Reforms drag amid growing tensions

The Modi Government, with its majoritarian streaks, looks increasingly vulnerable to political pressures after 19 months in office. Another session  of the Parliament went virtually ineffective, pushing more burdens of governance and unfinished reforms into the new year. 2015 also saw the “Modi charisma” take a dent with his party’s rout in Bihar

The Prime Minister revels in globe-trotting which helps him forge stronger bilateral economic and strategic relationships, but India, strutting about as a global power, is equally called upon to share global responsibilities. One moment of truth was the Paris Accord on climate change with obligations to cut carbon emissions without exceptions as India also falls in the category of polluters, however low the levels.

But at the other, year-end WTO Ministerial Conference in Nairobi, India and developing countries saw a fierce revival of the North-South conflict when developed countries led by USA tried to bring the 15-year old Doha Development Round to an unceremonious end. India had to fight hard to ensure two issues of vital concern for it – safeguard mechanism against export surges, and public stockholding for food security – were preserved though would have to be negotiated on details at WTO rounds.

2016 promises to be a year of even greater challenges than the outgoing twelve months which saw a semblance of macroeconomic stability but little added growth of the economy in real terms, over the previous year, with the result of the mid-year review (2015-16) lowers it to 7 to 7.5 percent in real GDP. Nor the review is sanguine about growth above this level in the coming year. That CPI inflation is likely to be within RBI target of about 6 percent may prove to be illusory, given fiscal challenges ahead in the Budget 2016-17. In any case, as more cash goes out in wages and salaries at government and corporate levels, even as demand may pick up, inflation catches on, to make RBI wary of any further easing in the near future, especially in the context of US Fed moves on rates in 2016.

RBI points out in its Financial Stability Report that while US Fed’s first rate hike of 25 basis points appeared to have been factored in by the markets, the pace of further increases may have a significant bearing on market behaviour. This along with the developments in China and sluggish global trade growth would “define the global economy going forward”. Increased volatility in financial markets and further slowdown in global trade could also be expected.

While Finance Minister Arun Jaitley continues to be optimistic about holding down fiscal deficit at the budgeted 3.9 percent of GDP, India’s current account balance has benefitted from the fall in crude oil prices and reduction in gold imports. The CAD was -1.4 per cent of GDP only in the first half of 2015/16. But in a situation where both domestic demand and private investment are not picking up,  RBI says attracting robust capital flows to finance the current account deficit would require a continuous thrust on structural reforms and improving the ease of doing business.

The crucial role of public investment in the current economic situation, with debt-burdened corporate sector unable to add to capital expenditure, gains focus in both the Finance Ministry’s review as well as the latest RBI report. Despite improved macroeconomic fundamentals, sluggishness in domestic demand and private investment call for higher public investment at a time when government is committed to fiscal consolidation. The weaknesses in external demand has adversely affected exports even though the current account deficit as a percentage to GDP has remained at comfortable levels.

With the economy showing “mixed signals”, the FM review raises the question of Government being able to adhere to the earlier road map of lowering fiscal deficit by a further 0.4 per cent in 2016-17. Indeed, with the changing macroeconomic situation, especially the fall in nominal GDP growth, the determinant of budget arithmetic, the Chief Economic Adviser has raised the question of review of the medium-term fiscal framework.”  If it involves a pro-cyclical fiscal policy, such a fiscal strategy has to take account of credibility issues that might arise.

These doubts arise in the context of the 7th Pay Commission and additional pension layouts, a possible decline in subsidies f oil prices move up. A continuous thrust on structural reforms has been emphasised in both reports. These call also for “unambiguous” policy stance, especially in tax matters, and improving the ease of doing business.

The FM Review chimes in with a call for clean-up of legacy of tax issues and continued supply side reforms. The listed priorities include possible implementation in 2016 of the aborted GST and a Bankruptcy law. While the financial system remains stable, according to the RBI, declining corporate profitability, high leverage and low debt servicing capacity continue to cause concern with their adverse impact on the financial sector. The hope is that a better monsoon could give some impetus to rural consumption. Besides erratic climatic conditions, challenges in economic management include limited policy space, weak corporate performance, stressed asset quality of financial institutions and low investment growth. Undoubtedly, the Modi Government will come under greater pressures in 2016 what with more state elections in mid-2016.

Whatever be the economic fundamentals of the economy and relatively fast-growing in relation to other emerging economies, India’s growth in fiscal 2017, as in current year, is likely to be fuelled mainly by private consumption and government investment.   Domestic demand and private investment are still not picking up, underscoring the need to step up public investments while export weakness also keeps the economy less buoyant. It is in this context that the Modi Government’s third budget would be unveiled at the end of February and there may be huge surprises in terms of resource mobilisation.

With elections due by mid-2016 in West Bengal, Tamil Nadu and Kerala,  Modi is expected to play his card such that his party does not fare too badly in states where BJP wants to create a new and enlarged base, if not immediate hold on power. This is because of negative signals that have come for the party from by-elections and local body elections in some of the states including Gujarat.  IPA