Economic Impact of UP Election

Introduction

    The scale of UP victory (>3/4th seat share) higher than any statistical analysis based on 2014 LS results: higher than both Surjit Bhalla's (@surjitbhalla) 60% seats and 5forty3's 2/3rd prediction. Political opposition/delaying tactics to Govt's economic policies likely to cease, both in RS and among party & affiliated organizations.  The Union Govt. will Re-Focus on economic objectives outlined in 2014 election manifesto and by the PM & his Govt. in the 2016-17 and earlier budgets. The mandate will allow the Union Govt. to accelerate Policy & institutional reform.

Policy Reforms

The Union government is likely to accelerate policy and institutional reforms that have already been announced by government, whether in the cabinet or in the budget. These include the following:

Welfare-subsidy reform

LPG reforms has made great progress. Govt has suggested at different times that other areas like kerosene, food, fertilizer, employment-NREGA would also be reformed  to eliminate corruption & admin inefficiency to reach benefits directly to poor, farmers & other needy groups.  So far these areas have been pursued very hesitantly and sporadically. Reforms are likely to be expedited so that the funds saved can be used to invest in infrastructure which promotes employment creating growth.

Strategic sales

  Strategic sales & public sector reform (PSUs, AI, ports, railway) reform to stop waste of resources into the sink hole, so funds can be used for infrastructure development. Strategic sale are opposed by vested interests (political, bureaucratic, management, labor) who enjoy the rents from Public sector while the public/tax payer pays the cost. The sweeping victory in UP will make it much easier to deal with obstructions and agitations from such vested interests, and thus accelerate the pace of change.

Labor Reform

  Labor law reforms were reiterated in the 2016-17 budget, in particular the reduction and integration of 44 odd labor laws into four functional ones. UP could also liberalize labor laws to encourage manufacturing, like Rajasthan & other BJP ruled States have started doing. 

Public Sector Bank (PSB)NPAs

        PSB bad loan problem, through decisions on sharing of losses by lender, borrower and tax payer/govt. NPAs whether at the country level or at the international level (e.g. Greece) is less about mechanisms, than about cost sharing than about appropriate sharing of costs between borrower, lender & tax payer.  Any decision will be criticized by opposition parties. However, with the Its hand strengthens by the electoral verdict, the govt is in a stronger position to deal with any criticism. The key here is too take & implement decisions quickly, rather than to search endlessly for a perfect solution (which does not exist) 

Goods & Services Tax (GST)

  The Union Govt. has an opportunity to remove some of the complications introduced at the urging of States, partly because govt did not have a majority in the Rajya Sabha.

Land Reform

   The Government can remove remaining constraints on land acquisition for infrastructure (e.g. through land pooling mechanism). It should also introduce the model land leasing law devised by NITI Ayog.

Foreign Direct Investment(FDI)

   The government has slowly and systematically eliminated unnecessary FDI restrictions and welcomed FDI. Given its announced intention to eliminate FIPB, there is now another opportunity to eliminate all FDI restrictions along with FIPB to encourage shift of manufacturing from newly-highly risky China to India.

Agriculture Productivity

    Allow the introduction of indigenously designed, tested and produced GM seeds followed by other GM seeds already evaluated, tested & cleared by the Indian regulatory agencies, which is so essential for enhancing agricultural productivity and incomes. Expedite removal of perishable goods from the APMC acts & the introduction  of e-markets.

UP administration

     There is also an opportunity to transform UP and consequently the Hindi heartland, by re-establishing rule of law, reducing corruption and accelerating economic growth.  One measure that would greatly facilitate transformation of the development paradigm, is the division of UP into 3 (or 4) separate administrative units, a halfway house to 3 (or 4) separate States. Each major sub-division (West UP, Central UP & East UP) would be under the charge of a deputy CM.  Bundelkhand admin could however be directly under the supervision of the CM. The CM would also act as a coordinator, planner, facilitator & supervisor of all major initiatives. He would also be the node between the union Govt/PMO and the DCM of the 3 quasi States.

Conclusion

      One of the results of the UP election results is likely to be a lengthening the time horizon of the policy options and institutional reforms considered by PM Modi led government from five to ten years. This implies less pressure to produce immediate results (populism) and greater likelihood of reforms that take time to work through the economy to produce visible results in growth and employment . However, the focus will remain on the reforms mentioned in the BJPs National election manifesto and the programs announced so far, with fine tuning based on the 21/2 years of running the union government.  The PMs words and actions over the past 2-3 years also suggests that he is likely to focus much more on establishing his place in history and to discourage some of his hyperactive followers from taking the law into their own hands or engage in violence and thus derail this long term objective.

Budget 2017-18 in Perspective

Introduction

  As a long term observer & commenter on budgets there are three aspects that are noteworthy from my perspective. One, the fiscal objectives of the government & action taken in achieving them, two the actions required post-demonetization to achieve/sustain its positive effects, and three the policy reforms in the budget that help achieve efficient growth & employment creation.

Fiscal Prudence & Programs

  After achieving the fiscal targets for 2016-17, the issue was weather to stick to the target of 3% for 2017-18 or to exceed it in the interest of greater investment expenditure on infrastructure. Govt managed the delicate balance, by relaxing the target by 0.2% to 3.2% while raising capital expenditure by 25% in BE terms (11% BE/actual). This allowed it retain its hard won fiscal credibility while addressing concerns over falling national investment rate by stepping up infrastructure investment & encouraging complementary private investment.

     The budget also fine tuned allocations on existing programs of the govt. (Swach Bharat, Skill India, Digital India/e gov) without introducing any adventurous new programs, that could become budget guzzlers. This was widely welcomed, though there was some disappointment that the move from inefficient, leaking subsidies to direct benefit transfers wasn't accelerated despite the success of LPG subsidy reforms.

Managing De-Monetization

  Soon after the demonization I had defined three potential areas of benefit and the policy actions needed to actualize and sustain them. The budget (& pre-budget announcements) offered some action on each, thus meeting the benchmarks one had set. Despite the predictable negative effects on GDP one had projected an increase in income tax related declarations & collections. This however needed to be sustained by implementation of promised corporate income tax reductions, and some movement on personal income tax reform(PIT). The PIT rate in the lowest bracket was reduced from 10% to 5% to incentivize new tax payers to enter the system. As this creates a sharp jump in rates between the first and second brackets(20%), and the reduction was offset by a rise in surcharge, it will require more comprehensive PIT reform in the next budget, including another look at exemptions & deductions. A clever way was also found to identify a set of CIT paying companies with high effective rates (>30%) and to reduce these to 25% without changing either the rates or the deductions-exemptions for the rest. Again in this case we would expect a more comprehensive reform in the next budget.

     The second area was housing and real estate. I had projected that demonetization would reduce prices, by reducing the black money part of the price. However, policy actions should make it easier for prices to fall (e.g. By reducing circle rates & stamp duties) and to make it easier to get credit for and do transactions in white. Pre-budget announcements on credit & interest subventions for low cost housing were followed in the budget by reduction in effective capital gains for one house, and easing of rules & conditions for creation of affordable housing. Eventually the whole policy approach to Housing & real estate would have to change from viewing it as a UN of black money to a white investment on par with investment in machinery & equipment of financial instruments.

     The third area was political-bureaucratic-police corruption, which has become the most important generator of black money in the last 30 years. To my surprise the budget accepted the Election commission recommendation to reduce the limit for acceptance of cash donation from an upper limit  Rs 20,000 to 2,000. Political parties who have complained that it is still too high should join the govt in reducing this further to Rs 200 or Rs 20. The 2nd proposal was the introduction of a bond that would make it possible to use tax paid income to make donations to a political party instead of being forced to generate black money to make anonymous donations. The bond will not make donations transparent, only make it possible to use "white" money for political donations.

Policy & Institutional Reforms

    Reform of ESI, PF and other social security subventions, which add ~ 30% to the cost of labor(with << commensurate benefits to workers), was promised in the last budget, but has made slow progress. Without it, the ban on cash payments above Rs 3 lakh is likely to have unanticipated consequences. It will make large scale subcontracting of labor very difficult and thus reduce informal employment further. At the same time the 30% addition to wage costs will continue to incentivize more capital intensive production methods in the organized sector.

  Reforms for sustaining economic growth and employment generation are a continuing, incremental process, and this budget had its complement of small but welcome announcements in several areas. In agriculture this included an intention to remove perishables from the ambit of the APMC, a model law for contract farming and further progress the national agricultural market (E NAM). There was also a commitment to integrate the 50 odd labor laws into 4 rationally organized ones. This is an essential compliment to the two track approach to labour reforms, where certain politically difficult issues are left to the States, while Center carries out the broader reform. Two other small but critical steps were the intention to abolish the Foreign investment promotion board (FIBB) and to resolve the legacy problems of PPP contracts by including it in the Arbitration law. The FIPB is a symbolic step but along with continuing reduction in Sectoral restrictions has a good effect on new investors. Financial sector reforms continued along the direction set by the Financial sector code. An announcement which is critically dependent on implementation is Strategic sale. The receipt budget made a provision of Rs 15,000 cr out of a total disinvestment target of Rs 72,000 cr. I read that as in indication that this process will finally start in 2017-18.

Conclusion

     In conclusion and on balance a good budget, as it was consistent with my expectations and benchmarks. 

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A version of this article appeared in the Hindu Business Line of  February 28, 2017, under the banner, "Viewing the Budget in Black and White." http://www.thehindubusinessline.com/todays-paper/tp-opinion/viewing-the-budget-in-black-and-white/article9562509.ece  

GDP 2016-17 and 2017-18: Forecasts & CSO est

CSO Estimate 2016-17

  In the first advance estimate for 2016-17 based on 6-7 months data, CSO estimated H1 2016-17 growth to average 7.2% and forecast full year growth at 7.1%. At that time I had revised my very cautious estimates of impact of demonetization on full year growth from -0.2% point to a range of -0.2% to -0.5% point from the bench mark H1 growth estimate of 7.2%.

    In the just released second advance estimate the CSO has raised its GDP growth estimate for H1 of 2016-17 by 1% point to 7.3%, leaving the full year growth estimate unchanged at 7.1%.

 If  I apply my last forecast to these adjusted numbers, the likely 7.1% growth for full year 2016-17 is precisely 0.2% point below the revised estimate for H1 of 2016-17 i.e. at the top end of my forecast range.[i]

   At this point I  have no reason to revise this forecast range, so GDP growth for 2016-17 could still end up a little below the currently predicted level of 7.1%.

Demonetization & Sector Slowdown

   It is important to note a few sub-sector details: The rate of growth of the sub-sector Trade, hotels, restraints, transport & communication is down sharply from 10.7%% in 2015-16 to 7.3% in 2016-17. As my analysis of demonetization showed, this sector was likely to be most severely affected by de monetization, My analysis also suggested that the recovery of the construction sector, which was expected to improve sharply during 2016-17, would be delayed.

  The data shows that growth of construction has remained virtually flat recovering marginally from 2.8% in 2015-16 to 3.1% in 2016-17. The third noteworthy element is that private final consumption which was expected to get a positive boost from the sharp increase in agricultural production after two back to back droughts has moved in the opposite direction.

   My analysis of March 2016 did not expect an increase in the growth rate of manufacturing sector, but an acceleration of organized/corporate manufacturing, perhaps accompanied by a slowdown in the unorganized parts. The deceleration in the GDP from manufacturing from 10.6% to 7.7% accompanied by a rise in sales & profits of the large corporate sector during the first 9 months of 2016-17, indicates that this forecast may turn out to be broadly correct.

The fact that the rate of growth private consumption growth is expected to fall only marginally from 7.3% to 7.2% is probably due to off-setting factors. The sharp increase of rural demand arising from the recovery of agriculture and allied growth from 0.8% in 2015-16 to 4.4% in 2016-17. A normal monsoon after two consecutive drought year would raise rural incomes in 2016-17 even more sharply than overall agricultural production giving a strong Philip to consumption. The sharp acceleration in government consumption which was expected, because of higher wage payments consequent to the implementation of the pay commission award also stimulated consumption. With disruption of daily wage labor in urban areas, some migrants also likely returned to their villages to take advantage of MGNAREGA employment. This would add to the government consumption expenditures.

The disruption in consumption arising from the shortage of cash due to demonetization during November & December 2016 and to a lesser extent in January 2017 would act in the opposite direction by reducing consumption. The fact that inventories grew at 17.2% in 2016-17 as against 7.9% in 2015-16 is suggestive of unsold stocks of goods because consumption grew less than anticipated. However, declared retail sales and consequently consumption may not have fallen as much as actual consumption, as shown in the analysis for Q3 below.

Given all the uncertainty created by demonetization Gross fixed investment growth collapsed from 6.1% in 2015-16 to 0.6% in 2016-17.

Quarterly Data

   It is important to recall that Annual GDP estimates are not based on or built up from, quarterly GDP estimates but on aggregate data available for 9 months or 12 months. On the contrary Quarterly GDP estimates are based on an interpolation/allocation of annual estimates to each quarter based on available indices. Thus quarterly data, at best provide information on trends and possibly random variations from trend. They must be used with extreme caution. 

Private Consumption

     The surprising increase of 10% in Private Consumption at const 2011-12 prices during Q3 could be due to a number of factors:

(1)   Sales which had happened during April-October but had not been declared, brought on the books.

(2)   Artificial Sales receipts created to show accumulated cash as earned income to be able to safely deposit in bank,

(3)   Temporary shift of consumer demand from unorganized to organized (taxed) sector so as to able to use check she or digital payments based on bank saving , as unavailable

(4)   Temporary shift in production from cash strapped unorganized sector to organized/tax paying sector operating on check & formal credit,

(5)   Base effect (lower growth in Q3:2015-16).

    How much of this could be sustained into the next quarter. (1) & (2) are unique to Q3 and can't be repeated in Q4. (5) depends on Q4 2015-16 growth. (3) and (4) will wind down during Q4 2016-17, as cash is re-injected into the economy, till a small residual representing faster digitization of economy remains. On net basis these factors could result in a measured growth rate of private consumption in in Q4, which is slightly higher than the actual. 

Conclusion

  There is a large amount of uncertainty in FY 2017-18 arising from both the domestic and the global side. This is further magnified by uncertainty about how the monetary policy committee and other policy organizations will react to these sources of risk.

      On the external front multilateral organizations are predicting an increase in World growth by up to 1% point and markets are predicting two or more upward adjustments in the US FRBs policy rate. On the downside are the political developments in the USA and Europe, the geo-economic uncertainty this gives rise to and their consequent negative effect on world growth. As forecasts of World growth recovery have proved over optimistic many times since 2009, the degree of confidence in above forecasts is low.
  On the domestic front the big uncertainty arises from demonetization and its impact on consumer behavior as well as the related measures that govt has taken and has hinted at taking. In the absence of data and historical experience of such a demonetization. Most initial forecasts have been determined by personal & political biases. After the second advance estimate from the CSO, the uncertainty has reduced somewhat, but the speed of the recovery in 2017-18 remains uncertain. This is because we don not know how pronounced the hysteresis effect will be, after sufficient cash has been injected back into the economy. That is the recovery could be a very sharp V shaped one or it could be U shape with negative effects lingering for a few quarters.

    Therefore my bottom line at this point remains a GDP growth forecast for 2017-18 of 7.5% +/- 0.75% (ie 6.75% to 8.25%). 

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[i] http://dravirmani.blogspot.in/2016/11/demonetization-economics_16.html