growth. However, August 2014 is the second consecutive month in which manufacturing sector recorded contraction. This is a bit perplexing as, normally, this is the time when production/inventory expands in anticipation of festival demand. The below par performance of industrial output growth so far this fiscal indicates that industrial recovery is still fragile. We expect industrial GDP to grow at 4.6% in FY15.
Even exports growth is showing a similar pattern. After recording an average 8.6% growth during the first four month of this fiscal, the exports growth slumped to 2.7% in September. On the other hand, import, which showed contraction during the first two months of this fiscal, has changed course and expanded by 26% in September 2014, mainly due to the unusual 449.7% growth in imports of gold. This resulted in trade deficit growing by a whopping 132.7%. Gold imports have made a comeback after RBI relaxed norms for import of gold for select trading companies in May 2014. Continuance of this trend will adversely impact the CAD as the hope of exports growth recovering to 8-10% this fiscal is fading due to weak and uneven global recovery. The World Trade Organisation (WTO) has cut its 2014 global trade growth forecast to 3.1% from its earlier estimate of 4.7%. The CAD is expected to come in at 2.3% in FY15.
Fiscal deficit has already touched 82.6% of FY15 budget during the first six month of this fiscal. During this period, while overall tax revenue has shown a growth of 7.1% against the budgeted 16.9%, services tax has shown a growth of 14.2% against the budgeted 31.0 %. On the non-tax revenue front while the government will benefit from the higher surplus transferred by RBI, the budgeted disinvestment amount of R634.25 billion will remain elusive notwithstanding favourable market conditions. With six months gone and disinvestment receipt so far has reached just R53 billion. Our estimate shows that slippage in revenue receipts (tax and non-tax revenue) could be R258 billion.
With the revenue likely to fall short of the budgeted amount, managing expenditure is going to be critical for the government. The staggered diesel price hike since September 2012 and the recent decline in the price of crude in the global market leading to diesel price deregulation means that the government’s oil subsidy burden for FY15 will be R150 billion lower than budgeted. Also, the austerity measures announced by the government would help the government compress the expenditure. Yet, we believe government will be able to end FY15 with a fiscal deficit of 4.2% of the GDP unless it cuts plan expenditure like previous years to meet the fiscal deficit target.
However, there are a number of positives as well. Monsoon eventually turned out to be less damaging than believed initially. Kharif sowing, at 102.7 million hectare (mhac) as on October 10, 2014, was only 2.1% lower than previous year. This will translate into an agricultural GDP growth of 1.3% in FY15.
Inflation has dropped significantly over the past few months. The crash in the commodity prices particularly crude prices has improved both the inflation and fiscal outlook. We now expect average wholesale price index (WPI) and consumer price index (CPI) based inflation to decline to 5.3% and 7.8%, respectively, in FY15 from 6.0% and 9.5% in FY14.
With the fiscal and inflation outlook improving, the yield on the benchmark 10-year G-sec has come down lately. We expect the yield on 10-year G-sec to trade in the range of 8.1-8.2% by the end of FY15 as against 8.8% at the end of FY14.
Although the hope for a rate cut as early as in December 2014 has increased, we believe it is still some time away. Declining inflation has provided more elbow room to RBI but the trajectory of inflation/inflationary expectations is still somewhat fuzzy in view of (i) waning of base effect after December 2014 and (ii) absence of clarity with respect to commodity, particularly crude prices (is it a ‘new normal’?). However, a rate cut in February 2015 looks like a possibility provided the inflation data does not surprise on the upside.
Despite a mixed outcome on the data front, the overall macro sentiment at the current juncture is buoyant. The fate of the economy since FY05 has been strongly correlated with investments. As investments grew 11.6% on average over FY05-FY12, the GDP clocked an average growth of 8.5%. With the investment growth falling to 2.4% and -2.5% in FY13 and FY14, respectively, GDP growth dwindled to below 5%. The key reason for the rise in investment growth over FY05-FY08 was a sharp increase in investments by the private corporate sector. This, however, declined to 3.4% over FY09-FY13, from 48.1% over FY05-FY08.
Although there is little that government can do to boost the global macro environment which played a key role in pushing India’s GDP growth to above 9% before 2008 global financial crisis, there is plenty it can do on the domestic front. A number of announcements have been made in this year’s budget to revive investment and address structural issues plaguing agricultural, industrial and infrastructure sector. However, it is time to convert these announcements into action. We believe that without a proactive policy and economic reforms which are also adequately supported by swift government actions, steering the economy towards a non-inflationary, high-growth path over the medium-term would be difficult.
Sunil Kumar Sinha, Devendra Kumar Pant & Apurva Yadav
Based on Ind-Ra report titled Economic Recovery Gradual but on Course
Sinha is Principal Economist, Pant is Chief Economist and Yadav is Senior Research Associate at India Ratings and Research (Ind-Ra)