Volume II Chapter 1
Chapter 1 Introduction Section A. Analytical review of recent development The Goods & Services Tax Paradigm Shift to Low Inflation Wedge between asset price & real economy Farm Loan Wavers- Macro Economic Impact Demonetization: Long Term Benefits & Short Term Cost Section B. Outlook & policies for 2017-18 Section C:Review of Development in 2016-17
Outlook & Policies for 2017-18
Outlook for Real Activity for 2017-18 For some time now, India has been in the throes of what Carmen Reinhart and Kenneth Rogoff have called balance sheet recessions ("weaker than potential growth" rather than "recessions" is a more appropriate characterization for India).
Outlook for Real Activity for 2017-18 Para 1: Credit & Investment Legacy General Scenario In most countries, booms are accompanied by rapid increases in credit growth, followed by deleveraging (or credit decline) after which credit growth can not necessarily will pick up. China has followed a different path: it has chosen to re-leverage with a vengeance in order to stave off a growth slowdown. This works in the short run, although at the expense of decreasing capital efficiency and building up financial sector vulnerabilities that could lead to dramatic growth slowdowns in the future.
Outlook for Real Activity for 2017-18 Indian Scenario Indian boom of mid 2000 is not followed by serious deleveraging. Slowdown in bank credit is the source of concern. If deleveraging is necessary condition for resuming growth than India needs more debt resolution and reduction in the short run.
Outlook for Real Activity for 2017-18 Para 2: Current Situation of Indian Economy A number of indicators GDP, core GVA (GVA excluding agriculture and Government), IIP, credit, investment and capacity utilization point to a deceleration in real activity. Real GVA growth for Q4 2016-17 was 5.6 per cent. Unless potential output growth is much lower than is commonly assumed (around 7 percent or more), output gaps are expected to widen.
Outlook for Real Activity for 2017-18 Para 3: Expectation in Volume I of Economic Survey Volume I range for GDP growth of between 6.75 and 7.5 percent factoring in More buoyant exports Post demonetization catch up in consumption Relaxation of monetary conditions which prevailed during demonetization.
Outlook for Real Activity for 2017-18 Para 4: Present factors affecting the expectations Deflationary bias is expected in economy reason beingü Real exchange rate appreciation. ü Farm loan waivers ü Increased stress to balance sheet in power, telecommunication and agricultural sector. ü Transitional Changes implementing the GST
Outlook for Real Activity for 2017-18 Para 6- Effect of farm loan waiver The deflationary impact of farm loan waiver will depend upon how many states imitate the same action as UP, Mahrashtra, MP & Karnataka. Deflationary impact is expected to be 0.35% due to the farm loan waiving.
Outlook for Real Activity for 2017-18 Para 7- Monetary Policy and it s effect Real policy rate is tighter than what was expected in Volume I. It is expected that if current monetary policy will continue then forecasted GDP will show a downside risk.
Outlook for Real Activity for 2017-18 Para 8- TBS and Prospects Since the Volume I Government & RBI has taken various steps to resolve the TBS problem. Market Confidence has boosted. Deleveraging the corporate balance sheets will be necessary to restore investment & credit demand. Deleveraging of bank balance sheets will be essential to unblock the choked channels of the supply of credit. However, the substantive growth impact of the steps taken will depend on the scope, effectiveness, and timeliness of resolution of stressed assets.
Outlook for Real Activity for 2017-18 Para 9- GST Effects There is also some upside from the GST. The removal of check posts and the consequent easing of transport constraints can provide some short-term fillip to economic activity.
Outlook for Real Activity for 2017-18 Para 10- Conclusion In Volume I growth in GDP was expected to be 7% from 6.75%. But the preceding discussion indicates that the balance of risks seem to have shifted to the downside. The balance of probabilities has changed accordingly, with outcomes closer to the upper end having much less weight than previous.
Outlook for Price & Inflation for 2017-18 Para 1 Anticipated Inflationary Trend The section on Paradigm Shift to Low Inflation argued that India might already be in the throes of a structural disinflationary shift, driven by more permanent developments in both the international oil market and domestic agriculture reflected in unanticipated inflation developments.
Outlook for Price & Inflation for 2017-18 RBI s newly adopted Flexible Inflation Targeting framework: Headline CPI- Measures target rate of inflation indicating price of essential consumotion goods and goods having highly volatile prices. Inflation in these prices hurts the lower income group. Core CPI- Represents long tern inflation trend of economy. It ignores food products and all such product of which prices are volatile like oil. This is done to separate permanent and temporary inflation movements. Para 2 Headline & Core CPI
Outlook for Price & Inflation for 2017-18 Para 3 Determiners of Inflation in Near Term Capital flows and exchange rates which are dependent upon the outlook & policies of advanced economies specially of US. Recent exchange rate appreciation The monsoon The GST impacts The 7 th Pay Commission Awards Likely Farm Loan Waivers The output gap
Outlook for Price & Inflation for 2017-18 Other Important Issues Food prices are expected to be on higher side and very encouraging due to the anticipated better rainfall than previous years. The GST is expected, on balance, to reduce prices because of the lower incidence of taxation compared to the combined incidence of central and state taxes previously. The 7th Pay Commission housing award is expected to increase inflation on average by between 0.4 and 1.2 percentage points, depending on whether just the Centre or the Centre and all the states implement the award.
Outlook for Price & Inflation for 2017-18 Other Important Issues Farm loan waivers are more likely to be deflationary than inflationary and hence impart a downward not upward bias to prices. Output gaps are important for inflation and the earlier discussion points to a weakening economy and widening output gaps.
Policy Instances
Monetary Policy Three main features have characterized the Monetary Policy since release of Volume I: 1. Real Interest rates are currently high. 2. Unusual volatility in G-Sec Rates of Bonds. (Chapter 3) 3. Glut of liquidity in banks has persisted for about 9 months. (Chapter 3)
Rates are also substantially higher than in comparable emerging market countries.
Nominal Neutral Rate & Repo Rate Normal or neutral interest rates are those that prevail when inflation is close to target and real GDP close to potential. At targeted inflation rate of 4%; neutral interest rate must be between 5.25-5.75 % but the present rate is 6% which shows a deflation of 25-75 Basis points. Current inflation, at 1.5 percent, is running well below the 4 percent target, with the domestic economy lacking the dynamism to push this back toward the target. Example: Capacity utilization in Q3 of 2016-17 is 72.7%. It is suggest that the policy rate should actually be below not 50-100 basis points or so above the neutral rate.
Conclusion: The scope for monetary easing is considerable, more than that suggested by comparison with neutral interest rates. The earlier the easing, complemented with other reform actions especially to address the TBS challenge, the quicker the economy can approach its full potential. Real Rates which affect the decision of consumer and investors are yearly average not what is at the certain point of time. In 2016-17 the average inflation rate was 1.8%, even if in 2017-18 we reach the targeted 4% the average will be 3%. Still the policy interest rate is substantially higher than targeted inflation rate.
Lending Rate, Base Rate & Policy Rates (Repo Rates): Argument against easing repo rate: Why repo rate should be reduced if base rate does not reduce accordingly. Base rate declines by 80 bp in comparison with 175 bp of policy rates. Answer: There are financial stability benefits from cutting policy rates The reduction in the cost of funds without a commensurate decline in lending rates will help restore banks' profitability. Lower rates will also facilitate the TBS problem resolution process. These reductions in lending rates benefit all borrowers, including small and medium enterprises (SMEs).
Fiscal Policy The fiscal outlook for this year is uncertain. Downside risk other than those discussed in budget previously include: Reduced tax revenues from slower nominal growth than anticipated. Reduced GST collections on account of the lower GST rates compared with the pre- GST taxes, and transitional challenges from GST implementation. Reduced spectrum receipts on account of the structural jolt to the viability of incumbent firms. Higher expenditures from the 7th Pay Commission estimated at Rs.30,000 crore. A Slight upside trend may also be seen by positive aspect of GST implementation and tax compliance policies by the demonetization process.
Other Policies Agricultural stress will need appropriate policy responses. Given that 2017 will also be a year of surplus rather than scarcity, and to the extent that firming up prices will be essential to boost agricultural incomes. Situation of cobweb cycle may arise if agriculture issues not seen properly. Proper remuneration policy, stable MSP and easy access to export market will protect both producers and consumers from production & price swings.
Cobweb Cycle Cobweb Cycle is featured by market in which supply by producer depends upon the prices in the previous period. It is the basic characteristic of the market in which time gap between production and selling is large. What to produce in next year is dependent on previous years experience. For example, if pulses prices are particularly high in a given year, more farmers will choose to plant pulses the next year to take advantage of the high price. This increased supply, however, will lead to lower prices.
Other Policies All the impediments that come in the way of realizing better prices for farmers stock limits imposed under the Essential Commodities Act, export restrictions, impediments to the implementation of e-nam need to be removed. The time is also ripe to consider whether direct support to farmers can be a more effective way to boost farm incomes over current indirect, Ineffective, and inefficient forms of support. National Agriculture Market (NAM) is a pan-india electronic trading portal which networks the existing APMC (Agriculture Produce & Market Committee) mandis to create a unified national market for agricultural commodities.