Indian Economy at Mid-year 2015-16: Some Observations

Economic Growth

Q1:  The Mid-year analysis of the CEA, lowered economic  growth projections  sharply from 8.1-8.5 per cent for 2015-16. Don't you think  it  is  too  pessimistic a  projection since  the  UPA had left  growth at  7.9 per cent  for 2013-14? Even  upper band  is a tad  higher than 7.3 per cent recorded last  year.

A1:  At the end of 2014-15, most macro-forecasters(public & private) had predicted a GDP growth rate of over 8% for 2015-16 with a steady growth in the first half and a stronger pick up in the second half of the year.  Since then they have reduced their forecasts of GDP growth in 2015-16 to below 7.5%.

     I retain my post-budget forecast of a 0.25% to 0.75% acceleration in GDP growth in 2015-16 over previous year. Given that GDP growth rate was 7.3% in 2014-15, my  expectation remains of a growth rate between 7.5% and 8%, though current data suggests it will be on the lower side. On the positive side is the recovery of IIP manufacturing growth from negative growth at end 2013-14 to a growth rate of 4.5% to 5.5% at present. This is underpinned by a strong recovery in both capital goods and consumer durable goods production.  The two back to back droughts in 20014-5 and 2015-6 have however taken a greater than anticipated toll on demand for consumer durables produced by the organized sector represented in the IIP. A decent Rabi crop should help revive rural incomes and demand for non-durables consumer goods. This will, however, need to be re-evaluated as more data comes in January.

Q2: It said private investment may remain weak next financial year as well. What is your view?

A2: Assuming that all the financial sector reform measures outlined in the budget (eg bankruptcy law) and elsewhere, are implemented I expect a steady but slow recovery of corporate demand, investment and growth during 2016-17. This would be stronger if the right choice is made in the fiscal-monetary balance as suggested above. There is nothing in the data so far to suggest a very sharp pick up in private investment in 2016-17.

World Economy

Q3: What is the effect of the Global economy on India?

A3: Many analysts are just beginning to understand that we are living in a near-deflationary World economy and many still don't understand that the Global financial crisis (2008) was more akin to the Great Depression than the worst post-war recession.[i] This was masked to a large extent by US QE till 2011 and in the oil/energy market till 2013, by the Chinese debt bubble.  What this means is that the standard effects of monetary and fiscal and economic co-relations that analysts have got used to in the inflationary post-war world have been disrupted and often yield wrong answers.

      Though low aggregate demand in developed countries was important in triggering deflationary trends, it is has been underpinned by excess supply from continued production and investment in China unmindful of the near zero or negative returns. The largest effect of Chinese over-supply is on "un-differentiated tradable goods", which in earlier analysis of Indian economy I have termed  "Globalised (part of the) Corporate sector". 

   Coming specifically to the Indian economy, both the decline in oil prices, from which India benefits and the collapse of nominal sales, revenues and profits in the "Globalised corporate sector"(which surprised analysts) are the direct results of the demand supply imbalances in  "undifferentiated tradable goods." As any improvement in this sector depends on US-EU actions on fiscal policy and Chinese actions in abandoning its investment-export growth model, not much relief can be expected in the next few years. Consequently India has to focus on reforming policies that either constrain or could drive the growth of the non-globalised parts of the economy. This includes Infrastructure, Agriculture, Education, Real Estate and Construction, Defense and substantial segments of the Manufacturing sector

Fiscal Deficit & Monetary Policy

Q4: The analysis said meeting fiscal deficit target at 3.9 per cent in the current financial year would be challenging due to decline in nominal gdp growth, though the target would be met. Next year, the fiscal deficit target could be relooked at but no decision has been taken as yet as gains from declining prices would not be much, seventh pay commission is there and OROP is there. Your take?

A4: As I said after pay commission report, I Expect the current year's fiscal deficit target to be met. The greater challenge is from the equity sale targets, given the decline in the stock market since the budget. 

     For 2016-17, I believe there is a clear choice between (a) Sticking to announced fiscal target & loosening monetary policy in line with the decline in CPI inflation, which requires a repo rate cut of another 75 bps, or (b) holding monetary policy tight (much tighter in real terms than it was 18months ago) and letting fiscal targets slip by raisin govt investment in infrastructure. In my view the former choice is a better one for revival of corporate investment & growth, given other complementary policies.

Q5: How much of a repo cut do you think is still required.

A5: Inflation as measured by both the CPI and the GDP Private consumption deflator PFCE) have fallen dramatically in the past two years. The PFCE deflator has fallen from peak inflation rate of 11.3% in the 3rd quarter of 2013-14 (ie Oct-Dec 2013) to 1.4% in the 2nd quarter of 2015-16 (ie jul-Sept 2015). Similarly CPI inflation has declined from a peak of 11.7% Novemebr 2013 to 5.4% in November 2015 (ie -6.3% ). Over the same period the repo rate has been reduced by 1% (or 1.25% if taken from the subsequent peak). Therefore the real repo has risen dramatically resulting in a sharp tightening of monetary policy over the last year despite a reduction in the fiscal deficit. This is true even if we use the core CPI inflation rate which declined by 3.4%. Based on this decline I have repeatedly said that a 2% reduction in the repo rate can safely be undertaken.  However RBI has reduced the repo rate by only 1.25% points leaving scope for a further reduction of 75 bps.

   Now that the uncertainty over the US Feds rate hike is over, I would recommend an immediate Repo rate cut of 25 bps. If this does not take place now, then I would recommend a 50bps rate cut at the next Monetary policy statement.

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[i] As I pointed out at the IMF from 2010 to 2012, the use of policies that worked in post-war recessions would likely extend this cycle by at least 2 years (ie 5-7 years) in the US and last at least 10years in the Euro area/EU(ie + UK).