Around this time last year, the country was recovering from the shock of demonetisation. It created economic hardship, but was a political success. Around the country, two questions were routinely asked to people waiting in long queues at the bank branches or the ATMs. “Are you facing any hardship?” to which the answer was “yes”.“Is demonetisation good for the country?” to which many people said, “Yes, some big fish are going to be caught with black money”. This response didn’t change, and much of the credit for the success of the narrative goes to the personal credibility of the prime minister. As New Year approached, there was some trepidation about the economic uncertainty caused by the note ban, as also whether some bigger dhamaka, or shocker, was also being planned. There was talk of a big-bang move to eliminate benami ownership of property.
Compared to 12 months ago, the outlook for India’s economy is much more optimistic and there is much less uncertainty. The pain of demonetisation and the rollout of Goods and Services Tax (GST) are behind us. We did see that after five successive quarters of decline, the July to September GDP data turned upward. The teething trouble of GST implementation is being speedily addressed by the GST council.Rates are being reduced, and slabs may be reduced, implying less scope for misclassification, discretion or disputes. A new panel has been set up for reforming the Direct Taxes, which will presumably advocate lower tax rates, fewer exemptions and a wider tax net. The recommendations of the Fiscal Responsibility and Budget Management Committee are also likely to be accepted, in terms of a target debt to GDP ratio and a time path to reducing the revenue deficit to zero. A new Finance Commission has been appointed, the first in the post-GST era.
The commission’s recommendations will apply to the five-year period commencing 1 April 2020, and its terms of reference also include (for the first time) issues like promoting the digital economy, ease of doing business in states, and direct benefit transfers. The new Bankruptcy and Insolvency Code is in full operation, and some big company delinquencies are being tackled, in a rule-bound and transparent way. All these reforms will pay dividends in the medium term.The most significant thing at the onset of 2018 is the global economy outlook. For the first time in more than six years, the latest projections of the International Monetary Fund (IMF) have been revised upward. The pattern for the past several years has been that IMF projects growth rates in January; these are progressively revised downward every three months. For the first time, the IMF is more optimistic than 11 months ago. This upward revision applies to North America, Europe, China, Japan and East Asia. Even Brazil, beset with economic and political problems, is expected to do better.
China’s 13th five-year plan, currently in progress, aims for an average growth rate of 6.5 per cent, slower than their previous four plans. This slowdown is deliberate, as the economy adjusts to a newer balance between industry and services, between exports and domestic, between investment and consumption, and between the old and the new economy. But the actual performance has exceeded 6.8 per cent in the most recent data. The improved sentiment for the global economy is good news for India’s exporting and manufacturing sectors.
This brings us to the India- specific situation. The economy already got a thumbs up from a ratings upgrade by Moody’s and an improved rank by the World Bank on the ease of doing business. Thus the external positive perception remains strong. There is certain optimism that the GDP trajectory will move upward, perhaps not too rapidly. Early signs of a pick-up in bank credit, and sharply improved export performance in November are good signs.
The increased spending on infrastructure and the various policy enablers to give a big push to affordable housing are sure to kick up demand. As 2018 will be the last Budget before the 2019 general elections, it is expected to provide fiscal fuel to growth. One of the lessons of the Gujarat polls, to be applied nationwide, is the focus on agriculture. How creatively the Budget achieves this without bending the fiscal rules too much is to be seen.
The main challenges come from rising oil prices and fiscal pressures. Unlike two years ago, the Centre can no longer count on an oil bonanza to help with reduced oil subsidies, reduced trade deficit and lower inflation. On these counts, the pressure will be in the opposite direction. The fiscal deficit is already expected to exceed this year’s target.
The states’ situation is more worrying. Many have taken on extra obligations like loan waivers and reduction in petrol excise. Besides, the GST council has to deal with compensation to the states, to meet collection shortfall. In a growing economy, higher fiscal deficits are usually tolerable, especially if they go toward capital spending. But India’s debt servicing ratio is not too comfortable, largely because the tax-to-GDP ratio is too low.
So a hawk-like caution about fiscal spending is always welcome. Fiscal resources will also be needed to help exports, which have been hit badly by GST (the refund delay), and by a strong exchange rate. The inflation rate is inching up, reducing the scope for any more rate cuts by the RBI. Private sector capital spending which partly depends on the interest rate cycle, will have to factor in the absence of a rate cut.
Despite the challenges, the economy is on an upswing, thanks to structural reforms, accommodating fiscal stance, a somewhat buoyant global economy, and improving consumer and investor confidence. So, the stage seems set for a happy and prosperous 2018.