Economy drifts despite FM’s claims

Maintaining his majoritarian assertiveness intact, Prime Minister Narendra Modi has retreated on land acquisition law, under political compulsions, to ensure a “farmer-friendly” image for his government. It is a confession of his government’s botched moves to promote a law with inadequate farmer safeguards, by a series of ordinances, in the face of country-wide resistance.

It is no wonder that with his poll pre-occupations in Bihar currently, Modi chose discretion better part of valour. However, as the leader of the Lok Sabha enjoying supremacy, Modi failed to use his skills to build a more co-operative government-opposition culture in Parliament. If he had, Modi would have not only helped to restore the image of parliamentary <g data-gr-id="57">democracy,</g> but also smoothened the way for some of his reforms, especially GST, to be put through.

To add to the Modi government’s problems, there is a rise in agitations across the country, particularly from the Patidar community in Gujarat led by young Hardik Patel. The agitation has been somewhat of a shock for Modi himself, besides the long drawn-out veterans’ protests for One Rank One Pension (OROP). The government’s attempts to carry out labour market reforms are stranded by a determined opposition of almost all trade unions with a call for a countrywide strike on September 2.

 

The economy, undergoing a slow recovery, is facing more challenges than perceived at the beginning of the year, and these have been highlighted in last week’s Annual Report of the Reserve Bank of India. The monsoon will again be below normal, it is now official, and large parts of Northern India including Bihar would miss the timely rainfall, which influences agricultural fortunes.

Rural distress from last year’s poor monsoon would get accentuated. The BJP-led government would now be forced to get cracking with anti-drought relief measures on a larger scale, focusing more on agricultural revival than its much-touted reform agenda. Finance Minister Arun Jaitley with daily utterances keeps the flag for 8 percent growth flying but ignores some intractable domestic structural constraints.

In addition to these structural constraints, a global crisis has re-emerged, emanating from China’s devaluation and its unpredictable set of policies in the weeks to come. (China is trying to ride two horses at the same time – get SDR status for its devalued Yuan and keep easing monetary and fiscal policies as necessary to save growth at not less than 7 percent in 2015 while stabilising the volatile Shanghai market.) 

While China may get away saying the new crisis is not from its devaluation but due to global factors, the fall-out from Beijing’s unpredictable moves becomes worldwide. Being the second largest economy and principal growth engine, there are fears of a hard landing in China.  China’s sharp slowdown has triggered tremors in global markets and had also led to further falls in prices of key 

commodities it depended on for its rapid growth. 

The concerns relate to both its banking system and the huge pile of debt it has accumulated after the massive stimulus of the past. India prides itself as being the only country better placed to meet any spillovers, let alone the negative consequences it has to bear in terms of rupee exchange rate and further loss of export momentum.

And with 8 to 9 percent growth, Jaitley says, India can replace China as the driver of the world economy. India’s growth constraints are mainly domestic, as detailed in the RBI annual report. Externally, India has a cushion to overcome any spillovers, with reserves of the order of 355 billion dollars, largely capital inflows including NRI deposits. External debt has risen over the last two years to 475 billion dollars by March 2015. Going forward, RBI sees current account deficits being held at sustainable levels with an estimated 1.5 percent of GDP in 2015/16. 

The government is on course to limit fiscal deficit and in fact Jaitley says it can spend more on social programmes with buoyant indirect tax revenues. The RBI assessment says with fiscal consolidation firmly underway and, given business optimism, the stage is now set for “unshackling stalled investments and for boosting new capital spending in order to accelerate the pace of growth”. 

Finance Ministry officials, taking a cue from Jaitley, have been egging on RBI Governor Dr Raghuram Rajan for a rate cut to revive economic growth prospects. The Governor says RBI continues with its monetary accommodation policy but would await data on inflation to make certain that disinflation continues along with higher growth. He has not ruled out cuts that would be data-dependent, he told his interviewers. 

Importantly, the RBI said in its report, resolute actions are needed to ease stress in financial assets, mitigate/resolve debt burdens so that stranded assets are put back to work quickly wherever feasible, and capital buffers are built to enable financial intermediaries to provide adequate flow of credit to productive sectors.

As the initiatives announced in the Union Budget to boost investment in infrastructure roll out, they should crowd in private investment and revive consumer sentiment, especially as inflation ebbs, the report noted. It urged early actions on disinvestment budgeted for and on strengthening the banking system to rid it of its current weaknesses.

To ease constraints in doing business cited by investors, RBI said significant changes are required in the legal and regulatory environment, labour market reforms, tax regime and administrative procedures. Emerging markets do not expect capital flows of the levels of recent years, as the developed countries gradually move away from monetary accommodation.

The outlook for capital flows is highly uncertain, with the widely anticipated normalisation of US monetary policy shortly. The US Federal Reserve meets on September 17-18 to determine the timing of the first rate increase in the Federal Funds rate held at near zero since 2008.  Any decision on a rise in US interest rates could generate capital outflows from emerging markets and also harden financing conditions as bond yields rise, according to analysts.