Citing stress in the agricultural sector, farm loan waivers and deflationary impulses as reasons for growing anxiety on the broader economy, the second volume of the Economic Survey for 2016-17 has warned that meeting the upper end of the 6.75-7.5 per cent GDP growth forecast for 2017-18 will be a “challenge”.
Forecasting “greater downside risks” to economic growth, the Survey, tabled in Parliament Friday, argues that the “scope for monetary policy easing is considerable” and could go up to 75 basis points.
Speaking to reporters, Chief Economic Advisor Arvind Subramanian said “there has been an across-the-board deceleration in real activity”.
The Survey notes that recent farm loan waivers will be deflationary since states waiving loans will either have to either cut expenditure or raise taxes — both of which will reduce demand in the economy. Uttar Pradesh, which announced farm loan waiver, had to resort to 13 per cent reduction in capital expenditure in order to fund loan waiver, Subramanian said. Such loan waivers, the Survey said, could reduce aggregate demand by as much as 0.7 per cent of GDP, imparting a significant deflationary shock to the economy.
It pointed to the possibility of some degree of moderation in stock prices from these “frothy levels”. “…the price-earnings (P/E) ratio of the Indian stock market reached a level of 23 in May 2017, and is estimated to have reached about 25 by mid-July. This is substantially greater than the long-run average of 18, and not far from the frothy levels reached in 2007,” it said. Unless profit growth of companies is rapid, there is a strong tendency for correction in stock prices all over the world, illustrated for India in the aftermath of the boom of the mid-2000s.
The Survey has noted that various factors such as launch of the GST, positive impacts of demonetisation, in-principle decision to privatise Air India along with further rationalisation of energy subsidies and actions to address the Twin Balance Sheet (TBS) challenge contribute to optimism in the economy. Also, a series of government and RBI actions and structural changes in the oil market have reduced the risk of sustained price increases, it said.
On the downside, the Survey cautions that “anxiety reigns because a series of deflationary impulses are weighing on an economy, yet to gather its full momentum and still away from its potential. These include: stressed farm revenues, as non-cereal food prices have declined; farm loan waivers and the fiscal tightening they will entail; and declining profitability in the power and telecommunication sectors, further exacerbating the TBS (twin balance sheet) problem”.
Tepid credit growth and negative growth in the private investment in the last year are the other trouble spots for the economy. The growth in real fixed investment was low since the second half of 2012-2013 and declined steeply after a temporary spurt in the second half of 2015-2016. “As per Survey calculations, private investment growth is estimated to be negative in 2016-17. The only demand boost came from consumption, which accounted for about 96 per cent of GDP growth in FY 2017,” it said.
Gross bank credit grew at 4.1 per cent in May 2017, while for full year 2016-17, it was 7 per cent. “Credit off-take from banks continued to decelerate and the non-performing assets situation deteriorated further. Sluggish growth and increasing indebtedness in some sectors of the economy have impacted the asset quality of banks and this is a cause for concern,” the Survey said.
While highlighting the stress areas, the economic report card said that sound macro-economic stability, low inflation and reduction in cash holding in the economy post demonetisation are the positive features of the economy.
“We seem to have achieved a 20 per cent reduction in equilibrium cash holding in the economy,” Subramanian said. Also, the government has added 5.4 lakh new taxpayers due to demonetisation, but the reported taxable income hasn’t increased that much, he said.
The Survey also highlights the fact that there has been significant moderation in CPI headline inflation during the last three years and that the current inflation is running well below the 4 per cent target, suggesting that inflation by March 2018 is likely to be below the RBI’s medium term target of 4 per cent.
The Survey points to scope of further monetary easing by the RBI. “Current inflation, at 1.5 per cent, is running well below the 4 per cent target, with the domestic economy lacking the dynamism to push this back toward the target,” it said.
“Cyclical conditions, then, suggest that the policy rate should actually be below-not 50-100 basis points or so above-the neutral rate. The conclusion is inescapable that the scope for monetary easing is considerable, more than that suggested by comparison with neutral interest rates,” it said.