As a pre-election year, the govt may go easy on tough reforms; inflation may be a worry despite RBI’s benign view
The 2018-19 fiscal year will be a particularly interesting albeit challenging one. FY17 and FY18 were two normal years on the domestic side while a less amorphous structure evolved for the global economy. The world economy looks stronger than before notwithstanding the move towards protectionism in the western world and an unchanged level of uncertainty on the political relations in the oil world. The comfort which was experienced on several fronts in the last two years may not be available this year which can potentially cause volatility.
First on the policy front, the government may prefer to be conservative in the face of a pre-elections year. This was one of the reasons why radical steps were taken in 2016 and 2017 on demonetisation and GST with 2018-19 being the cooling period. Therefore big bang reforms may not be expected, though the government has quite adeptly brought in reforms in most sectors in the last 3-4 years. Labour and land are the two stickier issues which would have to wait as farm distress and low employment growth have limited the contours of feasible reforms in these areas.
Second, the comfort of lower inflation may be over and while the present CPI number appears to be well within the 4-6 per cent band of monetary policy tolerance, the upside risks appear to be more than the downside possibilities, although the RBI in its latest policy has toned down its inflation projections. Oil is steady at $70 with an upside. Besides all the demand pull factors that have been benign so far would begin to move in the other direction. It must be remembered that low inflation also goes with loss of pricing power for corporates. Any revival of corporate power would be manifested in price changes, which remains a risk today.
Third, the direction of interest rates looks stable given the RBI’s recent stance. While the argument for rate cut would have some foundation in case inflation comes down sharply, it looks more likely that status quo will prevail. The government’s borrowing programme has been loaded heavily in the second half and by kicking the can to bring down rates in the short term, the risk of higher rates from October onwards cannot be ruled out.
Fourth, the rupee has been very strong in the last two years and the expected depreciation has not taken place despite a widening trade deficit. One reason has been the weak dollar vis-a-vis the euro caused by the policies being pursued. But there is reason to believe that US President Donald Trump’s ‘America First’ is aimed at making the US a powerful economy which includes a strong dollar. With a widening CAD, the possibility of a weaker rupee cannot be ruled out. While this is good for exports, volatility in the market is more definite, which will call for central bank action if the limits are breached.
Fifth, a recovery in the developed economies goes along with rising interest rates. This means that investors would get better returns and a stronger or stable dollar will mean reversal of capital flows from emerging markets. The quantum of FII flows in equity has been low tending towards negative. However, the debt flows have kept things moving which can change this year. The same holds for FDI. While India has managed a smart amount of $45 billion (equity) in the last three years, it is unlikely to be exceeded. Here again, most of the policies in the West are aimed at high spending on infrastructure which would provide opportunity for investors.
Sixth, while it is true that the monsoon pattern cannot be interpreted on the basis of past data, two very good monsoons could be followed by a sub-optimal one this year.
The Skymet has, however, projected a normal monsoon this time too. This will be a concern as the action so far has been more on increasing MSP as an answer to the problems of farmers as there has been surplus production for two years. Now an uneven distribution of rains will underscore the crux of sustainable agriculture which has been ignored in the good years. The impact on production, foreign trade and inflation would be important here.
Seventh, the stock market has been belligerent in FY18 where it was hard to find linkage with fundamentals. This being the case, the general expectations are that a correction is forthcoming and would be witnessed this year and the Sensex could go below 30,000. This has been exacerbated by the recent stand-off on the trade war between the US and China towards the end of March but could gather momentum in the coming months. Therefore, the high returns earned last year would not be replicated this year.
Eight, given this set up, the fiscal targets put forward of 3.3 per cent deficit for the year could have a downside in terms of the final number coming in higher. The very good disinvestment proceeds in FY18 can be attributed to favourable stock market conditions. If this is not repeated then it would be tougher to go through with the ambitious plan of ₹80,000 crore.
The banking conundrum
Ninth, the banking system will probably be the biggest conundrum for the government to resolve. The present crisis in on several sides and until it is evened out, will remain a drag.
High NPAs where the numbers are not yet identified, limited resolution of the IBC cases, capital shortages for growth of banks, governance issues etc, have all meant that the focus will be on a lot of housekeeping and ordinary business would be under pressure especially on the lending side.
Last, growth for the year has also been assumed by the government at less than 8 per cent, which is lower than that in FY16. Hence, while the tag of fastest growing economy will probably be retained, there may be less comfort internally with most of the conditions turning volatile. Private investment still appears to be stagnant while states are also not in a position to invest given their tenuous fiscal structures. The central government had cut down on capex last year and this could happen again in case conditions turn adverse.
Therefore, while the economy looks strong from the outside, the factors that have contributed to this vision could be under various pressures that could cast a shadow. This makes the year particularly important.
(The writer is Chief Economist, CARE Ratings. The views expressed are personal.)