All clear for Indian economy?

Maulik Tewari | Updated on January 24, 2018 Published on February 08, 2015






While much appears favourable for the economy at present, trend reversals in just a couple of factors — crude oil and global growth, for instance — have the potential to undermine the revival

The Indian stock market has been one of the top performing markets of 2014 with the benchmark rallying around 35 per cent since last year.

‘Hope’ has been a big driver of this rally. And what has been driving this hope is investor expectation of the new Government at the Centre unleashing a slew of reforms.

On the external front, the dramatic slide in crude oil prices since mid-June has heralded a decline in inflation, eased the current account deficit and led to a more stable rupee. Foreign institutional investors poured over $19 billion into the equity market in the 13 months to January 2015.

 In addition, an initial spate of reforms soon after the general elections also helped drive the rally.  These include faster project clearances, diesel deregulation, hike in FDI limits in insurance and defence, labour market reforms and auction of coal blocks, subsequent to their de-allocation.

 Looking ahead, it is clear that there are a host of positives working in favour of the economy. But the pace of recovery is dependent on overcoming near-term hurdles.

Looking back at 2014

Inflation, both at the wholesale and the retail levels, has come down significantly in the last year. This was primarily on account of easing food inflation and a cooling of global commodity prices, particularly crude oil.

The continued weakness in global crude oil prices — Brent prices fell for the sixth consecutive month in December — has helped a lot, given that India imports 80 per cent of its requirement. Another important factor has been the decline in food inflation, driven by price falls across crops — cereals, pulses and vegetables.

Food and fuel together account for a 55 per cent and 30 per cent weight in the consumer price index and the wholesale price index, respectively.

Globally, prices have also been falling due to weak demand, the result of a slowdown in large economies such as China and Europe. The impact of this is reflected in the prices of many globally traded commodities such as iron ore and coal that India imports.

Ergo: wholesale price inflation came down to an average of 3.9 per cent in 2014, from 6.3 per cent in 2013. And retail inflation dropped to 7.2 per cent, down about 3 percentage points from the year before. 

Uptick in growth

Economic growth too has shown an uptick, but there is room for improvement.  India’s GDP growth averaged 5.5 per cent during the half-year ended September 2014, slightly up from the 5 per cent growth recorded during the same period in 2013.

While the mining and services sectors expanded at higher rates, agriculture grew at a relatively slower rate than before.

This was, however, on expected lines, given the weak south-west monsoon.

But subdued growth in the manufacturing sector remains a concern. During the half-year ended September 2014, manufacturing grew at 1.8 per cent, the slowest across all sectors.

While the latest index of industrial production (IIP) numbers show that manufacturing expanded at 3 per cent in November compared to a contraction in October, one will have to wait and see if this sustains.

The services sector, which includes construction, trade, hotels, transport, communication and financial services, accounts for over 60 per cent of the GDP. Many segments within the sector have been growing at much faster rates than the overall GDP, so far.

Going forward, one risk to the sector is the weakness in global markets — many services such as IT and ITeS, travel and financial services are dependent, in varying degrees, on their exports. Others such as hotels and transport will have to wait for a faster growing domestic economy.

 Worth mentioning here are the new calculations from the Central Statistical Organisation (CSO), which suggest that growth over the past few years has been much higher than previously indicated. The CSO has brought forward the base year from 2004-05 to 2011-12, and has measured value addition in the economy at market prices as opposed to factor costs, in line with international norms.

The new approach also includes under-represented or informal sectors of the economy that were previously not accounted for.

CAD under control

On the external front, the economy has shown improvement. Helped by a lower trade deficit (exports of goods minus imports), India’s current account deficit fell to $18 billion (1.9 per cent of GDP) in the half-year ended September 2014, from $27 billion (3.1 per cent of GDP) in the year-ago period. 

Coupled with higher capital inflows, in both the debt ($14 billion) and the equity markets (over $10 billion), the lower current account deficit helped shore up the country’s foreign exchange (forex) reserves by $18 billion during the half-year ended September 2014. Rising further, the forex reserves have gone up to $322 billion by end-January 2015 from $314 billion at end-September 2014.

On the domestic front, though, the Government’s steadily rising fiscal deficit remains a concern. At ₹5.32 lakh crore, the fiscal deficit during April-December 2014 had already overshot the Budget estimate of ₹5.31 lakh crore for fiscal year 2014-15.

 And despite the optimism on the bourses, the recent December quarter results do not inspire much confidence — at the aggregate level, both revenue and net profit have been almost flat compared with the year-ago period.

And while the slump in global commodity prices has helped many a company reduce its raw material costs, thus boosting their operating profit margins, the bottom line growth has remained elusive.

What to expect in 2015

Declining inflation has already had a role to play in the RBI’s surprise decision last month to cut the repo rate (the rate at which the central bank lends to banks) by 25 basis points to 7.75 per cent after not undertaking any cuts for nearly a year-and-a-half.

Further cuts will be dependent on the trajectory of inflation and fiscal discipline by the Government. The central bank is optimistic on a retail inflation rate of 6 per cent by January 2016.

The RBI Governor has specified a real interest rate target of between 1.5 and 2 per cent and if inflation declines further, it can pave the way for further rate cuts.

So far, the fall in inflation has been achieved thanks to easing food inflation and declining global commodity prices.

Global farm product prices have been under pressure due to oversupply, weak demand and speculation going out of crops, such as corn and sugar, thanks to lower demand for bio-ethanol. In the case of crude oil, weak fundamentals seem to be catching up with the commodity.

Trends on both these fronts appear unlikely to reverse in a big way any time soon. According to the US Energy Information Administration, Brent crude prices, which averaged $62/bbl in December, are expected to average $58/bbl in 2015. Price rise can, therefore, be expected to remain subdued, with retail inflation hovering at 5-6 per cent in the coming months.

The monsoon effect

In India, with agriculture still largely rain-dependent, a normal monsoon is crucial to ensuring adequate supplies and keeping food inflation in check.

With the late improvement in north-east monsoon and in rabi sowing, output is expected to be higher in the current March quarter.

If increases in minimum support prices effected by this Government remain modest and global crop prices continue to moderate, food inflation can remain subdued.

Apart from this, the Modi Government’s structural measures aimed at addressing supply-side concerns too should help.

These include bringing onion and potato under the Essential Commodities Act, de-listing fruits and vegetables from the Agricultural Produce Marketing Committee Act (freeing farmers from restrictions to sell only to government-mandated agencies), extending credit to State Governments to import pulses and edible oils in case of domestic shortage and withholding export incentives on milk products.

Give it more time

The outlook for economic growth has improved, thanks to reforms undertaken by the Modi Government in the past few months. Measures such as faster project clearances, easier land acquisition norms, progress on the de-allocated coal blocks and the launch of the ‘Make in India’ campaign have created conditions conducive for industrial growth, but it will be some time before the impact of these can be felt in some significant way.

 What is also needed is a revival in the capital expenditure (capex) cycle, which has been subdued so far. Significant growth in capex will require stronger lending activity but banks have been reluctant to cut lending rates to stimulate more borrowing despite declining deposit rates and improved liquidity conditions. In the short term, this could impact the Government’s aim of stimulating growth.

A pick-up in industrial growth will have to be supported by a revival in consumption demand, which has been weak as indicated by the continued fall in consumer goods production.

Some advance indicators, such as the HSBC Markit Purchasing Managers’ Index, have been pointing towards an improvement in manufacturing.

 When it comes to government finances, the Central government’s fiscal deficit crossing the full-year target in the first nine months of fiscal 2014-15 has raised concern.

But the success of the recently-concluded sale of 10 per cent government stake in Coal India has brought some relief. The Government has set a disinvestment target of about ₹58,425 crore for 2014-15, and has so far raked in ₹24,258 crore from stake sales in Steel Authority of India and Coal India.

Besides, it has planned an aggressive disinvestment programme for the next two months consisting of other stake sales.

The Government is also banking on proceeds from the upcoming telecom spectrum auction and higher tax collections in the March quarter to shore up its revenues and rein in the fiscal deficit.

The upcoming spectrum auction is expected to fetch the Government ₹80,000 crore, a quarter of which would come in the current fiscal.

These efforts to bridge the fiscal deficit become all the more imperative, given that further rate cuts by the RBI are dependent on progress on the fiscal consolidation front.

What can derail it

While much appears favourable for the economy at present, trend reversals in just a couple of factors have the potential to undermine the revival.

Though it appears unlikely, any reversal in international crude oil prices on account of geo-political tensions is a risk to watch out for.

After all, these prices hold the key to the import bill and thus the current account deficit, the direction of the rupee as well as inflation.

Even the Government’s fiscal deficit will remain reliant on this factor, until all petroleum subsidies are dismantled. A reversal in this variable would also reduce the room for interest rate cuts.

 Finally, let’s not forget the all-important international cues.

The global economy is still not out of the woods and the resultant slowdown in demand could continue to hurt India’s exports.

With global trade accounting for over 50 per cent of GDP today and with at least a fourth of the Nifty companies having sizeable global linkages to their earnings, domestic economic prospects are no longer reliant on India alone.

Published on February 08, 2015
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