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

Economic Growth and Macro Stability: Budget 2016-17

Introduction

   Sustained fast growth of the economy requires a stable macro-economic framework,  policies that stimulate growth and institutions(including laws & rules) that support competitive self sustaining job creating business and promote employment opportunities. Though India's GDP growth rate has risen gradually to 7.6% in 2015-16 (estimated), parts of the economy are buffeted by global growth deceleration, capital market uncertainty and deflationary pressures. These have reduced nominal growth to 8.6% and put pressure on the globalised corporate sector, reducing the nominal growth rates of their sales and profits. The rural economy has been weakened by two consecutive droughts, the first such dual drought since the end 1990s.  In this note we review the budget to identify, what if anything the budget proposes to do about these issues.

Fiscal Balance

   The 2016-17 budget implicitly recognizes that a growth rate of 7.5% to 7.75% doesn't require an expansion of government expenditure or wide tax incentives, by sticking to the fiscal deficit (FD) target of 3.5% of GDP for next year. Such a panicked reaction that will haunt us for the next decade. The decision to stick to fiscal targets enhances the credibility of the government, reduces the risk of contagion from World turmoil & sudden stops in capital flows and lays the basis for a reduction in policy interest rates by the RBI. A reduction in the interest rate by 50 BPS will considerably ease the stress felt by the corporate sector by stimulating demand for consumer durables, including housing and automobiles. The proposed amendment of the RBI Act to create a Monetary Policy Committee will formalize flexible inflation targeting, enhance the credibility of the RBI and allow better Monetary-Fiscal policy balance. 

Subsidies & Investment

    When the fiscal deficit target for 2015-16 was loosened to accommodate more infrastructure investment by government. The question in our minds was whether the government would be able to shifting expenditure from consumption cum subsidies to investment. The fact that the Revenue deficit(RD) for 2015-16 is 0.3% point below the revised target suggests that it has successfully achieved an improvement in quality of government expenditures. As the revenue deficit is a rough measure of government dis-saving, this will help raise national savings and reduce dependence on foreign savings. The RD is projected to decline by only 0,2% point of GDP in 2016-17 compared to the 0.4% of GDP reduction in FD. This is partly due to wage pressures arising from pay commission report implementation, however the budget could have done much more on reform of the fertilizer, food and kerosene subsidy.  In the longer term the proposed bill to provide statutory backing to use of Aadhar for providing targeted benefits, will greatly improve the efficiency of subsidy expenditure and reduce leakages & corruption.

The adoption of Kelkar committee recommendations on Private-Public Partnership would also help in completing stalled projects and promote new PPP projects by reducing regulatory uncertainty. Among the proposals in the budget are, one a Public Utility Dispute resolution Bill, Guidelines for PPP re-negotiations if the external environment changes unpredictably and a Credit rating system for infrastructure taking account of special risks involved. 

Policy Initiatives

  There are a few notable policy initiatives in budget that will help improve the competitiveness of the economy, promote productivity and generate employment. The budget speech proposes to allow 100% FDI in food processing. Along with the previously proposed setting up of a National e-market in agricultural produce could be a game changer for agricultural marketing . For decades we have talked about the huge wastage of food because of lack of farm to market linkages and marketing. Recommendations of many weighty commissions have been received and implemented by Govt without much success. This is the only thing which has not been tried in India, though it has worked in other countries. According the FM 12 States have already amended their APMCs to allow them to join the E-marketing platform to be inaugurated in April 2016. This will set the stage for the FDI in marketing.

   The other measures announced in the budget, should tide the agriculture sector till the next monsoon, which is expected to be normal. The year following the last two consecutive droughts in the late 1980s, saw a jump of 16.7% in agriculture production. With a normal monsoon in 2016-17, we estimate an agricultural growth rate of 7% to 9%. The reform measures proposed in the last two years will help restore rural income, consumption & depleted savings.

The second significant reform is the proposed change in the Motor Vehicles Act to open up the passenger transport sector. Road transport falls in the concurrent list of the constitution but passenger transport has been declared a monopoly of the State Govts in most State. The proposed bill will allow private road transport companies to compete in States which adopt this change. This would allow a modernization of the sector, improving productivity and generating higher quality jobs.

The third significant reform proposal is a model law amending the Shops an Establishment to provide greater flexibility in operation to small establishments, subject to undiluted health & safety requirements. This will provide them with greater freedom and flexibility to compete with malls and other large establishment. This law too would require States to adopt it. The basic approach is to promote inter State competition in reforming laws and rules to promote employment.

Financial Sector

FM reiterated his intention to carry forward the financial reforms, such as Bankruptcy law (for non-financial companies) and proposed some new initiatives for financial firms and banks. The most significant long term reform was a Financial Firms Resolution bill. A number of changes were also announced regarding FDI in and taxation of Asset Reconstruction Companies (ARCs), DRTs, and Public Sector Banks which will expedite solution of the bad debt problem.

Conclusion

    There are were a number of small changes in the personal income tax, corporate tax, customs and excise duties. Some of these will help simplify the tax system while others will complicate the tax system. The net effect is a bit difficult to determine at this point. The budget also carried forward the effort to improve the system of tax administration and dispute resolution based on the recommendations of two tax administration reform committees. But the proof of the pudding in bureaucracy is always in the eating. Overall, the fiscal consolidation and reforms highlighted above make this good budget.
    I expect GDP growth to accelerate by about 0.2% points from the growth rate for 2015-16, and to be much better distributed across sectors & segments of the economy. In particular, rural economy will do much better,  with normal economy, I project an agricultural growth rate of 7% to 9%, based on past performance after two consecutive drought in late 1980s. The corporate sector is also likely to revive with a better mix of monetary-fiscal policy and improvement in the quality of the fisc with a shift from consumption-subsidies to infrastructure investment.
 

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 A version of this article appeared in the Indian Express of March 3rd, 2016, under the banne, "Race To The Top," at http://indianexpress.com/article/opinion/columns/union-budget-2016-race-to-the-top/ .