Economic Survey 2018 - Vol.1, Ch. 1:State of the Economy: Analytical Overview and Outlook for Policy (Download PDF)

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Overview: short term:- 1. GST 📹. The past year has been marked by some major reforms. The transformational Goods and Service Tax (GST) was launched in July 2017. With a policy change of such scale, scope, and complexity, the transition unsurprisingly encountered challenges of policy, law, and Information technology systems, which affected the informal sector.

    • GsT (Goods and Service Tax) : Yojana August 2017 Summary
    • Expeditious responses followed to rationalize and reduce rates and simplify compliance burdens.
  1. TBS
    • A decisive action was taken to grasp the nettle of the Twin Balance Sheet (TBS) challenge. Of the 4R՚s of the TBS- recognition, resolution, recapitalization and reforms, recognition was advanced further, while major measures were taken to address two other R՚s.
    • The new Indian Bankruptcy Code (IBC) has provided a resolution framework that will help corporates clean up their balance sheets and reduce their debts.
    • The government announced a large recapitalization package (about 1.2 % of GDP) to strengthen the balance sheets of the public sector banks (PSBs)
    • As these twin reforms take hold, firms should finally be able to resume spending and banks to lend even the stressed sectors of infrastructure and manufacturing.
  2. Macro economics
    • In the first half, India՚s economy temporarily “decoupled,” decelerating as the rest of the world accelerated.
    • The macroeconomic development remained the second best performer amongst major countries, with strong macroeconomic fundamentals.
    • 📝 The reasons for decelerating can be attributed to
    • Demonetization
    • Teething difficulties in the new GST
    • High and rising real interest rates
    • An intensifying overhang from TBS challenge
    • Sharp fall in food prices that impacted agricultural incomes
  3. Revival of economy
    • In the second half of the year, the economy witnessed robust signs of revival.
    • Economic growth improved as synchronous global economic recovery boosted exports.
    • 👌 India jumped 30 spots on the World Bank՚s Ease of Doing Business rankings.
    • Actions to liberalize the foreign direct investment (FDI) regime helped increase flows by 20 %
  4. Macro-economic stability

    Fiscal deficits, the current account, and inflation were all higher than expected, though not reflecting in part higher international oil prices-India՚s historic macroeconomic vulnerability.

  5. Effect on market
    • Bond yields rose sharply, leading to an exceptionally marked steepening of the yield curve - even as stock prices continued to surge.
    • Evidently, markets expect rapid growth, which would warrant the run-up in stock prices, but are also pricing in some macro-balance concerns.
    • Even the ratings upgrade carried warnings of potential macro-economic challenges.
  6. Future action plans.
    • Despite major policy reforms and even in the absence of major new actions, the policy agenda remains full. Over the coming year, the government will need to focus on the 4 R՚s.
    • The government will also need to
    • stabilize GST implementation to remove uncertainty for exporters, facilitate easier compliance, and expand the tax base
    • privatize Air India;
    • stave off any nascent threats to macroeconomic stability, notably from persistently high oil prices, and sharp, disruptive corrections to elevated asset prices.
  7. Short-term effect
  • The world economy maintains its growth momentum, and oil prices do not persist at current levels, the Indian economy should resume converging towards its medium-term growth potential.
  • India would then regain its status as the fastest growing major economy

Overview-Medium Term

The problems faced in the medium term are

  1. Use of GST council 📝
    • India has created one of the most effective institutional mechanisms for cooperative federalism, the GST Council.
    • At a time when international events have been marked by a retreat into economic nativism and the attendant seizing of control Indian states and the center have offered up a refreshing counter-narrative, voluntarily choosing to relinquish and then pool sovereignty for a larger collective cause
    • 📝 Cooperative federalism is of course not a substitute for states՚ own efforts at furthering economic and social development, but it is a critical complement.
    • “cooperative federalism technology” of the GST Council could be used to
    • create a common agricultural market
    • integrate fragmented and inefficient electricity markets
    • solve interstate water disputes
    • implement direct benefit transfers (DBT)
    • make access to social benefits portable across states
    • combat air pollution
  2. Facilitating “exit”
    • The IBC resolution process could prove a valuable technology for tackling this long-standing problem in the Indian corporate sector.
    • Financial Resolution and Deposit Insurance (FRDI) bill would do the same for financial firms.
    • The IBC aims to solve the previous problems faced while ‘exit’ through the expedient of transparently auctioning off stressed firms to the highest bidders, excluding those which are toxically blemished.
    • Ensuring timetables and accepting bidding outcomes.
  3. Rationalize government resources
    • The poor need to be redirected away from subsidies towards public provision of essential private goods and services at low prices.
    • Progress has been made in providing bank accounts, cooking gas, housing, power, and toilets (amongst others) .
    • The pace and magnitude of this improvement will depend upon the extent to which increased physical availability/provision is converted into greater actual use:
    • toilet building into toilet use
    • bank accounts into financial inclusion
    • cooking gas connections into consistent gas offtake
    • village electrification into extensive household connections.
Chart of Gas Connections: Ujjwala

Stabilise fiscal and current accounts

  • India՚s fiscal and current accounts, both of which tend to deteriorate when oil prices rise.
  • Overcoming the fiscal vulnerability requires breaking the inertia of the tax-GDP ratio. It is striking that the center՚s tax-GDP ratio is no higher than it was in the 1980s, despite average economic growth of 6.5 % , the most rapid in India՚s history
  • There is evidence of a noteworthy increase in the number of tax filers in the demonetization-GST period
  • Overcoming the fiscal vulnerability also requires halting the steady conversion of contingent liabilities into actual ones, which has impeded progress in debt reduction even in the face of solid growth and apparently favorable debt dynamics.
  • Addressing the current account vulnerability requires raising the trajectory of export growth. Reviving manufacturing and making the sector internationally competitive have been the twin goals of the Make in India program.

Other Important Facts

  • The issue is that both competitive exchange rates and open capital accounts are helpful for growth. Changes in price competitiveness can make a major difference to export performance.
  • At the same time, open capital accounts attract foreign saving, providing additional funds for investment, which can help in growth.
  • Social and economic benefits to attacking corruption and weak governance.
    • Decision to ban promoters of firms with nonperforming loans from the IBC.
    • In the case of spectrum, coal, and renewables, auctions may have led to a winners՚ curse, whereby firms overbid for assets, leading to adverse consequences in each of the sectors; but they created transparency and avoided rents seeking with enormous benefits, actual and perceptional.
  • The role of markets and states, private capital and public institutions
  • To redistribute to check growing inequality and cushion against the impact of globalization.
  • Limitations on state capacity (center and states) affect the delivery of essential services such as health and education.
  • The private sector has always had to struggle with the stigma that came with being midwifed in the era of the license-quota-control Raj.
  • The IT boom that started in the 1990s, because the sector had developed on intrinsic competitive merit rather than proximity to government, had adopted exemplary governance standards, listed on international stock exchanges, and thrived in the global market place.
  • Healthy and educated individuals, with the ability to adapt and learn on an ongoing basis, need to be the core of the future labor force.
  • The two issues to be resolved are
  • Agriculture
  • Employment

Recent Developments

The Global Outlook: Baseline and Risks

  • In 2017, roughly three-quarters of countries experienced improvements in their growth rates, the highest share since 2010. The reasons why the recovery is spread throughout the globe is
  • Goods and services has finally emerged from its state of inactive.
  • commodity producers such as Russia, Brazil, and Saudi Arabia, which for the past few years been suffering from depressed prices, have benefitted from the upswing in demand.
  • Even as global growth and commodity prices have surged, inflation has remained remarkably quiescent.
  • Rapid growth, ultra-low interest rates-at a late stage in the economic cycle have produced the rarest of combinations: record-high high bond prices and stock market valuations, both at the same time.

📝 What Are the Risks Faced by the World Economy?

There are the usual geo-political and geo-economic risks:

  • war in the Korean peninsula
  • political upheaval in the Middle East
  • aggressive output cuts by Saudi Arabia (and Russia) in advance of the planned listing of the Saudi Arabian oil company, Aramco, which could force oil prices even higher
  • a final reckoning from China՚s unprecedented credit surge in the form of capital controls, slowdown in growth, and a sharply depreciating currency with consequences for the global economy
  • trade tensions that could lead to skirmishes, and then spiral out of control.
  • the main risks lie on the macrofinance front in advanced economies.

What is the Risk on Micro Finance Front in Advanced Economies?

  • Asset valuation (price-equity) tend to their mean and faster and higher they climb, especially so late in the economic cycle, the greater the risk of sharp correction.
  • Simultaneously high valuations of both bonds and equities tend to be briefly lived. If future earnings and economic growth are so bright, justifying high equity prices, interest rates cannot be forever so low, and if interest rates rise-or if markets even sense that the central banks need to shift their stance, both bond and equity prices could correct sharply.
  • The IMF is now forecasting that advanced country output gaps will close in 2018 for the first time since the Global Financial Crisis. As this occurs, wages would start rising, eating into profits (which would prick equity valuations) ; and as inflation rises in tandem, policy makers would be forced into raising rates, deflating bond valuations and further undermining share prices.

What Would Happen to Growth if Asset Prices Correct?

  • For one, a large decline in wealth would force advanced country consumers to cut back on their spending, which in turn would lead firms to curtail their investments.
  • The second being decline in asset prices.
  • Assessing future risks hinges on two calls: interest rate policy and asset valuations.

📝 Understanding India՚s (Temporary) “Decoupling”

Until early 2016, India՚s growth had been accelerating when growth in other countries was decelerating. But then the converse happened. The world economy embarked on a synchronous recovery, but India՚s GDP growth-and indeed a number of other indicators such as industrial production, credit, and investment-decelerated. The reasons for this are

  1. India՚s monetary conditions decoupled. This tightening of monetary conditions contributed to the divergence in economic activity in two ways. First, it depressed consumption and investment compared to that in other countries. Second, it attracted capital inflows.
  2. Demonetization temporarily reduced demand and hampered production, especially in the informal sector, which transacts mainly in cash.
  3. GST, affected supply chains, especially those in which small traders (who found it difficult to comply with the paperwork demands) were suppliers of intermediates to larger manufacturing companies.
  4. TBS and its effects have cumulated as the non-performing assets have increased the financial situation of stressed firms and banks have steadily worsened.
  5. Oil prices in the first three quarters of 2017 - 18 have been about 16 % greater in dollar terms than in the previous year.

What is the Outlook for 2017 - 18?

  1. Economic activity:
    • High frequency indicators do suggest that a robust recovery is taking hold as reflected in a variety of indicators, including overall GVA, manufacturing GVA, the IIP, gross capital formation and exports.
    • The re-acceleration of export growth to 13.6 % in the third quarter of FY2018 and deceleration of import growth to 13.1 % suggest that the demonetization and GST effects are receding. Services export and private remittances are also rebounding.
    • Fiscal factor to provide boost to aggregate demand.
    • Cyclical conditions may also lead to lower tax and non-tax revenues, which act as an automatic stabilizer.
    • Higher oil prices requires tighter monetary policy to meet the inflation target, real interest rates could exert a drag on consumption.
    • Putting all these factors together, a pick-up in growth to between 7 and 7.5 % in 2018 - 19 can be forecasted, re-instating India as the world՚s fastest growing major economy.
    • The biggest source of upside potential will be exports.
    • Persistently high oil prices (at current levels) remain a key risk.
    • One eventuality to guard against is a classic emerging market “sudden stall” induced by sharp corrections to elevated stock prices.
    • The current account deficit is well below the 3 % of GDP threshold beyond which vulnerability emerges.
    • Foreign exchange reserves have reached a record level of about $ 432 billion (spot and forward) at end-December
  2. Fiscal developments
  • Bond yields have increased sharply since August 2017, reflecting a variety of factors, including concerns that the fiscal deficit might be greater-than-budgeted, expectations of higher inflation, a rebound in activity that would narrow the output gap, and expectations of rate increases in the US.
  • The fiscal deficit for the first eight months of 2017 - 18 reached 112 % of the total for the year, far above the 89 % norm.
  • GST revenue collections are surprisingly robust given that these are early days of such a disruptive change.
  • The numbers imply a substantial increase in reported incomes (and hence in formalization) of about 1.5 % to 2.3 % of GDP. As a result of the budget overruns the central government՚s fiscal deficit until November 2017.
  • In contrast, state governments seem to be hewing closely to their targeted fiscal consolidation.
  • In the case of borrowing by the states, markets have perhaps inadequately taken into account the fact that higher market borrowings by them does not reflect higher deficits.
  • Another factor contributing to the rise in bond yields has been stepped-up Open Market Operations (OMO) by the RBI.

What is the Outlook for 2018 - 19?

  • If macro-economic stability is kept under control, the ongoing reforms are stabilized, and the world economy remains buoyant as today, growth could start recovering towards its medium term economic potential of at least 8 % .
  • The acceleration of global growth should in principle provide a solid boost to export demand.
  • If higher oil prices requires tighter monetary policy to meet the inflation target, real interest rates could exercise a drag on consumption.
  • Putting all these factors together, a pick-up in growth to between 7 and 7.5 % in 2018 - 19 can be forecasted.
  • The biggest source of upside potential will be exports.

What Would be the Testing Points?

  • Implementation of the IBC process. Here timeliness in resolution and acceptance of the IBC solutions.
  • Persistently high oil prices (at current levels) remain a key risk.
  • One eventuality to guard against is a classic emerging market “sudden stall” induced by sharp corrections to elevated stock prices.

- Published/Last Modified on: February 8, 2018


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