The International Monetary Fund has cut the global growth forecast and now expects the world economy to expand by 3.4 % in 2016. This is 0.2% below its forecast of October 2015. The revision has come just as Beijing released numbers that showed China posting the slowest growth yet in 25 years. Though it reported a growth of 6.9% in 2015, the year saw turbulence in the Chinese economy, with heavy capital outflows and stock market volatility. The IMF has kept its growth forecast for China unchanged at 6.3% in 2016, and the fear is that China’s economic slowdown could have a trigger effect on others.
Image source: IMF World Economic Outlook
Among the countries coming under the Brazil, Russia, India, China, South Africa (BRICS) bloc, only India has shown a good performance. Among developed nations nnly US is showing improved performance. The recent decision to hike the policy rate by the Fed is some indication that monetary policymakers believe that the U.S. economy is on a recovery path. It is, however, to be remembered that the Fed has not yet relaxed its accommodative posture, which indicates that the recovery is fragile. Oil prices are not expected to rise, which means that oil-producing countries will continue to be in a limbo. Among the developing economies, concerns about the performance of China will continue. If anything, China’s growth rate will further decline.
While the improved performance of the U.S. is a helpful factor, the rise in interest rate may have its own effects on capital flows to developing economies. As a consequence, financial markets may see greater volatility. Among the emerging economies, the slowdown in the performance of China and the consequent further devaluation of yuan may have serious spillover effects. Thus, the picture, as a whole, does not look very encouraging.
In years 2004-12 Indian economy expanded at fast clip of CAGR more than 8% per annum it was driven by four economic drivers – public investment, private investment, private consumption and exports. Out of these four drivers investment after reaching high of 38% in 2008 has declined precipitously, while current govt is trying to revive it by projecting business friendly image and trying to pass crucial legislation like GST and encouraging state govt. to work on reforms like labour and land acquisition. However suffering from global headwinds the economy refuses to grow at higher clip to generate millions of jobs which India needs to reap its demographic dividend.
The mid-year economic analysis estimates India’s growth rate in 2015-16 to be between 7 -7.5%. Looking at the performance from the supply side, in agriculture, the growth rate may not be higher than the previous year which itself was low. The erratic weather in 2015 does not hold out much promise for 2015-16. This lower than estimated growth, inching up of retail inflation and declining IIP data has given rise to fears of stagflation in India.
Positive factor for Indian economy: Oil Boost and positive performance vis-a vis other emerging countries
Internationally crude oil prices have collapsed to the delight of importing nations like India and to the consternation of oil exporters like Saudi Arabia, Russia. Primary reason behind this spectacular collapse from $110 in Jun 2014 to current $28 per barrel is – increase in supply due to advent of Shale oil producers in US and weak economic growth outlook mainly due to weak Chinese data.
Collapse in oil prices has been the biggest driver of growth for India economy, boosting it by more than 1% in 2015-16 by increasing household purchasing power, improving corporate margins, and creating budgetary space to increase expenditures .
However, that this is a one-time boost because it’s the change in oil prices — not their level — that creates the growth dividend. To the extent that oil stabilises, India will lose this growth dividend next year. There could be offsets, as a normal monsoon could boost rural demand.
Oil producing nations primarily GCC countries are big source of remittance as they host more than 7 million India expatriate workers. With their economy slowing due to fall in crude price some belt tightening and consequent effect on migrant workers from India is expected. Moreover these countries are destination for majority of exports from India hence with their economy slowing their won’t be any respite for decreasing Indian exports.
Private consumption in automobiles is picking up partly because of the benefit accruing to consumers due to the fall in petroleum prices. The consumption goods sector of IIP has done well. Public sector investment has shown a rise. Capital expenditure of the Central government during the period April-October 2015 rose by 31%. However, it must be noted that bulk of the public investment came from the public sector enterprises.
India’s economic profile has grown compared to other countries as it has been anointed as fastest growing major economy of the world for current fiscal year. However this being attractive but is not helping to attract investment as the international fund keep withdrawing from emerging market due to increase in risk factor to safer haven of US treasury bonds regardless of India’s individual attractiveness. But with sound macro economic fundamentals and high growth rate India would attract investments afresh once the exodus of international funds stops.
Growth drivers slowing down
Out of India’s four growth four drivers – public investment, private sector investment, exports and private consumption. Two key drivers, the export markets and the private consumption are slowing or contracting. Global trade growth has been roiled by China’s slowdown and yuan’s depreciation, while back-to-back deficient monsoons have sapped rural consumption capacity.
Basic goods and capital goods – proxies for manufacturing and investment demand – contracted 0.7% and 24.4%, respectively. Nikkei India Manufacturing Purchasing Managers’ Index, where the survey revealed a drop in output in December when companies scaled back production on a decline in new orders. According to economists except few bright spots like automobiles and consumer durables, demand is precariously placed.
Indian exports have declined consecutively for 13 months thus making a record which has not been seen since 1952-53. An emerging economy such as India needs to expand international trade to sustain 7-8% growth. At present, exports contribute only 16 %to India’s GDP — low compared to peers such as China (34%), South Africa (27%) and Indonesia (26%).
In the services sector, the growth rate may not be much different from that of the previous year. Performance of exports, has been weak. Overall, exports during the period of April-October declined by 17.6%. Much of this is due to the decline in the export of petroleum products, by more than 50%. However, non-oil exports also declined by 8.7% during this period. This does not auger well for many industries.
Government is mulling stepping public expenditure in capital assets creation to jump start economy. This policy is borrowing a page from keynesian economics which envisages governmenta expenditure to create growth, employment which itself wouold encourage private investment. Under this policy Indian railways is envisaging mammoth Rs. 8.5 lakh crore capital expenditure. Such mammoth expenditure would create infrastructure like Dedicated Freight Corridor, High Speed Railway among others. Railways have high backward and forward linkages with the economy hence this large investment is expected to have positive impact on the economy.
The policy stance of keeping the fiscal deficit constant and expecting an improvement in public investment to emerge from effective expenditure and implementation has been suggested by Chief Economic Advisor Arvind Subramaniam in mid year review of economy. Fiscal consolidation been tried for a number of quarters and has failed, because of which manufacturing growth has suffered. Together with the difficulties in agriculture, this means growth possibilities lie around the 6% rather than the 7 %+, which most economists believe India is capable of achieving.
Critics of public investment model
Government is cautioned against fiscally expansion by admirers of the Washington Consensus who argue against an expansionary budget on grounds that fiscal consolidation will be damaged. India’s fiscal consolidation programme is based on norms drawn from the European Union (EU). If fiscal deficit (currently estimated to be on target of 3.5% of GDP) is breached by higher government spending there is possibility of crowding out of private investment by govt. debt and this would perpetuate the already lower private sector investment in the country.
Public investment alone inadequate
India’s investment rate has declined precipitously from 38% in 2008 to 28% in FY 2014. This fall in investment is chiefly due to withdrawal of private investment who have been scared away from market by low gross capital formation (low profits due to economic slowdown), or suffering from lack of financial closure due to earlier over optimist revenue projection. This slowdown is in private investment is markedly higher in infrastructure sector like roads, airports and power plants.
Here the crux of matter is vicious circle – economic slowdown forcing infrastructure projects to return lower than estimates hence difficulty in servicing debts, this in turn is raising NPA of banks (primarily public sector) which are now getting shy of lending hence perpetuating the downturn in economy.
It leaves government in catch-22 situation where it needs to spend more in capital expenditure (creation of assets like roads, power plants etc) to raise economic growth and hence create more jobs and eventually raise its financial position by tax buoyancy. However since its finance are strained due to slowdown such action would need fiscally expansionary steps which can crowd out already lower private investments and worsen country’s finances and economic outlook in short term.
Seventh Pay Commission burden
The fiscal picture for 2016 however is going to be difficult as additional burden imposed by the Seventh Pay Commission is substantial. The expenditure on pay and pension will increase by 20% and it will amount to a burden of 0.4% of GDP, after taking into account the additional tax revenue on the increased emoluments. Economic experts are already calling for delaying the seventh commission award by a year to delay the fiscal impact.
Indian international trade suffers from both tariff and non-tariff barriers. Implementation of sound trade facilitation policies for low trade and transaction costs would lower non-tariff barriers and would attract investors to make in India and consider it making their manufacturing hub. Given the recent push to sign the WTO Trade Facilitation Agreement, which is estimated to create 18 million jobs in developing countries, mostly in India, trade facilitation measures need to be put in place.
India spends nearly 2% of GDP on subsidy regime of which a substantial part is lost to leakage and corruption. Political parties are reluctant to review the subsidy regime. Resolving the subsidy regime through targeted cash transfers can address some of the issue of fiscal discipline of government.
Other way to generate resources is divestment of public sector. It is estimated that by selling its non strategic stake in companies government can raise up to 0.35% of GDP thus leading the way to fiscal consolidation of Indian economy. However prompted by lower market prices govt. reluctant to divest. Moreover there is strident opposition from unions against strategic sales. Due to this govt has fallen behind its own target of raising resources from divestment every year in last 15 years except twice.
There can be no intrinsic argument against the government selling some assets only to acquire others. It can be beneficial for growth and employment, and therefore for welfare. For reforming subsidy regime as govt. is already highlighting that move is towards better delivery rather than curtailing the subsidy itself needs to be both better communicated to public and implemented faster for consolidation of fiscal resources for growth.
References <http://www.thehindu.com/opinion/lead/improve-the-investment-climate/article8093167.ece?ref=sliderNews>, <http://www.thehindu.com/opinion/editorial/stagflation-risk-ahead/article8108426.ece?homepage=true>, <http://www.thehindubusinessline.com/opinion/our-logistics-are-a-major-trade-barrier/article8120891.ece?homepage=true>, <http://www.thehindu.com/opinion/editorial/dealing-with-the-slowdown-with-global-growth-forecast/article8130655.ece?homepage=true>, <http://www.thehindubusinessline.com/opinion/the-economy-urgently-requires-a-stimulus/article8130654.ece?homepage=true>, <http://www.thehindu.com/opinion/lead/indian-economy-growth-public-investment-crucial-for-a-new-normal/article8148229.ece>, <http://indianexpress.com/article/opinion/columns/sell-to-spend/>, RSTV debates, <http://www.economist.com/news/leaders/21688854-low-energy-prices-ought-be-shot-arm-economy-think-again-whos-afraid-cheap>