Economic Survey II: Optimism and anxieties

Survey remarks that current repo rate of 6% is about 25-75 bps above the neutral rate

The analysis on the state of the economy presented in the Economic Survey-II, refreshingly lays bare both the optimism about the medium-term outlook, as well as the anxiety that is building in the immediate term.

Optimism stems from the structural reforms and policy decisions being taken by the government and the Reserve Bank of India (RBI), and the pervasive macro-economic stability that these have engendered. Anxiety is attributed to factors such as the continuing twin balance sheet problem, short-term costs of demonetisation and the transition to the goods and services tax (GST), the fiscal impact of crop loan waivers and sub-par economic growth. Some of this pessimism regarding the near term outlook was mirrored in the forward looking surveys released recently by RBI, which indicated a dip in business sentiments and consumer confidence. 

The Survey focuses on the macroeconomic impact of farm loan waivers, estimating that contagion could drive the total amount to as high as Rs 2.7 lakh crore. It elaborates four channels through which the waivers would affect aggregate demand: An increase in private consumption via higher private sector net wealth; the public sector impact vide changes in expenditure and taxation; crowding out on account of higher state government borrowings; and crowding in through higher credit availability, following a decline in bank non-performing assets. The Survey estimates that since most states would not have the fiscal space to fund loan waivers, they would have to curtail other expenditure. On balance, it forecasts that for the maximum possible loan waiver of Rs 2.7 lakh crore, aggregate demand would be reduced by Rs 1.1 lakh crore, imparting a significant deflationary shock to the economy. While the Survey acknowledges that the normalisation of food prices would push up retail inflation from the historic lows seen in June 2017, it concludes that inflation in March 2018 would likely be lower than RBI’s medium-term target of four per cent. 

Economic Survey-I released in February 2017, had forecast a range for real gross domestic product (GDP) growth for FY18 of 6.75 per cent to 7.5 per cent. Economic Survey-II concludes that the balance of risks have shifted to the downside, following the real exchange rate appreciation, moderation in profitability in the power and telecommunications sectors, farm loan waivers, and the short-term impact of GST. Accordingly, Economic Survey-II places a lower probability on outcomes closer to the upper end of the GDP growth forecast range of 6.75 per cent to 7.5 per cent for the current financial year. 

The Survey remarks that the current repo rate of six per cent is about 25-75 bps above the neutral rate, and further asserts that cyclical conditions suggest the policy rate should be below the neutral rate, concluding that there is substantial scope for monetary easing, which would be welcomed by borrowers. Some of these views differ from those of the Monetary Policy Committee of RBI, which forecast inflation at a little above four per cent by Q4 of FY18, growth of gross valued added at basic prices at 7.3 per cent for FY18, and maintained a neutral stance of monetary policy, in its August 2017 review. Moreover, it cautioned that implementation of farm loan waivers by state governments may lead to fiscal slippages and undermine the quality of public spending, entailing inflationary spillovers. On the fiscal policy front, the Survey highlights risks to meeting the budgeted targets for FY18, including lesser tax revenues arising as a result of lower-than-expected nominal GDP growth, moderate tax rates post-GST, and the transitional challenges related to the implementation of GST; lower spectrum receipts; and higher expenditures related to the Seventh Central Pay Commission’s award. This list can be augmented by halving the surplus that RBI has announced it will transfer to the Central government in FY18, relative to FY17. 

Looking ahead, the Survey highlights the upside potential to government revenues from higher compliance post-GST and demonetisation. Moreover, it emphasises the importance of implementing various actual and promised measures, such as the GST, privatisation of Air India and addressing the twin balance sheet problem.
 

Naresh Takkar, Managing Director and Group CEO, ICRA

(Views expressed are personal)