Economic Survey: 2015-16 has presented its macro view as a balance between structural headwinds and cyclical tailwinds. While India has seen a definite improvement in its macro stability due to a much lower inflation, current account deficit and fiscal deficit in 2015-16, partly helped by benign commodity price scenario, it continues to face risks on account of fragile global environment, monsoon related uncertainty, overvalued exchange rate against many currencies and fractured balance sheets of corporates and banks. Hence, the Survey has taken a cautious approach to growth in 2016-17 and projected it in a broader band of 7% to 7.75%, primarily to reflect the wide range of possibilities.
As regards monetary policy, the Survey sees a clear scope for further policy easing against the backdrop of benign outlook for inflation, under-utilised industrial capacities and over-indebtedness of corporates.
This is in conflict with the RBI’s assessment, which remains concerned about the inflationary potential of the Seventh Pay Commission’s recommendations and a push to major structural reforms in the Union Budget.
Moreover, the Survey has identified “tight liquidity conditions” as the primary hurdle to monetary transmission. In its view, tight liquidity conditions despite significant cuts in policy rates have kept Indian interest rates and exchange rate higher than their desired levels, hurting growth, exports and corporate balance sheets.
In our opinion, this has increased the probability of a 25 bps repo rate cut in early March, if the government achieves the fiscal deficit target of 3.9% for 2015-16 (the chances for which look pretty high).
The Survey has presented an excellent analysis of growing vulnerability of Indian agriculture on account of weather related risks and has urged India’s government to be more proactive than reactive while preparing its Contingency Plan for a monsoon. Declaration of support prices well before kharif sowing operations, incentivizing farmers to produce crops susceptible to domestic supply pressures (eg, pulses) and timely contracting of imports of sensitive commodities are recommended as essential measures to minimise agrarian stresses.
The Survey has appropriately identified the impaired financial positions of some large corporates and the state-owned banks as a major threat to the nation’s financial stability, unless addressed without any further time loss. It has aptly described this problem as the “Twin Balance Sheet Challenge”.
To get out of this situation, the Survey says that banks must recognize the stresses fast and this recognition must be accompanied with adequate capital that can be raised either through selloff of government assets and/or by reducing the RBI’s own capital holding. The Survey shows that the RBI has one of the highest ratio of shareholder equity to assets amongst various central banks. However, all these steps need to be taken in close coordination between the RBI and government. Once done, resolution and reform can be pursued with full vigour.
The Survey sees several challenges to the achievement of fiscal deficit target at 3.5% of GDP in 2016-17 on the back of uncertainties for economic growth and revenue mobilization; and imminent hikes in wage bill and pension payment.
A combination of lower revenue receipts and higher current expenditure does not augur well for the government capex that has emerged as the primary stimulant to growth in 2015-16. While the Survey has recommended “increase in taxes” and “cuts in unproductive expenditures” as the necessary measures to protect fiscal consolidation, one is not sure about its political practicability, given that five major states are going to polls in 2016.
While making predictions and crafting appropriate policies amid heightened uncertainty is hard, the Economic Survey has presented a balanced picture of headwinds and tailwinds.
By Rupa Rege Nitsure
Group Chief Economist, L&T Financial Holdings