Will elusive investment recovery take root?

It seems unlikely until the final quarter of 2018

The year 2017 brought with it a period of adjustment for the Indian economy, to events like demonetisation, implementation of major policy changes like the Real Estate (Regulation and Development) Act, 2016 and the Goods and Services Tax (GST), even as NPA levels of banks remained high and insolvency proceedings were initiated against 12 large borrowers.

This was a year of false starts, such as the bountiful rainfall in the first half of the monsoon season, which subsequently fizzled out, resulting in a tepid kharif harvest, amid vocalisation of farmer distress and a spurt of crop loan waivers.

The dip in the CPI inflation to a series-low in June 2017 turned out to be rather short-lived, with increases in food and commodity prices causing inflation to rebound. The early presentation of the Union Budget led to front-loading of spending, enlarging the fiscal deficit.

The decline in GDP growth to a 13-quarter low in April-June 2017 spurred calls for a fiscal stimulus, which abated following the modest recovery in growth in the ensuing quarter. How the design of the bank recapitalisation bonds would impact the Government of India’s fiscal deficit, added to the uncertainty.

Revenue concerns crept to the fore, related to slower-than-budgeted growth of income tax, the cut in excise duty on fuels, the dip in the surplus transferred by the Reserve Bank of India and the slide in GST collections.

At the state government level, pay revisions and crop loan waivers led to concerns that productive capital spending will be sacrificed, given the fiscal constraints, raising worries regarding the quality of expenditure and economic growth.

The uptick in inflation, concerns over fiscal slippage, an end to the domestic rate cut cycle and hardening treasury yields in the US, disquieted the Indian bond market, causing G-Sec yields to rise rapidly in the second half of the year.

Looking ahead, presuming the arrival of a normal monsoon, a commitment towards fiscal consolidation at the Central and the state level, and the commencement of broader efficiency gains related to the GST, the growth of gross value added at basic prices is likely to improve to 7.3 per cent in calendar year 2018 from the modest 5.9 per cent in calendar year 2017.

Factors at play

Of greater importance than the headline growth estimate will be whether the elusive investment recovery will take root, which seems unlikely until the last quarter of 2018.

Additionally, the outcome of the ongoing resolution process will determine the sufficiency of the announced recapitalisation programme for public sector banks. This will provide clarity on the ability of banks to support credit and the overall economic growth in 2018 and beyond.

Elevated commodity prices and the impact of the Central and state government pay revisions will continue to push up inflation in H1 CY2018, while the 2018 monsoon is likely to influence the trajectory of food inflation in the subsequent months.

At present, the CPI inflation appears set to rise to 4.2 per cent in 2018 from 3.3 per cent in 2017.

Given that the Monetary Policy Committee responded to the modest average inflation in 2017 with only one rate cut of 25 bps in August 2017, we do not expect it to commence hiking the repo rate unless the CPI inflation is forecast to persist above 5 per cent for at least two quarters.

The fiscal outlook will be dictated by the Union Budget for FY2019, the last full Budget prior to the next Parliamentary elections, which will likely focus on rural and urban infrastructure, and social security. An assessment of the revenue buoyancy after GST and the extent to which the recent reforms have widened the tax base will critically influence the fiscal space for reducing tax rates or increasing spending, without compromising on fiscal deficit targets.

That said, we see a low likelihood that the fiscal deficit in FY2019 will be curtailed below the target of 3 per cent of GSDP that the Government had indicated in the last Budget.

Higher inflation and persistence of fiscal uncertainties are likely to ensure that bond yields remain elevated for much of 2018. To sum up, 2018 is likely to ring in higher economic growth and inflation, a steady repo rate, elevated bond yields and concerns regarding the fiscal deficit.

The writer is principal economist, ICRA Limited

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