The New Year will probably have a few things going for the Indian economy, even though these may not translate into higher growth. Gains from big legislative reforms such as the Goods and Services Tax (GST) and The Insolvency and Bankruptcy Code (IBC) will start accruing in the coming year(s). Lower global crude oil prices — of $50 or so a barrel — will certainly help. But a powering down of the global economy will restrain India’s manufacturing and services exports. Double-digit growth rates became possible in the past only when exports jumped during periods of high global growth. Despite higher capacity utilitsation, companies may go slow on investments due to policy uncertainty in an election year, and banks grappling with bad loans will still find it difficult to lend. There is limited fiscal space for extra government expenditure over the next three months. On the other hand, subdued farm incomes and the wearing off of Pay Commission awards may dent the consumption story. Pre-election noises promising unemployment allowances and farm debt waivers point to rising stress on the fisc, both at the Centre and in the states. Added to this are global uncertainties. Overall, 2019 looks like a lacklustre year, presenting a weak outlook for the economy, and more volatility in the stock markets.
Big reforms, slow impact
Two decisions taken by the BJP-led government over the past four-and-a-half years have been transformative: the GST Act, and the IBC. The initial hiccups in the implementation of GST could disappear in 2019, with streamlining of procedures. As revenue streams turn more encouraging, the government will probably fix a single tax rate for all goods and services. The IBC, on the other hand, offers huge possibilities in addressing the bad loans problem. The process will likely mature in 2019 and beyond, with a bulk of the cases being resolved through mutual consultations between banks and company promoters. These are huge pluses, and paint a wonderful investment picture for long-term investors.
However, it is important to acknowledge that significant reforms have their own journey time; it takes a number of incremental improvements, and letting these play out, to generate confidence and prepare stakeholders for the big transformation. Enacting the GST and IBC laws is no mean achievement, but they were in the making for long. The seeds of GST were sown in 2000, and insolvency reforms have been in the works since 1992. For the economy to start realising the gains from the two reform measures requires these to stabilise and consolidate on the ground. In mature economies, most insolvency cases are resolved outside the courts. India will get there in good time. The impact of these measures will be immense, and will be felt in the medium to long term.
Polls, politics, policies
In any election year, three or four crucial months are lost because there is no concerted expenditure push by the government. Bound by the Model Code of Conduct, the government will be able to present only a Vote on Account (also called Interim Budget) which allows for basic spending for a part of the year. Once the new government is sworn in, it takes about a month to present the full Budget, which symbolically also serves as its first big economic policy statement. In other words, the April-June quarter will just pass by, in elections and government formation.
By and large, economic momentum in the short run has little to do with politics. Whether it is the BJP-led NDA or the Congress-led UPA or a non-BJP, non-Congress Third Front, India’s reform path is more or less set. The action shifts to the markets, which are influenced by the moods and expectations of the people given the economic conditions, the promise that political parties are seen to hold (or not hold) ahead of elections, and the uncertainties, if any, the election results throw up. High growth rates are critical for jobs, and political parties are almost always keen to spend more, seek lower rates of interest on loans, demand more lending by banks for micro, small and medium enterprises, and hunt for avenues to raise funds (from RBI reserves, cross-selling of government holding by PSUs, etc).
In 2014, Narendra Modi promised development, an end to the so-called policy paralysis, a revival of investments, growth and jobs, and a war on corruption. The markets couldn’t have asked for more. Over the last four years, the government under Prime Minister Modi has launched many programmes and new schemes, but by and large, it has expanded its role in the economy. Be it directing credit, demanding forbearance for particular sectors, merging state-owned banks, asking oil PSUs to buy government holdings in each other, increasing taxes on fuel despite a sharp drop in global crude prices, or spending money on large welfare programmes, the government has shown a preference for state-led interventions over market solutions. But this hasn’t helped boost private sector investment, critical for job creation. While there is no credible employment data available, the economy has clearly been unable to provide income-earning opportunities to the million-plus individuals who enter the labour market every month.
If the BJP returns to power, it will have to do better to put the economy in a different growth orbit, so that more jobs are created. Will the Congress propose anything dramatically different? Party president Rahul Gandhi’s mocking of the NDA government as a “suit-boot ki sarkaar” and, more recently, promising a nationwide farm loan waiver, send out a certain kind of signal. The new Congress governments in MP, Rajasthan, and Chhattisgarh have already announced farm loan waivers.
This stance by the Congress will put competitive populist pressure on the BJP ahead of the Lok Sabha elections. Such policies adversely impact government finances, lead to higher deficits, and reduce the headroom for the central bank to reduce policy rates. This in turn, affects private investment decisions.
Several worries at home…
Multiple factors on the domestic front raise red flags for the economy. The liquidity crisis that has hit non-banking finance companies affects specific segments. Belt-tightening by the government due to limited fiscal space will prevent any dramatic rise in public sector expenditure. The balance sheet clean-up of banks and high-debt companies will take a while, and fresh capital expenditure may take up to 12 months. Even if companies have utilised their capacities, the first round of additional capacity would come more from brownfield expansion, rather than greenfield. Further, this has to be driven more through consumer demand within, rather than exports. But consumers need jobs to earn income and spend. Debt-funded consumption may not be sustainable.
…Amid global uncertainty
Right now, the world is talking about a cyclical slowdown, if not a recession. The fall in the prices of crude oil, a bellwether of global growth, is of particular concern. Although the Federal Reserve has increased rates for five consecutive quarters, the last one less than two weeks ago, worries have emerged now over whether the US would grow as fast as it did in 2018, when the annualised quarterly growth was 4%. Interest rate hikes in the US would essentially mean a further strengthening of the dollar, making it more difficult for emerging economies to repay their dollar debts. In China, growth has already moderated, but there are still questions as to how much more its economy will slow down. Growth prospects in Europe do not inspire confidence. The International Monetary Fund expects the global economy to grow at 2.5% in 2019, compared with 2.9% in 2018.
To sum up the 2019 outlook
National elections will not impact the economy in the short run (6-12 months). The impact of the new government’s decisions will take a while to show. What we need to worry more about is the markets, more because they factor in or discount the likely future changes. Equity markets do not necessarily move based on profit numbers posted by companies, but to the discount rate investors apply in arriving at current prices.