Morale boost for Indian economy
The Modi Government looks set to improve upon its mixed record in growth and reform thus far, as the economy enters the crucial second half of fiscal 2017, gaining from a good monsoon and outcomes awaited from a set of effective policy actions taken.
Additional comfort for the Government must come from the recent “surgical strikes” across LOC, however, nebulous the dimensions thereof are, which have helped to create greater confidence, in the aftermath of Uri incident of September 18, in our ability to safeguard effectively our borders against incursions by Pakistan-based militants.
For its part, IMF has marginally revised up its July GDP projection of 7.4 percent to 7.6 percent for both 2016 and 2017 (at market prices) and has noted India’s “robust growth” and status as the fastest-growing economy which, along with rebalancing China, sustain global growth in a world of subdued demand. But it has a large agenda for deliverables by India.
In its World Economic Outlook (WEO), prior to annual Fund-Bank meetings, IMF estimates the weakened world economy to grow at 3.1 percent in 2016 (in PPP terms and 2.4 percent at market-based exchange rates) while global trade growth on deceleration may be less than 2 percent in 2016. The trade decline is attributed to both lack of investments globally and a rise in protectionist trends.
Among advanced economies, WEO reports a loss of momentum in US growth with weakness in non-residential and fixed investment, especially in the energy sector, though consumption has remained strong and labour market (employment) holds firm. The projected rise in global growth to 3.4 percent in 2017 thus hinges crucially on the rise in growth in emerging and other developing economies, and recovery in the US, IMF says.
Prospects differ sharply across countries and regions, with emerging Asia in general and India, in particular, showing robust growth and sub-Saharan Africa experiencing a sharp slowdown. Inflation in emerging market and developing economies is steady and capital flows into emerging markets have recovered since February, according to WEO.
China, the world’s second-largest economy, now rebalancing, is expected to grow by 6.6 percent in 2016 and slow to 6.2 percent in 2017 absent further stimulus. IMF cautions on spillovers from China’s economy impacting on trade and global commodity prices. With its bigger global role, it is important for China to address internal imbalances to approach smoothly a sustainable consumption- and service-oriented growth, IMF said,
Devoting a large section in its narration for India, WEO notes GDP will continue to expand at the fastest pace among major economies. The 7.6 percent growth is assumed from “large terms-of-trade gains, positive policy actions, structural reforms” including GST, and adoption of the inflation-targeting framework.
Improved confidence is expected to support consumer demand and investment, but, in the near term, private investment will likely be constrained by weakened corporate and public sector bank balance sheets.
While India has benefited from the large terms of trade gain triggered by lower commodity prices and inflation has declined, underlying pressures arising from bottlenecks in food storage and distribution sector point to the need for further structural reforms to ensure CPI inflation remains within the target band over the medium term.
IMF estimates CPI to hover at 5.5 percent in 2016 (as against 4.9 percent in 2015) and lower to 5.2 percent in 2017. A slight increase, however, is projected in current account deficit from -1.1 percent of GDP in 2015 to -1.4 percent in 2016 and to -2.0 percent in 2017, possibly on the assumption of a larger turnover in trade and financial flows both ways.
The WEO said important policy actions taken toward GST implementation would be positive for investment and growth. This tax reform and the elimination of poorly targeted subsidies are needed to widen the revenue base and “expand the fiscal envelope to support investment in infrastructure, education, and health care”.
The Outlook also calls for additional measures to enhance efficiency in the mining sector and increase electricity generation to boost productive capacity. “Additional labour market reforms to reduce rigidities are essential for maximising the employment potential of the demographic dividend and making growth more inclusive.”
On public sector banks, IMF has urged continued efforts by the Reserve Bank of India to strengthen bank balance sheets through full recognition of losses and increasing bank capital buffers which are “critical for improving the quality of domestic financial intermediation”.
In other major emerging economies, both Russia and Brazil remain in contraction in 2016 for the second year but now seem closer to exit recession and register modest growth in 2017 with Russia at 1.8 percent and Brazil at 0.5 percent.
Apart from the subdued outlook for advanced economies with uncertainty surrounding the UK vote to leave EU and expected reduction in trade and financial flows between UK and EU over the medium term, IMF also refers to growing economic, political, and institutional uncertainty adding to global pressures for populist and inward-looking policies.
The Brexit vote and the ongoing U.S. Presidential election campaign have highlighted “a fraying consensus” about the benefits of cross-border economic integration. “Concerns about the impact of foreign competition on jobs and wages in a context of weak growth have enhanced the appeal of protectionist policy approaches, with potential ramifications for global trade flows and integration more broadly.”, WEO recorded in its new appraisal of negative global trends.
Concerns about unequal (and widening) income distribution are rising, fueled by weak income growth as productivity dynamics remain disappointing, it said. Uncertainty about the evolution of these trends may lead firms to defer investment and hiring decisions, thus slowing near-term activity, while an inward-looking policy shift could also stoke further cross-border political discord.
IMF Economic Counsellor Maurice Obstfeld says in a forward to WEO that in general, centrifugal political forces across the European continent are making it harder to advance or even maintain economic reforms. Similar tensions afflict the U.S. political scene, where anti-immigrant and anti-trade rhetoric have been prominent from the start of the current Presidential election round. Across the world, protectionist trade measures have been on the rise.
An instant rate cut by the new monetary authority
The newly constituted Monetary Policy Committee (MPC) at its first meeting has announced a repo rate cut, from 6.5 to 6.25 percent, to facilitate the revival of credit to productive sectors with improving growth prospects post a normal monsoon.
In this first MPC policy review since Dr Urjit Patel took over as Governor and also, the fourth bi-monthly for the current fiscal year, the decision on rate cut was unanimous by the six-member Monetary Policy Committee. The repo rate cut takes immediate effect.
MPC has taken a robust view of the outlook for growth in fiscal 2017 after a normal monsoon and an expected surge in consumption demand with the pay revisions.
The RBI announcement said with repo rate reduction, the reverse repo rate under the LAF stands adjusted to 5.75 percent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75 percent.
The decision of the MPC, the statement added, is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 percent by March 2017 and the medium-term target of 4 percent within a band of +/- 2 percent.
The repo rate had been held at 6.5 percent for several months by the former Governor Dr Raghuram Rajan on the basis of inflation trends, in the Central bank’s disinflation trajectory. But Dr Rajan had maintained an accommodative stance after a series of rate cuts totalling 150 basis points.
However, the transmission of these cuts to borrowers had been lagging depriving them the benefit of lower lending rate. The MPC now envisages a trajectory taking headline CPI inflation towards a central tendency of 5 percent by March 2017, with risks tilted to the upside albeit lower than in the second and third bimonthly monetary policy statements of June and August respectively.
Growth momentum is expected to quicken with a normal monsoon raising agricultural growth and rural demand, as well as by the stimulus to the urban consumption spending from the pay commission’s award.
The accommodative stance of monetary policy and comfortable liquidity conditions should support a revival of credit to the productive sectors.
However, the continuing sluggishness in world trade and smaller terms of trade gains than in the past point to a further slackening of external demand going forward. Accordingly, the projection of growth of real gross value added (GVA) for 2016-17 is retained at 7.6 percent, with risks evenly balanced around it.
MPC expects “the strong improvement in sowing, along with supply management measures, will improve the food inflation outlook.”
It noted that the “sharp drop in inflation reflects a downward shift in the momentum of food inflation – which holds the key to future inflation outcomes – rather than merely the statistical effects of a favourable base effect”.
The Government, MPC notes, has announced several measures to cool food inflation pressures, especially with regard to pulses. These measures should help in moderating the momentum of food inflation in the months ahead. This has opened up space for policy action, as indicated in the third bi-monthly monetary policy statement.
Easy liquidity conditions engendered by the Reserve Bank’s operations should also enable the smooth transmission of the policy action through various market segments. Furthermore, MPC said, banks should find added impetus for better transmission by the recent downward adjustment in small savings rates.
The only note of caution in the resolution was potential cost push pressures that may emerge, including the 7th pay commission award on house rent allowances, and the increase in minimum wages with possible spillovers through minimum support prices. “The fuller play of these factors will need vigilance to prevent a generalised cost spiral from taking root,” it said.
(The views expressed are strictly personal.)