Economic Outlook and Policy Challenges (Economic Survey Chapter 1)


 Context

The Indian Economy has sustained a macro-economic environment of relatively lower inflation, fiscal discipline and moderate current account deficit coupled with broadly stable rupee-dollar exchange rate.
As per the advance estimates released by the Central Statistics Office, the growth rate of GDP at constant market prices for the year 2016-17 is placed at 7.1 per cent, as against 7.6 per cent in 2015-16.This estimate is based mainly on information for the first seven to eight months of the financial year. Government final consumption expenditure is the major driver of GDP growth in the current year.
This year has been marked by several historic economic policy developments. On the domestic side, a constitutional amendment paved the way for the long-awaited and transformational goods and services tax (GST) while demonetisation of the large currency notes signaled a regime shift to punitively raise the costs of illicit activities. On the international front, Brexit and the US elections may herald a tectonic shift, forebodingly laden with darker possibilities for the global, and even the Indian, economy.
Each had impact on the Indian economy which have been analysed in the following chapter.

This year has been marked by several historic economic policy developments. On the domestic side, a constitutional amendment paved the way for the long-awaited and transformational Goods and Services Tax (GST) while demonetisation of the large currency notes signalled a regime shift to punitively raise the costs of illicit activities. On the international front, Brexit and the US elections may herald a tectonic shift, forebodingly laden with darker possibilities for the global, and even the Indian, economy.
A radical governance-cum-social engineering measure was enacted on November 8, 2016. The two largest denomination notes, Rs 500 and Rs 1000-together comprising 86 percent of all the cash in circulation-were “demonetised” with immediate effect, ceasing to be legal tender except for a few specified purposes.
The aim of the action was fourfold: to curb corruption, counterfeiting, the use of high denomination notes for terrorist activities, and especially the accumulation of “black money”, generated by income that has not been declared to the tax authorities. The action followed a series of earlier efforts to curb such illicit activities, including the creation of the Special Investigation Team (SIT) in the 2014 budget, the Black Money Act, 2015; the Benami Transactions Act of 2016; the information exchange agreement with Switzerland, changes in the tax treaties with Mauritius and Cyprus, and the Income Disclosure Scheme.
Beyond these headline reforms were other less-heralded but nonetheless important actions. The government enacted a package of measures to assist the clothing sector that by virtue of being export-oriented and labour-intensive could provide a boost to employment, especially female employment. The National Payments Corporation of India (NPCI) successfully finalized the Unified Payments Interface (UPI) platform. By facilitating inter-operability it will unleash the power of mobile phones in achieving digitalization of payments and financial inclusion, and making the “M” an integral part of the government’s flagship “JAM”-Jan Dhan, Aadhar, and Mobile- initiative. Further FDI reform measures were implemented, allowing India to become one of the world’s largest recipients of foreign direct investment.
These measures cemented India’s reputation as one of the few bright spots in an otherwise grim global economy. India is not only among the world’s fastest growing major economies, underpinned by a stable macro-economy with declining inflation and improving fiscal and external balances.
Future reforms need to consider three major challenges: Reducing Inefficient redistribution,” strengthening state capacity in delivering essential services and regulating markets, and dispelling the ambivalence about protecting property rights and embracing the private sector.
The central government alone runs about 950 central sector and centrally sponsored schemes and sub-schemes which cost about 5 percent of GDP. Restructuring it will require efforts and time and even then limited results could be expected.
Competitive federalism has been a powerful agent of change in relation to attracting investment and talent; it has been less in evidence in relation to essential service delivery.
The improvement of the Public Distribution System (PDS) in Chhattisgarh, the incentivization of agriculture in Madhya Pradesh, reforms in the power sector in Gujarat which improved delivery and cost recovery, the efficiency of social programs in Tamil Nadu, and the recent use of technology to help make Haryana kerosene-free.
But on health and education there are insufficient instances of good models that can travel widely within India and that are seen as attractive political opportunities. Competitive populism needs a counterpart in competitive service delivery.

Trade as Engine of Growth
Given that India’s growth ambitions of 8-10 percent require export growth of about 15-20 percent, any serious retreat from openness on the part of India’s trading partners would jeopardize those ambitions.
For India, three external developments are of significant consequence. In the short run, the change in the outlook for global interest rates as a result of the US elections and the implied change in expectations of US fiscal and monetary policy will impact on India’s capital ?ows and exchange rates. Markets are factoring in a regime change in advanced countries, especially US macroeconomic policy, with high expectations of fiscal stimulus.
Second, the medium-term political outlook for globalisation and in particular for the world’s “political carrying capacity for globalisation” may have changed in the wake of recent developments. In the short run a strong dollar and declining competitiveness might exacerbate the lure of protectionist policies.
Third, developments in the US, especially the rise of the dollar, will have implications for China’s currency and currency policy. If China is able to successfully re-balance its economy, the spill over effects on India and the rest of the world will be positive.

Developments during 2016-17
Real GDP growth in the first half of the year was 7.2 percent, on the weaker side of the 7.0-7.75 per cent projection in the Economic Survey 2015-16 and somewhat lower than the 7.6 percent rate recorded in the second half of 2015-16.
The main problem was fixed investment, which declined sharply as stressed balance sheets in the corporate sector continued to take a toll on firm’s’ spending plans. On the positive side, the economy was buoyed by government consumption, as the 7th Pay Commission salary recommendations were implemented.
The major highlights of the sectoral growth outcome of the first half of 2016-17 were:
(i) Moderation in industrial and nongovernment service sectors;
(ii) The modest pick-up in agricultural growth on the back of improved monsoon; and
(iii) Strong growth in public administration and defence services
The Consumer Price Index (CPI)- New Series infation, which averaged 4.9 per cent during April-December 2016, has displayed a downward trend since July when it became apparent that kharif agricultural production in general, and pulses in particular would be bountiful. The decline in pulses prices has contributed substantially to the decline in CPI infation which reached 3.4 percent at end-December.
The second distinctive feature has been the reversal of WPI inflation, from a low of (-) 5.1 percent in August 2015 to 3.4 percent at end-December 2016.
The outlook for the year as a whole is for CPI in?ation to be below the RBI’s target of 5 percent, a trend likely to be assisted by demonetisation.

External Sector
The current account deficit has declined to reach about 0.3 percent of GDP in the first half of FY 2017. Foreign exchange reserves are at comfortable levels, having have risen from around US$350 billion at end-January 2016 to US$ 360 billion at end-December 2016 and are well above standard norms for reserve adequacy.
In part, surging net FDI in flows, which grew from 1.7 percent of GDP in FY2016 to 3.2 percent of GDP in the second quarter of FY2017, helped the balance-of-payments.
The trade deficit declined by 23.5 per cent in April-December 2016 over corresponding period of previous year. During the first half of the fiscal year, the main factor was the contraction in imports, which was far steeper than the fall in exports. But during October-December, both exports and imports started a long-awaited recovery, growing at an average rate of more than 5 per cent.
The improvement in exports appears to be linked to improvements in the world economy, led by better growth in the US and Germany.
The net services surplus declined in the first half, as software service exports slowed and financial service exports declined. Net private remittances declined by $4.5 bn in the first half of 2016- 17 compared to the same period of 2015-16, weighed down by the lagged effects of the oil price decline, which affected in?ows from the Gulf region.

Fiscal Performance
Trends in the fiscal sector in the first half have been unexceptional and the central government is committed to achieving its fiscal deficit target of 3.5 percent of GDP this year. Excise duties and services taxes have benefited from the additional revenue measures introduced last year.
The most notable feature has been the over-performance of excise duties in turn based on buoyant petroleum consumption: real consumption of petroleum products (petrol) increased by 11.2 percent during April-December 2016 compared to same period in the previous year.
Indirect taxes, especially petroleum excises, have held up even after demonetisation in part due to the exemption of petroleum products from its scope.
Non-tax revenues have been challenged owing to shortfall in spectrum and disinvestment receipts but also to forecast optimism; the stress in public sector enterprises has also reduced dividend payments.
The consolidated deficit of the states has increased steadily in recent years, rising from 2.5 percent of GDP in 2014-15 to 3.6 percent of GDP in 2015-16, in part because of the UDAY scheme.

Economic Outlook
Demonetization
Demonetisation affects the economy through three different channels. It is potentially:
• An aggregate demand shock because it reduces the supply of money and affects private wealth, especially of those holding unaccounted money;
• An aggregate supply shock to the extent that economic activity relies on cash as an input (for example, agricultural production might be affected since sowing requires the use of labour traditionally paid in cash); and
• An uncertainty shock because economic agents face imponderables related to the magnitude and duration of the cash shortage and the policy responses (perhaps causing consumers to defer or reduce discretionary consumption and firms to scale back investments).

Impact on GDP
Consumer spending and two-wheelers, as the best indicator of both rural and less affuent demand;
• Real credit growth; and
• Real estate prices
Contrary to early fears, as of January 15, 2017 aggregate sowing of the two major rabi crops-wheat and pulses (gram)–exceeded last year’s planting by 7.1 percent and 10.7 percent, respectively .
Recorded GDP growth in the second half of FY 2017 will understate the overall impact because the most affected parts of the economy-informal and cash-based- are either not captured in the national income accounts or to the extent they are, their measurement is based on formal sector indicators.
For example, informal manufacturing is proxied by the Index of Industrial Production, which includes mostly large establishments. So, on the production or supply side, the effect on economic activity will be underestimated.

Outlook for 2017-18
India’s exports appear to be recovering, based on an uptick in global economic activity. This is expected to continue in the aftermath of the US elections and expectations of a fiscal stimulus.
The IMF’s January update of its World Economic Outlook forecast is projecting an increase in global growth from 3.1 percent in 2016 to 3.4 percent in 2017, with a corresponding increase in growth for advanced economies from 1.6 percent to 1.9 percent. Given the high elasticity of Indian real export growth to global GDP, exports could contribute to higher growth next year, by as much as 1 percentage point.
International oil prices are expected to be about 10-15 percent higher in 2017 compared to 2016, which would create a drag of about 0.5 percentage points. On the other hand, consumption is expected to receive a boost from two sources: catch-up after the demonetisation-induced reduction in the last two quarters of 2016-17; and cheaper borrowing costs, which are likely to be lower in 2017 than 2016 by as much as 75 to 100 basis points. As a result, spending on housing and consumer durables and semi-durables could rise smartly.
Since no clear progress is yet visible in tackling the twin balance sheet problem, private investment is unlikely to recover significantly from the levels of FY 2017. Some of this weakness could be offset through higher public investment, but that would depend on the stance of fiscal policy next year, which has to balance the short-term requirements of an economy recovering from demonetisation against the medium-term necessity of adhering to fiscal discipline-and the need to be seen as doing so.
Putting these factors together, we expect real GDP growth to be in the 6¾ to 7½ percent range in FY 2018. Even under this forecast, India would remain the fastest growing major economy in the world.
There are three main downside risks to the forecast. First, the extent to which the effects of demonetisation could linger into next year, especially if uncertainty remains on the policy response. Currency shortages also affect supplies of certain agricultural products, especially milk (where procurement has been low), sugar (where cane availability and drought in the southern states will restrict production), and potatoes and onions (where sowings have been low). Vigilance is essential to prevent other agricultural products becoming in 2017-18 what pulses were in 2015-16.

Fiscal Outlook
The fiscal outlook for the central government for next year will be marked by three factors. First, the increase in the tax to GDP ratio of about 0.5 percentage points in each of the last two years, owing to the oil windfall will disappear. In fact, excise-related taxes will decline by about 0.1 percentage point of GDP, a swing of about 0.6 percentage points relative to FY2017.
Second, there will be a fiscal windfall both from the high denomination notes that are not returned to the RBI and from higher tax collections as a result of increased disclosure under the Pradhan Mantra Garib Kalyan Yojana (PMGKY). Both of these are likely to be one-off in nature, and in both cases the magnitudes are uncertain.
A third factor will be the implementation of the GST. It appears that the GST will probably be implemented later in the fiscal year. The transition to the GST is so complicated from an administrative and technology perspective that revenue collection will take some time to reach full potential.
Combined with the government’s commitment to compensating the states for any shortfall in their own GST collections (relative to a baseline of 14 percent increase), the outlook must be cautious with respect to revenue collections. The fiscal gains from implementing the GST and demonetisation, while almost certain to occur, will probably take time to be fully realized.

Macro-Economic Outlook
An economy recovering from demonetisation will need policy support. On the assumption that the equilibrium cash-GDP ratio will be lower than before November 8, the banking system will benefit from a higher level of deposits. Thus, market interest rates-deposits, lending, and yields on g-secs-should be lower in 2017-18 than 2016-17.
This will provide a boost to the economy (provided, of course, liquidity is no longer a binding constraint). A corollary is that policy rates can be lower not necessarily to lead and nudge market rates but to validate them. Of course, any sharp uptick in oil prices and those of agricultural products, would limit the scope for monetary easing.
Fiscal policy is another potential source of policy support. This year the arguments may be slightly different from those of last year in two respects. Unlike last year, there is more cyclical weakness on account of demonetisation.
Moreover, the government has acquired more credibility, because of posting steady and consistent improvements in the fiscal situation for three consecutive years, the central government fiscal deficit declining from 4.5 percent of GDP in 2013- 14 to 4.1 percent, 3.9 percent, and 3.5 percent in the following three years. But fiscal policy needs to balance the cyclical imperatives with medium term issues relating to prudence and credibility.

Exchange Rate Policy
Given India’s need for exports to sustain a healthy growth rate, it is important to track India’s competitiveness.
A second reason to review India’s competitiveness is the rise of countries such as Vietnam, Bangladesh, and the Philippines that compete with India across a range of manufacturing and services.
A simple look at the indices of real effective exchange rates suggests that since the crisis of 2013, India’s rupee has appreciated by 19.4 percent (October 2016 over Jan 2014) according to the IMF’s measure, and 12.0 percent according to the RBI’s measure.
Both these indices could be potentially misleading. The RBI’s measure for example assigns an unusually high weight to the United Arab Emirates as it is a major source of India’s oil imports, and a trans-shipment point for India’s exports. But little of this trade has to do with competitiveness.
The surprising finding is that the IMF and RBI indices overstate the rupee’s appreciation since 2014, largely because they give such a large weight to the euro, which has been exceptionally weak. When the rupee is compared mainly to the comparatively stronger Asian currencies both REERASIA-M and REER-ASIA-H show the loss of competitiveness has been much less, 8.3 percent and 10.4 percent respectively (October 2016 over January 2014).
In other words, India has managed to maintain export competitiveness despite capital in?ows and in?ation that has been greater than in trading partners. Re?ecting this, India’s global market share in manufacturing exports has risen between 2010 and 2015.

Trade Policy
At a time of a possible resurgence of protectionist pressures and India’s need for open markets abroad to underpin rapid economic growth domestically, it is increasingly clear that India and other emerging market economies must play a more proactive role in ensuring open global markets.
At the same time, with the likely US retreat from regional initiatives such as the Trans-Pacific Partnership (TPP) in Asia and the Trans-Atlantic Trade and Investment Partnership (TTIP) with the EU, it is possible that the relevance of the World Trade Organization might increase. As a major stakeholder and given the geo-political shifts under way, reviving the WTO and multilateralism more broadly could be proactively pursued by India.

Women
This burden on women can take several forms: threat to life and safety while going out for open defecation, reduction in food and water intake practices to minimize the need to exit the home to use toilets, polluted water leading to women and children dying from childbirth-related infections, and a host of other impacts.
Women’s personal hygiene is therefore important not just for better health outcomes but also for the intrinsic value in conferring freedom that comes from having control over their bodies, a kind of basic right to physical privacy. Put differently, impeded access may well be creating “gender-based sanitation insecurity.”

Other Random Observations
1. New estimates based on railway passenger traffic data reveal annual work-related migration of about 9 million people, almost double what the 2011 Census suggests.
2. China’s credit rating was upgraded from A+ to AA- in December 2010 while India’s has remained unchanged at BBB-. From 2009 to 2015, China’s credit-to-GDP soared from about 142 percent to 205 percent and its growth decelerated. The contrast with India’s indicators is striking, which have remained low in range of 70-80.
3. Welfare spending in India suffers from misallocation: as the pair of charts show, the districts with the most poor (in red on the left) are the ones that suffer from the greatest shortfall of funds (in red on the right) in social programs. The districts accounting for the poorest 40% receive 29% of the total funding.
4. India has 7 taxpayers for every 100 voters ranking us 13th amongst 18 of our democratic G-20 peers.
5. India’s share of working age to non-working age population will peak later and at a lower level than that for other countries but last longer. The peak of the growth boost due to the demographic dividend is fast approaching, with peninsular states peaking soon and the hinterland states peaking much later.

Supplementary Readings
A. JAM Trinity
JAM stands for three things – the Jan Dhan Yojana, the Aadhaar initiative of UIDAI and Mobile number. These three things are now often called the Trinity of reforms in India. The JAM Trinity holds the key to one of the biggest pieces of reform ever attempted in India, i.e., direct subsidy transfers. The NDA government is pinning its hopes on these three modes of identification ((JAM) to deliver direct benefits to India’s poor.
Until now, the government has operated a multitude of subsidy schemes to ensure a minimum standard of living for the poor. These take the traditional delivery routes to deliver affordable products or services to them. So, we have the MGNREGA, operated through the panchayats, which pays minimum wages to rural workers. The Centre and States supply rice, wheat, pulses, cooking oil, sugar and kerosene at heavily subsidised prices through the PDS. Then, sectors such as power, fertilisers and oil sell their products to people below market prices. It is natural that such subsidies cost the exchequer quite a bit. Yet, as they make their winding way through the hands of intermediaries, leakages, corruption and inefficiencies eat away large parts.
It is here that the government is quite confident that the three constituents of JAM could be of immense help. With Aadhaar helping in direct biometric identification of disadvantaged citizens and Jan Dhan bank accounts and mobile phones allowing direct transfers of funds into their accounts, it may be possible to cut out all the intermediaries. Thus JAM Trinity has become such an important part of Indian economy that within launch of this terminology it has become immensely popular in financial circles.
To implement the concept of JAM trinity we have to overcome various challenges like lack of infrastructure facilities in terms of access to banking facilities especially in remotest areas, privacy and security issues in ADHAAR.
B. Credit Rating Agencies
Credit rating agencies are whistleblowers. They have expertise in the art of monitoring, evaluation and forecast. They offer information to the investors for taking investment decisions. They help governments to devise policies to avoid imminent crises such as recession, current account deficit, fiscal deficit, other macroeconomic imbalances such as inflation or deflation. They, nevertheless, have to be transparent and accountable. They have to behave with responsibility and caution otherwise they can lead to panic, fear fluctuations in growth, investment and trade. In recent past it has been seen how credit rating agencies were inadequate in telling when sub-prime crisis was building in America, or sovereign debt crisis was building up in Europe.
Reasons for failure
• It was because they failed to maintain their neutrality.
• They also remained motivated by profit motive.
• Conflict of interest
• They joined hands with corporate sector and political bosses to hideously serve their purposes rather than serving the interest of investors in particular and public at large.
• They have lost their trust and respectability and now people are questioning them.

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