Global Outlook for 2016
US GDP growth in 2% to 2.5% range with greater likelihood of being
at the lower end of the range. End year
Inflation likely to remain below FED target of 2%. Consequently FED unlikely to
raise rates more than once or twice during year. EU & Japan recovery very
slow.
China real growth already below 6%, likely to fall below 4.5% in about
3 years. Negative effects on global
economy are already in process as the vaunted market reforms are likely to
remain on paper for political economy reasons (maintaining monopoly of CCPs
political power). Official GDP growth rate likely to be propped up by further
credit expansion, but this time channeled formally through government budget account.
The eventual bursting of this latest bubble will ensure that actual growth
falls below 4.5%, even if official growth is maintained at 5.5% to 6.5% for 3-5
years. Thus China will continue to
export deflation to the World with continuing negative effects on the
Globalised part of Indian corporate sector (e.g. metals & mining). However,
because of the reintroduction of capital and other economic controls, and
tightening of political and media controls, public surprises for global
economic are likely to be moderated.
Outlook for Oil:
Oil prices are likely to remain range bound in $30 to $45 range, with annual
average growth for 2016 over 2015 being in single digit.
Implication for India: Recovery in the Globalized Corporate sector,
namely in its Investment, Profits and Output growth will be slow. Deflationary
pressure on Indian prices will continue but on a more moderate scale than in
2015.
Indian Economy
Review of 2015-16
In the beginning of 2014-15 and 2015-16 we forecast
an acceleration in GDP growth of 0.5% in each case. The actual results have
been an average acceleration of about 0.25% point (assuming the NAS projection
for 2015-16 comes true). In September
2015, we predicted that end year (ie March 2016) CPI inflation would be between
4.5% and 5% with 60% probability, I also put a 20% probability of inflation
between 5% to 5.5% and 20% probability
of 4% to 4.5%. One of the investment banks has estimated that March 2016
inflation will be 5%, within the predicted range, but 0.25% above the predicted
mean of 4.75%.
Despite an average GDP growth rate of
around 7.6% in constant prices, and nominal of 8.6% in 2015-16 (CSO projection)
two sectors have seen noticeably slower growth. These are agriculture-rural and
listed companies. The former is clearly due to the rare occurrence of two
consecutive droughts. The latter is related to the global deflationary impulses
(discussed above) and the sharp decline in nominal GDP growth over the last 5
years. The former also has a (greater) effect on the latter through what one
has called "quality downshifting" (movement down the quality ladder
for consumer goods) as people buy
cheaper lower quality goods to reduce drawdown of savings.
Prospects for 2016-17
There are three domestic developments
that will affect the economy during 2016-17. The most important is a normal
monsoon after two consecutive drought years. To my knowledge there is no record
of three consecutive drought years. The last time there were two consecutive
droughts in late 1980s the following year of normal monsoon saw an agricultural
growth of about 19%. My rough estimates suggest that agriculture growth in
2016-17 is likely to be around 8%-9%. This will correct one major source of
unbalanced growth, have a positive effect on corporate demand and profits and
on animal spirits as reflected for instance in the stock markets.
Corporate sector growth in the first half of the year, before the good
harvest comes in, will be more directly affected by the increased government
infrastructure orders that have been set in motion in the 2015-16 budget. These
will start getting translated into actual expenditures and investment in
2016-17.
The third factor will be the fall
in real interest rates from the highs they had risen to during 2015-16.
This will have a positive impact on consumer durables, housing and construction
industries and on consumer durables demand generally.
The sector spread of
growth will therefore definitely improve in 2016-17. Depending on the degree to
which each of these three factors play out, we project an acceleration in GDP
growth, of between 0.2% & 0.5% point
above the 2016-17 level. As of February, CSO estimated 2015-16 growth
rate of 7.6%. If this growth rate holds, GDP growth in 2016-17 will be in the 7.8%
to 8.1% range. If 2015-16 growth is revised down, one would expect a
corresponding adjustment in 2016-17 growth.
Given these domestic and international developments, my probabilistic forecast
for end year CPI inflation (March 2017) is as follows: 70% probability of inflation
rate of 4% to 5%, 20% probability of inflation rate below 4% (the RBI target
for 2018) and 10% probability of inflation rate above 5%. This forecasts
incorporates a repo rate reduction of 75 basis points within the first quarter
of 2016-17.
Monetary Policy
Recommendation (30/3/16)
I recommend a repo rate cut of 50 BPS in
the April policy, followed by a rate cut of 25 BPS in the June policy. The primary
reason for dividing up the recommended rate cut of 75 BPS is the uncertainty in
the minds of many economists about whether there will be a normal monsoon. One is fairly confident, based on historical patterns, that there will
be a normal monsoon this year, but by their very nature the "black swan" of a third consecutive
drought can't be ruled out. This rate
cut is also incorporated in the inflation and growth forecasts given earlier.
Liquidity & Imperfect Markets
Ever since the start of the Indian debate
on "Inflation Targeting" a decade ago, one has pointed to the danger
of assuming that Indian financial markets work like the highly integrated and
developed US financial market. Indian financial markets were highly fragmented
and underdeveloped in 1991 when economic and financial reforms started. Since
then financial and other reforms have resulted in the development of markets
for consumer finance and many other segments. However, they still nowhere near
the level of the US financial market.
One monetary policy consequence of this difference, that one had pointed
to, was that old fashioned monetary targets like reserve money, M1 and M3
growth were not as irrelevant/useless as they were considered to be in
developed countries. Another consequence
of imperfect markets was and is the imperfect/inadequate transmission of repo
rate signals into interest rates charged by banks as well as those prevailing
in the financial markets.
The increased focus on "transmission" during the last year and
the returning focus on "long term liquidity" in the RBIs monetary
policy, is an implicit recognition of the way in which Indian financial markets
differ from developed ones. Thus it is a very welcome development.
Conclusion
Economic growth will likely accelerate by 0.2% to 0.5% point in 2016-17 over
the growth rate for 2015-16, and this growth will be much more evenly
distributed over sectors and areas. If the CSO estimate of growth for 7.6% in
2015-16 is correct, GDP growth in 2016-17 is projected to be between 7.8% and 8.1%.
Sectors such as agriculture, construction and corporate sectors that
have been below par will pick up significantly. The top end of the range is
however likely only if monsoon is well distributed and timely and the
monetary-fiscal policy mix continues to improve. Passage of key legislation such as Bankruptcy law and GST would also reduce risks to the economy and increase the probability of 8% growth.
CPI Inflation will decline further from a likely 5% in March 2016 to an
expected value of about 4.4% in March 2017, with a 20% probability of 4%
or lower, which is the RBI target for
March 2018. Given decelerating inflation, nominal GDP growth is unlikely to
recover from very sharply from the CSO estimated 8.6% for 2016-17. Thus one
should expect nominal sales and profits to close the gap with real GDP growth
rates that has happened since the sharp decline in inflation.