Growth-inflation mix in near term limits room for large policy stimulus… FY21 Budget has to explore ways to maximise impact of limited resources
The official First Advance Estimate of FY20 GDP growth is 5% (see graphic), and further shallow cuts, on balance, are likely in future revisions (to 4.7–4.8%), given the expected dynamics of growth drivers in Q3 and Q4. The current estimate is derived largely by extrapolating the available data for 7-8 months onto the full year. Some components of the GDP (e.g. IIP) are estimated using the ratio of (seasonally adjusted) prints of the seven months to the annual values “of past years”. Other extrapolations used are financial results of listed companies up to Q2, first advance estimates of crop output, accounts of the Centre and state governments, bank deposits and credit, commercial vehicle sales, volume indicators of freight, etc. The performance on most of these metrics had been quite poor in H1, but many high frequency indicators of economic activity have improved in November and December. However, constraints on central and state governments’ spending, continuing weak or only slightly improved credit offtake and likely financial markets volatility will probably keep the expected recovery in Q4 very modest.
The two most striking aspects of the growth forecasts were the very sharp, almost precipitous, drop in fixed capital investment and the low nominal growth rate. The latter is both the cause and effect of shortfalls in government tax collections, slower corporate profit growth, and multiple other metrics that are linked more to nominal rather than real (i.e., inflation adjusted) activity. The fiscal arithmetic of the Centre will be impacted and limit a slippage from the budgeted fiscal deficit within the ambit of FRBM on additional spends. The worry is the former, which is the real cause and amplifier of the slowdown, particularly in the manufacturing segment. Capex (real) growth is forecast to have fallen to 1% in FY20, from an average of 9% in the previous three years, and 6% since the start of the current GDP series. The Centre’s recently released National Infrastructure Pipeline project needs to be expedited, amongst various other measures.
Juxtaposed against this slowdown is the likely high CPI headline inflation print for December 2019, which we forecast at 6.9% with upside risk. Even WPI inflation in December is expected to rise sharply to 2.6% from 0.6% the previous month. Although the rise is due to onions and a couple of other vegetables, and is likely to correct in January, CPI inflation, even excluding onions, has moved up since September 2019. The proximate reason has been the “protein complex”—meat, fish, eggs and pulses (see graphic). Globally, too, food prices have moved up sharply, although this has been mostly due to pork prices in China. Despite the rise in vegetables prices, India’s core (excluding-food and energy) inflation had continued to remain muted, and had consistently fallen over the past year. However, there is a risk of even core inflation ticking up. Some part of this will be the base effect of last year’s fall, but there are fundamental price pressures building up as well. The proximate risk is, of course, crude oil prices, given the present geo-strategic situation, but over time, more broadly on expectations of a global recovery post the US-China trade deal and other factors. A global growth revival, however modest, particularly in China, could pull up industrial metals. Gold prices have gone up sharply.
FY20 is more or less done. The focus will now be on the recovery path for FY21, with the trade-offs noted above defining the mix of policy instruments which can be further deployed to revive growth. The scope for further cuts in the policy repo rate in the near future remain limited, although other monetary policy stimulus measures are still on the table to accelerate transmission (as RBI has demonstrated with its operations twist). The Monetary Policy Committee (MPC) made it clear that it will lean more towards its inflation targeting mandate, till there are signs of inflation stabilising close to the 4% target. As we have repeatedly emphasised, one of the key inputs in the MPC decision will be the refresh of RBI’s Household Inflation Expectations Survey. Since this survey is likely in progress now, the saliency of the persisting rise in vegetables prices and the recent hike in petrol and diesel prices is likely to keep inflation expectations elevated. While a reversion down in inflation in H1 FY21 might create some space for additional monetary policy easing, the heavy lifting will have to be done by the fiscal policy, supplemented by trade, ease of business and other policies.
The first improvement is likely to be a nominal growth rate higher than the 7.5% estimated for FY20, probably around 10%, which will provide some extra room for manoeuvre. While fiscal policy is still likely to be circumscribed by relatively weak tax revenue growth, the government has shown an intent to use its limited resources more effectively, both through pragmatism in revenue augmentation (dispute resolution, non-tax revenues, access to foreign capital, etc) and expenditure rationalisation and management. These measures need to be taken forward to monetise as much of latent assets as possible, cut spending overlaps and increase coordination with states.
Improving credit offtake and delivery will be central to a quick recovery, and using fiscal revenues to leverage private funds (as is already being tried for the Partial Credit Guarantee and Last mile funding corpuses) besides further recapitalisation of PSBs will be central to reducing risk aversion and enhancing bankability of projects. FY20 will certainly have been the trough, but growth revival will not be easy, given the multiple structural impediments. An innovative coordination of policy levers will need to be carefully thought out.
Vikram Chhabra contributed to the article
Author is Senior vice president, Business and Economic Research, Axis Bank. Views are personal