An increase in the frequency of global event risks and the resultant slowdown in demand has tripped growth in most emerging markets, including Asia. The International Monetary Fund estimates that world GDP growth will slow from 4.8 per cent in 2010-11 to 3.1 per cent this year. China continues to decelerate, while the Brexit vote has clouded growth prospects in the UK and Europe.

In the midst of these headwinds, domestic cushions are expected to shield India’s growth. The economy expanded 7.6 per cent year-on-year in 2015-16 from 7.3 per cent the year before. Consumption spending (primarily urban demand) and public investment emerged as the main drivers, while private sector interests stayed sluggish amidst a challenging external sector. Exports fell 16 straight months to March 2016, and offset the benefit from a narrower commodities’ import bill.

Growth is likely to improve to 7.8 per cent in 2016-17 on the same dynamics. Private consumption is, in fact, likely to play a bigger role in boosting growth this year due to higher wages and rural spending. Public capital spending will be constrained by fiscal targets, while private sector participation remains weak. More importantly, there are two catalysts — an increase in public sector wages/pensions and a strong monsoon — that will provide timely tailwinds to domestic demand. While a return to consumption-driven growth is not without risks, we do not expect price pressures to run amok as in the past.

The Centre approved the Seventh Pay Commission proposals this month and raised public sector wages and pensions by 16 per cent and 23.6 per cent, respectively. An increase in allowances, including those for housing rents, was, however, deferred. As witnessed during the past pay commissions, demand for consumer durables and non-durables is likely to improve. Demand was notably stronger during the Sixth Pay Commission payouts in 2008-09 but this was due to the accompanying fiscal stimulus packages implemented to cushion the economy from the global financial crisis.

Higher wages/pensions will be a catalyst for private discretionary spending this year, but the boost to spending will be lower than in the case of the Sixth Pay Commission. Incomes are under pressure from a weak manufacturing/industrial sector, sluggish external sector and excess capacity. On the fiscal front, the Budget had already made room for a partial implementation of the pay commission proposals. With indirect tax collections robust to date and increasing its weightage in the overall revenue mix, we do not see the risk of a large fiscal slippage. But state finances might deteriorate slightly which will keep India’s cumulative (Central and State) fiscal deficit high at more than 6 per cent of GDP this year, above most of its peers with similar debt ratings.

Monsoon momentum

The southwest monsoon got off to a slow start in June but improved strongly in early July. This momentum needs to continue right through August, since monsoon foodgrain crop accounts for half the annual production. Rural wages are likely to get a welcome boost from strong rainfall. Incomes had suffered in the wake of two successive below-normal rains and modest increases in minimum support prices.

Farm output fell 1.7 per cent YoY in the last two fiscal years. Minimum support prices for agricultural produce were raised by a slower 4 per cent in the past two years, down from 12 per cent in 2012-13. These factors depressed rural wage increases to 5 per cent last year compared with over 15 per cent three years back.

Interestingly, the agricultural sector has become more resilient to the weather. The share of horticulture ( fruits, vegetables, spices) has increased to over a third of total farm output.

More importantly, horticulture exceeded foodgrain production for three successive years. In spite of sub-normal rains in ten out of the past fifteen years, horticulture output experienced only one year of decline. Even as real-time strength of rain might not be crucial for horticulture and other irrigated areas, timely replenishment of reservoir levels and availability of ground water would depend on this year’s rainfall. These are running below last year’s averages but are making gradual progress.

As of July 6, storage in the reservoirs was at 18 per cent of live storage capacity, amounting to 55 per cent of the storage of the same period last year, up from 48 per cent in late June. Things are moving in the right direction for the agricultural sector as far as this year’s southwest monsoon is concerned. With the pace of pick-up in farm output likely to double this year, GVA (gross value added) growth is poised to rise 7.6 per cent from 7.2 per cent in FY16.

Risks remain

Consumption-driven growth is, however, not without risks. In the past, demand-driven growth has often proven inflationary. While the likelihood of overshooting this year’s 5 per cent target for CPI inflation is high, the risk of runaway inflation is limited.

This is because low commodity prices, good spatial/temporal spread of the ongoing monsoon, partial implementation of the pay commission awards (particularly excluding a hike in housing rent allowance), government’s administrative steps and tamer inflationary expectations have provided a more conducive price backdrop. Wage pressures are far from threatening, given excess capacity and a modest upturn in rural incomes. Annual inflation is, therefore, likely to average around 5.4-5.5 per cent.

Nonetheless, inflation trends need to be watched closely in the months ahead, especially as consumption plays an increasingly important role for growth. Increasing weightage of horticulture will also keep food inflation prone to intermittent supply shocks and volatility, as was evident in the inflation spurt in the second quarter of 2016, against the first quarter.

Monetary policy transition

In this context, the central bank will be in transition mode until the late third quarter of 2016. The new governor is likely to be named anytime now, followed by the monetary policy committee members next month. Factoring in the recent uptick in the second quarter of 2016, inflation numbers (5.7 per cent YoY as against the target at 5 per cent) and the Reserve Bank of India awaiting a change in guard, policy rates are unlikely to be tweaked in the interim.

The room to ease rates is likely to reopen in the fourth quarter of 2016 when there is further clarity on the policy leaning of the new governor, inflation targets are reviewed (if any) and the new policy committee takes charge of rate decisions.

The writer is Economist and Vice-President at DBS Bank, Singapore

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