Dark clouds are hovering over India’s economy, unnerving markets, policy-makers and others with a stake in this global bright spot. Growth in the April-June quarter decelerated a bit more than anticipated, the current account widened a bit more than comfortable, while August inflation rose a bit more than post-GST projections. Individually, none of these developments are alarming. But together they have created a squall, creating concerns if these forewarn a bigger storm brewing. Doubts have arisen if the slowdown is more than a temporary destocking dip. If so, is it cyclical or structural, and how should the government respond? The government went into a huddle as several macroeconomic assumptions seemed going haywire. But the most disturbing is the rapid deterioration of business and consumer sentiments, indicating a lack of confidence in the government’s ability to steer the economy through the uncertainties stoked by its very own policy shocks. The sheer number of negative reports dotting newspapers take us back to 2012-13 and 2013-14—that was a time gripped by ‘policy paralysis’; this is a time of ‘policy shocks’!
Some recent survey reports elaborate further. Mastercard’s January-June 2017 survey showed the largest fall in consumer confidence in India across Asia-Pacific markets over July-December 2016; consumers’ economic outlook and quality of life both suffered. Nielsen’s reported an eight-percentage point drop in consumer confidence in Q1-2017-18 relative to the previously polled quarter, December 2016, the reasons being lower optimism on job prospects, job security concerns and spending caution. RBI’s June 2017 Consumer Confidence Survey on households’ perceptions and expectations for the general economic situation, employment and price conditions, personal income and spending behaviours showed both current and future situation indices falling.
Turn to producers or business confidence, and the story is no different. RBI’s Business Expectations Index declined in Q1-2017-18 (105.4) from 106.0 in Q4-2016-17, reflecting lowered business sentiments in manufacturing; business expectations for Q2-2017-18 have deteriorated too. Dun & Bradstreet’s Composite Business Optimism Index for the September 2017 quarter, conducted in June 2017, is down 13.3% from a year ago, as concerns about GST impact, weak demand conditions, and twin balance-sheet problems hurt business confidence. August’s Manufacturing PMI also captured worries about the possibilities of unexpected policy decisions weighing upon confidence, dragging down sentiments from July’s 11-month high. Services PMI showed a decrease in overall sentiment with the underlying trend of uncertainty and businesses holding back on investments. There could be many more.
So, how should the government respond? Many businessmen felt the economy is starved of demand, to which some economists extended support by characterising the slowdown as cyclical, requiring urgent fiscal-monetary support. There is a problem, however. Policy-makers, both government and RBI, remained heavily invested in ensuring macroeconomic stability, a theme they encashed several times over by enticing foreign investors into domestic debt market in the last three years. Now, international markets have suddenly turned a little adverse, oil prices have hardened a little more than anticipated and the US Federal Reserve has turned a little more hawkish than expected. Lowering the policy rate at this point could be risky. The $400 billion war chest could soon seem inadequate if the tide of capital flows was to reverse!
To top it all, if the government reneged on fiscal consolidation, problems could compound no sooner as bond yields harden. The return of fiscal dominance could dent credibility of the new inflation-targeting regime. Post-GST, CPI-core inflation has already risen, increasing the upside risks to future projections; if it amplifies, that could force a premature reversal of the monetary stance, further hurting business sentiments. One can only hope that credit rating agencies looked through all this. So, it’s unsurprising that many analysts have warned of the potential risks, advising instead to stay the course on structural reforms. Some advisories are very specific—go after factor market reforms. This appears very reasonable on the surface. But think deeper and it’s a strange fix. How would structural reforms address the demand deficiency? From a macro-framework viewpoint, the situation would be no different than 2012-13 and 2013-14. Then the UPA government remained hands up; with no fiscal and monetary space to counter a growth slowdown, it let business sentiments sink deeper. Similarly, if there is nothing substantive today on the NDA government’s table to stimulate demand, how are business sentiments to reverse?
Would more structural reforms work? It is difficult to estimate as these are long-term fixes and need time to improve business sentiments. But no one seriously expects the government to embark upon difficult factor market reforms in the last 18 months of its tenure. To the contrary, one such grand reform, namely GST implementation, is at the heart of the current spell of uncertainty, compounding the pain after demonetisation. In 2012-13 and 2013-14, a paralysed government failed to respond to businessmen’s needs. Today, in stark contrast, it’s a hyper-active government led by ever-agile tax bureaucracy inducing more uncertainties across the business spectrum. The sheer number of policy and tax rate changes by the central government and GST Council can only parallel the numerous notifications issued by RBI during the demonetisation months! There is only a wish for a smoother GST transition with no more hiccups.
But does that mean once the roll-out is through, sentiments will look up again? Surely not. Some sources of uncertainty could be fragile, scattered: A simple notification by tax authorities on advance tax payments could stir up a hornets’ nest when the going is already tough. Over the last three years, several policy actions or non-actions by the government have accentuated uncertainties and made investment riskier. Sunil Jain has succinctly elaborated on an exhaustive list of such developments in this newspaper (“Is investing in India getting riskier?” September 26, https://goo.gl/U66u4E). Some of these risk getting deeply entrenched for lack of policy clarity or direction.
Consider the handling of NPA resolution in the banking sector. If a dot plot on RBI’s one-year ahead projections on banks’ NPAs for last three years were to be constructed, the discernible thinking within the government and RBI would be quite amusing. The sudden, recent spurt in actions eventually resulting in the roll-out of the resolution code has brought some order. However, from businessmen’s perspective, the manner and timing of these policy actions are no less than shocks borne during demonetisation or GST roll-out. Worse, they still do not know where public banks are headed, whether the government will capitalise these adequately and, more importantly, when bank lending will resume. For now, it is a pool of uncertainties in which they are struggling to figure out where the new ecosystem for funding future investments is going to settle. It is hard to imagine if businesses can withstand any further policy shocks as they wait for demand to return. Amidst all this, it must not be forgotten that failure to assess true demand conditions in the economy has left many businesses flummoxed, a significant source of uncertainties in the last three years. Persistent divergence between official claims and that experienced by firms with low capacity utilisation and top line growth has left traces of distrust. Selling them NPA resolution code and GST roll-out as low-hanging fruits would require a long walk. What if July-September growth decelerated further below 5%?