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February 07, 2017

Outlook Fiscal 2018: And down came consumption

Policy prudence to the fore


The Budget for fiscal 2018 resisted the temptation to raise the fiscal deficit target and support a sluggisheconomy. The Reserve Bank of India (RBI), too, stayed focused on taming consumer inflation to 4% on a durablebasis and bucked pressure to wield the scalpel in its February monetary policy review.


In the absence of any support from the global economy, which in itself is in the midst of a turbulent political phase,India’s economic growth will be a slow grind-up. We expect GDP to rise to 7.4% in fiscal 2018 over 6.9% in thecurrent fiscal assuming another normal monsoon and a substantive pick-up in pent-up after demonetisation.


So what’s the benefit of the conservative monetary and fiscal stance? First, it strengthens the macroeconomicfundamentals by improving the growth inflation mix in a slow but steady manner. We have seen that in theaftermath of the global financial crisis, India did resort to monetary and fiscal stimulus. This led to high growthbut also pushed up the fiscal deficit and inflation. Ultimately, that kicker proved transient.


Second, macroeconomic prudence enhances the credibility of policy making, improves investor confidence, andmakes the economy resilient to external shocks. We have already witnessed how improvement in macroeconomicfundaments lends stability to currency in turbulent times. Unlike in 2013, when the so-called ‘taper tantrum’ ledto extreme volatility in the rupee, in the past two years the rupee has shown remarkable stability despite globalshocks.


Calendar 2017 is likely to be quite flighty given the protectionist stance in the US authorities, the possibility ofgame-changing elections in Germany and France, and a messy Brexit. All of these can be bucketed as ‘politicalrisk’, and if they materialise, can quickly morph into economic risk. In such an environment, countries withprudent policies will remain relatively resilient to, if not insulated from, turmoil.


Domestic short-term indicators – the Index of Industrial Production and Consumer price index (CPI)-basedinflation-- edged downwards in January, reflecting the impact of demonetisation. CPI inflation softened to 3.2%in January from 3.4% in December, primarily because of a 70 basis points (bps) drop in food inflation. The fuelcomponent of CPI rose afresh on rising crude oil prices and weaker rupee. Meanwhile, the stickiness in coreinflation is contrary to the refrain that demonetisation had materially dented core demand; core inflation (CPIexcluding food) rose to 5.1% in January, from 5% in December.


The discomfort in India’s inflation dynamics arises from the stickiness of core inflation and the sudden jump inWholesale Price Index-based inflation in January. Although WPI is not the preferred metric for the RBI, it doesindicate that consumer inflation could start rising soon.


Industrial production in December fell by 0.4 %, due to a 2% contraction in the manufacturing sector. Mining andpower did relatively well. Falling by 5.8% in December, the consumer-oriented sectors joined the investmentorientedsectors, which have been the laggards.


The next policy challenge for the government is the implementation of the Goods & Services Tax (GST) by July.Although an ideal GST is unlikely, it will yet mark a significant improvement over the prevalent distorted indirecttax structure in India.