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The Indian economy has shown a strong V-shaped recovery driven largely by domestic growth impulses. If one considers nine consecutive quarters since the fourth quarter of 2015-16, Gross Domestic Product (GDP) growth fell quarter after quarter from a peak of 9% to a trough of 5.6% in the first quarter of 2017-18. As is widely recognized, this was due to demonetization and the transitory adverse effects of the goods and services tax implementation. These eventually subsided and for the last three quarters, growth steadily recovered to 6.3%, 7.0% and 7.7% in the second, third and fourth quarters of 2017-18, respectively. This sharp recovery is based entirely on domestic factors as the contribution of net export growth to GDP has been zero or negative since the third quarter of 2016-17. From the demand side, two segments which have supported growth, particularly in the fourth quarter of 2017-18, are government consumption and overall investment demand. The growth in gross fixed capital formation was as high as 14.4% in the fourth quarter of 2017-18.
The real investment rate has also increased to 34.6% in the fourth quarter of 2017-18, although paradoxically, the nominal investment rate during this period remained below 31%. This difference is explained by relatively lower implicit price deflator of investment goods when compared to that for consumption goods.
Productivity focus
Many of the government’s policy initiatives have shown a clear productivity-enhancing supply-side thrust including demonetization and the GST. The new Monetary Policy Framework agreement has institutionalized a consumer price index (CPI) inflation target of 4% on average. Key policy initiatives (Make in India, Start-up India) also aim at improving productivity. Two early policy successes are related to the market determination of mineral and spectrum prices. The power sector further benefitted from the Ujwal DISCOM Assurance Yojana scheme. For real estate and banking, the regulatory framework was changed. Additional fiscal space was created by better targeting of subsidies while the expansion for rail/road projects was prioritized.
Two factors may create short-term drags on India’s prospects for maintaining a sustained level of high growth: rising global crude prices and prospects of fiscal slippage. Global crude prices recently touched $80 a barrel. for the first time since 2014. The supply factors include U.S. sanctions on Iran and the crisis in Venezuela.
On the demand side, according to the World Bank, world oil consumption grew strongly in 2017, up by 1.6% year-on-year. In 2018, U.S. consumption growth is expected to gather further momentum. Rising crude prices may adversely affect most indicators of India’s macro balance including trade and current account deficits, inflation, exchange rate and fiscal deficit. Reversing a falling trend since December 2017, CPI-based inflation increased to 4.6% in April 2018 due to rising prices of petrol and diesel used for transport. Continued pressure on inflation may prompt the RBI to revise the repo rate upwards during the current year.
The Centre’s fiscal deficit-GDP ratio, after showing a steady improvement since 2014-15, slipped back to a level of more than 3.5% of GDP in 2017-18, exceeding the fiscal responsibility and budget management (FRBM) target of 3% and the budgeted target of 3.2%. With the general election around the corner, this situation may not improve in spite of the fact that the FRBM Act has been modified, shifting the policy anchor to achieving a debt-GDP ratio of 40% while retaining the fiscal deficit target at 3% of GDP. This target is now to be reached by March 2021.
D.K. Srivastava is Chief Policy Advisor at EY India
This news has appeared on The Hindu. Courtesy The Hindu
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