Pages

Friday, September 8, 2017

Growth Prospects: Deceleration, Demonetization, GST



Introduction

   The advance and revised estimates for the year 2016-17 gave as some indication of the effects of demonetization on GDP growth. However, there were doubts and disagreement between analysts about whether the negative effects would be limited to Q4 of 2016-17. With the CSO releasing data on Q1 of 2017-18, we are in a better position to provide a quantitative impact of demonetization on GDP, as the effects of demonetization can be separated from the earlier deceleration of growth from its quarterly peak in mid 2015-16. We are also in a position to take stock of earlier forecasts of GDP for FY 2017-18.

Demonetization

  From the GDP data now available, we estimate that Demonetization reduced GDP growth by ~1.2% point in first half of 2017 or by ~0.6% point in 12 post-Demonetization. This is at the mid-point of my forecast range of -0.2% to -1% on 12 month basis[i]. The methodology, though far from perfect, accounts for /adjusts for the decelerating trend in quarterly GDP growth since the middle of 2015-16. 

Deceleration in GDP growth

         GDP growth decelerated from 7.9% in July-Sept 2015(Q22015-16) to 5.7% in April-June 2017(Q1 2017-18), while GVA decelerated from peak of 8.2% to 5.6% over the same period.  Our analysis suggests that the GDP growth deceleration since mid-2015-16 is due to the following factors:
(a) Monetary policy has not only been tight for last two years, but has tightened over last 18 months because of sharply falling inflation. The real repo rate has been on an uptrend from the beginning of 2014, rising from a neutral 0.3% in January 2014 to 6.3% in august 2017. The direct negative effect of rising real interest rates has been strongest on manufacturing and construction, Another consequence of high real rates relative to global rates, is excessive capital inflows into debt (and carry trade, which gives free money to foreigners). This results in appreciation of the real effective exchange rate of the Rupee (REER 36), which has appreciated from 104.7 to ~120 over the same period. Since February 2015 it has however moved progressively above the gradually appreciating trendline & appreciated by 6.6% till July 2017. This in turn resulted in loss of competitiveness & worsening of net exports of goods (Exports-Imports: X-M), which are almost 62% of its absolute value in Q2 2015-16 and 48% of its absolute value in Q1 2015-16.
 (b) A return of the Indian economy from deflation to inflation in manufacturing & other internationally tradable goods. Inflation measured by the deflator for manufacturing, which was negative from Q1 of 2015-16 to Q1 2016-17 turned positive in Q2 of 2016-17 and has risen progressively since then. Similarly inflation as measured by mining deflator turned positive i Q3 2016-17 for the first time since Q2 of 2014-15. The deflation results in leads and lags in input & output prices that result in overestimation of value added in manufacturing & other goods, while the return to normal inflation reverses these effects on inputs & outputs so that average growth measures values which would have prevailed in absence of deflation episode.
(c) Public Sector bank(PSB) NPAs were incurred largely in 2009-13, after the Global Financial Crisis(GFC) in 2008, partly because of the unjustified euphoria generated by quick recovery in 2009 due to appropriate fiscal monetary policies. The recovery led to abandoning of fiscal sobriety in 2010 & lending pressure by government on Public sector banks. However, the increasing NPAs were more hidden or in speculative domain. Tighter regulations on NPAs since 2014 and their disclosure to public forced Banks,  companies and capital markets to see & evaluate the risks more carefully and clearly, worsening Credit/Investment in 2015 & 2016.

Reforms for Growth

With uncertainties and risks from introduction of GST still hanging over the economy, the key question at this point is what specific policy changes can help revive growth: The following reforms, in order of feasibility and impact, should be accelerated by government:
(1) Government must refocus on subsidy reform and put the savings from reduction in corruption and administrative efficiency, into public goods infrastructure investment. This will be an important driver of grwoth as long as private corporate investment remains weak.
(2) It should expeditiously complete already launched reforms in Bankruptcy law, rules & procedures and the cleanup of the NPAs in PSBs. 
(3) To get the full benefits of GST and minimize the costs, the GST council must undertake drastic simplification of the GST (to 3 slab System with one base rate, basic food, health, education as exempt sectors & surcharges on 6-12 carefully selected indutries+services).[ii]
(4) Reform Export-Import (EXIM) policy (Agriculture, Textile), and unify customs (import) duty into a uniform 10% duty on all manufactures & minerals (GST is seperate).(a) Suspend the IT-electronics agreement for 3-5years (if possible).  Either through EPZs or FTZ or other temporary mechanisms (5-10years) provide an opportunity to Labor intensive industries & Export Supply Chains to shift base from China to India.[iii]
(5)  Two consecutive normal monsoons provide an opportunity to eliminate all export controls & QRs  on agricultural commodities and reduce export duties to zero immediately. If government wants to help farmers on a permanent & longer term basis, it should also repeal ECA & APMC, approve all GM seeds recommended by the GEAC & induce hold-out States to join the National e-market for all agricultural products. Remaining impediments to FDI in food retailing of agricultural & related products should also be removed.
(6) Education is one of the remaining heavily controlled sectors of the Indian economy. Central Govt. can make a start by replacing controls on higher education with modern, rational regulation (based on asymmetric information & moral hazard problems faced by users).
(7) Reform of the two most distorted markets, labor & land, are not 0-1 processes. They have multiple dimensions, each one badly riddled with controls, distortions and corruption. So a phased program of labor & land reform can be drawn up and implemented step by step over next five years as political opportunity permits.

Outlook

    In my judgment the negative effects of demonetization on GDP are largely over. Because of fears of getting shortchanged on input credit from GST, there was an inventory draw down in June, and a possible slowdown in production even before that. Both these will be offset in August and Q2 of 2017-18. On balance I expect the economy to bottom out in July, but the speed of recovery will depend on the reforms & Monetary policy. 2017-18 GDP Growth is likely to be below my mean forecast of 7.5%, but within the range of 6.75% to 8.25% that I had forecast at the beginning of the financial year.[iv]
----------------------

A version of this article appeared in Economic Times on 8/9/2017 under the banner, " Post-demonetisation economy: Exorcising DeMo’s demons" at https://blogs.economictimes.indiatimes.com/et-commentary/post-demonetisation-economy-exorcising-demos-demons/



[i]  http://dravirmani.blogspot.in/2016/11/demonetization-economics_16.html
[ii] https://www.facebook.com/arvindvirmani2/posts/780808875419702
[iii] Further details in tax reform chapter of forthcomng book: India at 70 years, Modi at 3 years
[iv] http://dravirmani.blogspot.in/2017/03/gdp-2016-17-and-2017-18-forecasts-cso.html , http://dravirmani.blogspot.in/2017/02/monetary-policy-8217.html
(a)  AV, "Towards a Competitive Economy: VAT and Customs Duty Reform," Planning Commission Working Paper No. 4/2002-PC, April 2002.  http://www.planningcommission.nic.in/reports/wrkpapers/wp_vat.pdf ; Arvind Virmani, "Customs Tariff Reform," Economic and Political Weekly, Vol. XL No. 11, March 12-18, 2005, pp. 1006-1008

Sunday, September 3, 2017

India-China Trade: Q&A post-Doklam

Q1. China has emerged as India’s largest trading replacing US in March 2008.  During the economic liberalisation in 1991, the level of bilateral trade between the two countries was not significant, as the trade basket was restricted to a limited number of products. But, within a short time span, China became the India’s single most important trading partner. How would like to define the journey so far? What were the triggers for growth?
A2: The increase in trade is due primarily, if not wholly to a massive increase in Chinese exports to India, which are now 5 times its Imports from India. Consequently, India has a huge trade deficit with India. 

Q2.  There is huge amount of complexity in the relationship between India and China. And there is an undercurrent of suspicion as well. How have those factors spilled over to the bilateral trade? What kind of manifestations of that spill-over effect have we seen so far?
A2: China is a non-market economy and given its communist party controlled government and economic system, it can employ subtle forms of Non Tariff barriers, by just telling companies not to import certain products or from certain countries. Thus if doesn't even allow us to export pharmaceuticles & other items where we have demonstrated comparative advantage. It also engages in dumping manufactured goods at the cost which is less than the sum of parts used in it.

Q3. You were the Chief Economic Adviser to The Government of India, Ministry of Commerce during 2007-2009. What was your strategic outlook to handle India-China relationship during that time? What are the observations and insights you derived during that stint?
A3: In Indian system, Trade policy is under the purview of the commerce ministry. As general policy we didn't discriminate against any country wit respect to tariffs or regulatory standard. We also supported MOC in removing Non tariff barriers directed at us.

Q4. What kind of impact China’s ambitious plans like Strings of Pearls, China-Pakistan Economic Corridor and One Belt One Road (OBOR) on the India-China bilateral trade?
A5: They have no direct effect on bilateral trade. The ports built by China are largely redundant and consequently unprofitable & with very low capacity utilization. With the exception of Pakistan, the road & rail infrastructure built under OBOR are open for India & other countries to use. Pakistan doesn't allow India to use its infrastructure for transit & trade with Afghanistan or Central Asia & consequently has zero impact on bilateral trade.

Q5. How important is the normal India-China bi-lateral relation to various bodies like BRICS, RCEP, ASEAN etc.? What kind of impact will India-China relationship have on those platforms, going forward?
A5: Multilateral organizations stand on their own and depend on their own mutually accepted rules. The huge trade imbalance that China has with India is probably delaying the conclusion of an RCEP agreements. If China acknowledges this imbalance and accepts its consequence in RCEP, the RCEP could conclude much faster

Q6. China is trying to assert itself in the South-East Asia more aggressively. How will that factor reshape the India-China bilateral trade? 
A6: Aggressiveness always induces caution, and this is will have similar effects

Q7. India mainly exports raw materials to China such as cotton, ores, organic chemicals and copper. However, as the experts say that the Chinese economy rebalances to become more consumer led, there will be a further fall in exports. What’s your thought on it? How should India tackle this situation? Is there a need to re-strategize and explore new export possibilities in the Chinese market?
A7: China's trade with developing countries follows the Prebisch-Singer hypothesis of trade between the Center and the periphery: China imports natural resources from EMDCs and exports manufactured goods to them. This is an essential element of its economic development strategy. The only way this pattern to change is for China to shift its labor-intensive manufacturing to India (FDI) as it's becoming uncompetitive in China.  We welcome this move Eg to exclusive Chinese ETZ/FTZ in India.

Q8. Various sectors in India like pharmaceutical, electronics and machinery are dependent is Chinese imports. How Can India reduce dependence on Chinese imports?
A8: The "Make in India" & "Ease of Doing Business" must be used to promote these sectors especially by attracting FDI currently operating in these sectors in China and even Chinese firms that are willing to abide by rules applicable to other FDI.

Q9. The trade deficit is a cause of concern for India, which stands at $ 51.09 billion in FY2017. What can India do to reduce the trade deficit?
A9: Follow a policy of reciprocity & symmetry with respect non-tariff barriers, though we are at an inherent dis advantage in our transparent democratic system and their non-transparent one.

 Q10. What can India do to make the trade relationship with China more equal? Is the strategy to market India as an investment destination an answer?
A10: Yes we welcome Chinese investment in manufacturing and infrastructure, subject to cyber security consideration.

Q11. As per the news reports, a trade war seems to be looming between India and China after New Delhi imposed anti-dumping duties on 93 Chinese products amidst a military standoff in Doklam area. An article in The Global Times, part of the ruling Communist Party's publication group, urged Chinese firms to "reconsider the risks" of investing in India and warned New Delhi to be "prepared for the possible consequences for its ill-considered action." How do you read the situation at the moment?
A11: This is false News by hyper-nationalist elements in China. These 93 anti-dumping duties have been  imposed over a decade since the Global Financial crises in 2008, without any hint of a trade war. 

Q12. Analysts are of the view that the growth in economic ties with China will come through small entrepreneurs. However, how will the MSME sector withstand various restrictive measures and work towards the growth? Don’t you think MSME sector will bear brunt of all these developments?
A12: The issue with China is the asymmetric benefits derived by a non-market economy and the imbalance in trade. Economic ties can can progress if and only if China is agreeable to removing non-transparent barriers on India's exports. MSMEs would be the primary beneficiaries of this.

Q13. What role can the BRICS summit to be held in China play to diffuse the tension between the countries?
A13: Summits provide an opportunity for leaders to come to informal understanding. Some progress in reducing tensions is likely

Q14. What are the possibilities and opportunities both the countries can explore for economic and trade cooperation, going forward?
A14: As indicated RCEP is one forum in which progress could be made. Another is Chinese FDI in Indian manufacturing.

Q15. What should both the governments do to make sure trade shouldn’t get affected because of various developments?
A15: Remove the lacuna in the border management agreements that have ensured that scuffles on LAC don't turn into fatal incidents, and turning LAC into a better defined LOC.