India faces tough external environment
By mid-year, India has realised that its economy is grossly under-performing, well below the expectations raised in the Union Budget for <g data-gr-id="70">fiscal year</g> 2016. However, the continuing fall in global oil and commodity prices has been a boon to India’s finances. Falling prices has enabled the containment of fiscal deficit within target (3.9 percent of GDP).
The Government is re-working its growth estimates from around 8 percent to between 7 and 7.5 percent. However, judging by the IMF’s World Economic Outlook, which articulates greater downside risks for emerging market and developing economies, the external environment for India could get worse.
The environment is one of declining commodity prices; reduced capital flows to emerging markets and pressure on their currencies, and increasing financial market volatility. Financial market turmoils and China’s abrupt slowdown and the Yuan devaluation in August had triggered more risks and vulnerabilities though India is confident of riding out any spillovers.
Nevertheless, India stands to lose from further weakening in global prospects due to a slower recovery in advanced economies than what was assumed earlier. A more gradual improvement in developed economies could reduce the “pull” from major economies thus affecting India’s exports, already on a low ebb.
With the first increase in U.S. policy rates approaching and a worsening of the global outlook, IMF says, financial conditions for emerging markets have tightened since the spring, especially in recent weeks. Relatively favorable output and price performance in the U.S. could soon justify an interest-rate increase, but the possible global repercussions, especially in emerging and developing economies, add to current uncertainties, according to IMF.
China’s shift from export- and- investment-led growth and manufacturing, in favor of a greater focus on consumption and services, has “near-term implications” for its growth and relations with trade partners, though it may not be of much significance for India. However, it is China’s slowdown and less demand that turned commodity prices downward over the last few years, with the fall accelerating recently. In moderating the negative impact of an uneven recovery in the world economy, IMF suggests raising both actual and potential output through a combination of demand support and structural reforms that should remain the economic policy priority. In advanced economies, accommodative monetary stance remains essential along with macroprudential policies to contain financial sector risks as needed.
For emerging market and developing economies, supporting demand and reducing vulnerabilities in the more challenging external environment poses difficult trade-offs, IMF notes. Typically, though India does not get a mention, the general remedy lies in structural reforms to raise productivity and urgently remove bottlenecks to production that could help countries to also diversify their export base.
For oil importers (like India), lower oil prices have reduced price pressures and external vulnerabilities, which will “ease the burden on monetary policy”. It is observed many emerging markets have increased their resilience to external shocks. Thanks to increased exchange rate flexibility, higher reserves, more reliance on FDI flows and stronger policy frameworks, many countries like India are now in a stronger position to manage heightened volatility.
But India, given its high level of corporate debt, in the wake of low-interest rates, must now prepare itself for higher interest rates. Despite differences in country-specific outlooks, the new forecasts mark down expected near-term growth marginally but nearly across the board for emerging market and developing economies.
Global real GDP grew at 3.4 percent last year and was forecast to grow at only 3.1 percent this year, but IMF expects growth to rebound to 3.6 percent next year. The current year’s lower projection is attributed to perceptions of downside risks appearing more pronounced that they did just a few months ago. Three factors cited in the Outlook for the downgrade are China’s troubled transition to a more consumption-led growth, fall in commodity prices which is on, and the impending increase in US interest rates.
The US Fed’s decision whether to begin the normalisation of monetary policy, with a lift-off in interest rates this year itself, will be known when the FOMC meets in the last week of October. Meanwhile, reports suggest that Fed may hold off action given relatively poorer job numbers in September and the rise in dollar holding down inflation, well below the Fed target of 2 percent.
Growth prospects in emerging markets and developing economies vary across countries and regions. But the outlook in 2015 is weakening, with growth for these economies as a group projected to decline from 4.6 percent in 2014 to 4.0 percent in 2015. However, the IMF expects a rebound in growth to 4.5 percent in these economies in 2016. Such a figure, it says, would reflect not a general recovery but partial normalisation for countries in economic contraction like Brazil, Russia, and others in Latin America and the Middle East.
Growth next year would also be helped by expected stronger pick-up in advanced economies as well as the easing of sanctions on Iran. As against this, IMF also points out financial and fiscal concerns and a risk of deflation that may afflict some countries. As policy advice, IMF urges monetary accommodation where output gaps are negative, supplemented by financial measures where fiscal space permits.
It makes a strong pitch for infrastructure investment at a time of very low long-term real interest rates. Higher investment is one way to enhance potential output growth, but targeted structural reforms can also play an important positive role to enhance future growth. Continued strengthening of micro- and macro-prudential policy frameworks will also support resilience to economic shocks, whether originating domestically or from abroad, the Outlook said.
On India, IMF and the World Bank have maintained growth estimate at 7.5 percent while ADB more recently lowered its estimate to 7.4 and 7.8 percent for 2015 and 2016. While the RBI had reduced 2015 estimate to 7.4 from 7.6 percent in its September 29 policy statement, Finance Minister Arun Jaitley is also less sanguine about the budgetary projection of a minimum of 8 percent and has said the economy would do better than in 2014/15 (7.3 percent).
Finance Ministry officials have been at pains to dispel the prevailing despair about the lack of robust recovery and asserted that the economy would register not less than 7.5 percent growth. With “strong” macro-fundamentals, reduced deficits and sizeable reserves, India would also handle better unforeseen external shocks.
Chief Economic Adviser Arvind Subramanian says a more precise revised estimate of growth would be made after the release of second quarter GDP results (November-end). An expected shortfall in direct tax receipts of 5 percent would be more than made up by increased indirect tax revenues, and the revenue and fiscal deficits would conform to budget estimates.
The government itself looks more to foreign direct investment and thus keeps talking of greater liberalisation of norms that would create conditions for attracting larger investment inflows. Meanwhile, the Finance Minister has urged domestic corporates to make investments following RBI’s rate cuts by 125 basis points and with inflation under control. Decision-making is now faster; public spending has increased, and reforms would be gone through, he asserts.
(The views expressed are strictly personal)