Inflation, GDP among slew of tough economic issues awaiting next govt

Coalition or otherwise, the new govt will also have its hands full dealing with the IL&FS and Jet Airways crisis, crude prices and bank consolidation

The contours of the next government, whether it would be a rag-tag coalition or one party-dominated, would become clear on Thursday. Whatever its composition, the coming government will have to look at the dire needs of the economy which has been slowing down, besides rising food inflation and crude prices, problems created by grounding of Jet Airways and the IL&FS crisis and consolidation in the banking sector. Let us look at these problems and how the government can solve them:

Economy:

Economic growth is slowing down, and there are few resources to perk it up. And herein lies the greatest challenge for the next government, irrespective of the parties that form it. Gross domestic product (GDP) growth was officially projected to come down to seven per cent in 2018-19, the lowest under the Modi government. And the finance ministry believes growth would remain at seven per cent in the current financial year too. However, the multi-lateral agencies have pegged it bit higher. For instance, IMF estimated growth at 7.3 per cent, though lower than 7.5 per cent projected earlier. The World Bank put it at 7.5 per cent. As such, growth would be stuck in 7-7.5 per cent for three years. It was 7.2 per cent in 2017-18. 

With the government struggling to rein in fiscal deficit at 3.4 per cent for 2018-19, boosting private investments would be a key, for which again the government has to rein in fiscal deficit so that resources aren't crowded out. The Interim Budget had pegged the deficit at 3.2 per cent of GDP for 2019-20, higher than the original goal of 3 per cent. One has to watch the first Budget of the next government to see that number. Already, there are concerns about ambitious revenue projections, especially those on direct taxes. Dwindling tax revenues would put the government in a spot on the issue of giving additional resources to the common man to perk up demand. While at the macro level, private final consumption expenditure does not tell a sorry tale, there are worrying signs in micro numbers, particularly those on demand in rural areas, such as two-wheeler sales which grew just 4.8 per cent in 2018-19 against 14.8 per cent the previous year. Indicating further erosion of demand, two-wheeler sales plunged 16.4 per cent in the April, 2019. D K Srivastava, chief policy advisor at EY India says the government should set up a counter-cyclical fund and also allow fiscal deficit to widen by up to 1.5 per cent of GDP during a slowdown. 

Building pressure on food inflation would be another worrying point. Though consumer price index (CPI)-based food inflation is still low, that based on the wholesale price index (WPI) was over seven per cent in April. Early pressure on inflation is seen in WPI and then in CPI. The exact trajectory of the monsoon would play a key part in it.

Bank mergers:

With the NDA government having bitten the bullet on bank mergers, the next regime will have to take the step forward to create economies of scale. While associate banks of SBI and Bharatiya Mahila Bank have been merged with the country's largest lender, the merger of Vijaya Bank and Dena Bank with Bank of Boroda is already underway. The number of public sector banks has already been pared to 19 from over 25.

The government might look at the experience of the Vijaya-Dena-BoB merger, before going for another consolidation. According to sources, the merger would take another year to complete.

However, some banks are already being considered for merger and the plan might be put before the next finance minister. Punjab National Bank and Canara Bank could be merged. Mid-sized banks such as Allahabad Bank, Andhra Bank, Bank of Maharashtra, Central Bank of India, Indian Overseas Bank, UCO Bank, United Bank of India and Union Bank of India could be considered for merger with the two banks.

Besides economies of scale, this would also enable banks to come out of prompt corrective action (PCA) mehanism of the RBI and enable them to lend to productive forces, which is needed to boost economic growth.

The number of banks under PCA framework, which imposes lending restrictions and prevents them from expanding, among other curbs, has already been reduced to four from eleven earlier.

The government will however, have to see whether synergies work between these banks to merge or not, and whether economies of scale would arrest or raise their non-performing assets. For that, the success of Vijaya-Dena-BoB merger may have to be assessed properly.

NPAs of public sector banks have already touched over 14 per cent of advances at the end of 2017-18.

When the Cabinet had approved the Vijaya-Dena-BoB merger, the government had said the amalgamated bank would be better equipped in the changing environment to meet the credit needs of a growing economy, absorb shocks and capacity to raise resources.

The merged entity already has economies of scale, as with a total business of about Rs 15 trillion, it is the third-largest lender in India, after State Bank of India (SBI) and HDFC Bank.

However, the success of the new entity will have to be tested in the next one year before expanding the move.

Disinvestment:

Given the challenging task of reining in fiscal deficit at 3.2 per cent of GDP in 2019-20, the Interim Budget has pegged proceeds from disinvestment at Rs 90,000 crore, higher than about Rs 84,000 crore garnered the previous year. One has to watch the final number in the Budget, to be presented in July. If direct tax numbers are lowered, proceeds from disinvestments and other categories will have to be raised to rein in fiscal deficit, assuming expenditure remains at the same level as projected.

The government mopped up more than the budget target by way of disinvestment proceeds in the last three years. But in the first two years, the disinvestment receipts lagged the Budget numbers, and stood at just Rs 37,736.85 crore against a budgeted Rs 63,425 crore in 2014-15. And in the next financial year, the receipts were just over Rs 42,000 crore against the target of Rs 69,500 crore.

Thereafter the story changed and the government got over Rs one trillion in 2017-18 against the Budget target of Rs 72,500 crore. 

Even as disinvestment targets have been met in recent years, strategic disinvestment hasn't realy been a success. In fact, after the failure in the first four years, the government did not give any number to strategic disinvestment in 2019-20. This was despite the fact that Air India was on the block throughout the year and was shelved at the eleventh hour. However, PFC-REC merger of FY19 was also a strategic sale of sorts.

The government might consider privatising Air India this financial year. The civil aviation ministry has already told the carrier that it should prepare 2018-19 financials for itself and its subsidiaries by June end as the Prime Minister's Office (PMO) has decided to speed up the disinvestment process of its subsidiaries, according to news agency PTI. .

A ministerial panel has already cleared the strategic sale of the airline's ground handling subsidiary, Air India Air Transport Services. Plans are afoot for selling another subsidiary, Air India Engineering Services.

Air India has a total debt burden of about Rs 55,000 crore, a key privatisation hurdle.

The Department of Investment and Public Asset Management (DIPAM) is also examining plans to launch three equity exchange-traded funds (ETFs) in the current fiscal year. An ETF is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. It provides diversification to investors and is cheaper than investing in an actively managed mutual fund.

According to the plans being prepared and to be presented to the new government, the proposed ETFs will be sector-specific -- one each in banking, metals and commodities, and energy.

Ranen Banerjee, leader, public finance and economics at PwC India, says the disinvestment goal for 2019-20 will be met. He feels that out of various receipts, disinvestments were easiest to meet in initial years of the government.

Crude prices:

The Interim Budget for 2019-20 was prepared assuming an average price of $65 a barrel for the Indian basket of oil. According to Petroleum Planning and Analysis Cell (PPAC) figures, the prices stood at $71 a barrel this April. Bank of America Merrill Lynch (BofAML) has warned that Brent crude, which is one-fourth of the Indian basket, could reach $90 a barrel due to the new International Marine Organisation (IMO) rules regarding shipping fuels and a weaker dollar following a de-escalation of US-China trade war, according to news agency Reuters .

BofAML claimed that the IMO rules on allowable sulphur content, which come into force in 2020, could cause a spike in middle distillate demand, pushing prices upward. A weakening dollar could also spike prices, should the US-China trade war simmer down.

If Brent prices really go that high, it would become a challenge for the  new government to contain the subsidy burden on liquified petroleum gas (LPG) cylinders. There would also be pressure on the government to lower taxes on petrol and diesel, which were raised during the NDA rule initially and lowered only partially later.

As taxes can't be lowered drastically, since the government has to  play a key role in propelling economic growth till the private investments come back, the pressure would mount on the GST Council to bring in fuels under the goods and services tax regime. Much would depend on the Centre's persuasive skills in getting the states to agree to this, given that a large chunk of states' revenues comes from oil taxes.

The government has budgeted Rs 32,989 crore as LPG subsidy for 2019-20, almost 63 per cent higher than Rs 20,283 provided in 2018-19. Now, the government mostly provides LPG subsidy in the petroleum sector. With 94 per cent penetration of LPG to households, this subsidy would remain in the near future. Kerosene subsidy has been reducing over the years and is budgeted to stay at Rs 4,489 crore in FY20, a bit lower than Rs 4,550 crore the previous year.

Jet Airways and IL&FS crises:

As much as Rs 8,400 crore owed to 26 lenders, including SBI, is stuck up in the beleaguered Jet Airways and another Rs 57,000 crore in IL&FS.

The next government would face a huge challenge on this account. But, it can do in Jet's case apart from  getting its National Investment and Infrastructure Fund (NIIF) to bid for the airlines and conducting a probe into alleged fund diversion. The consortium of lenders had shortlisted NIIF, private equity firm TPG Capital, Indigo Partners and Etihad Airways to submit their bids after they put forward their Expression of Interest (EoI). Of these, only Etihad expressed interest in buying a stake in the debt-laden airline and that too on May 10, the last date of the bidding. It was reported that others had lost interest in Jet after its aircraft and slots at airports in Delhi and Mumbai were given to competitors.

But there have been unsolicited bids too. London-based AdiGro Group, the parent company of AdiGro Aviation, has offered to restart the airline's operations by July 1. Sanjay Viswanathan, Founder and Chairman of AdiGroup has expressed interest in partnering with Etihad Airways and turning around the 25-year-old airline which had its operations on April 17.

Consortium leader SBI had reportedly approached unsolicited bidders last week including UK-based entrepreneur Jason Unsworth, Mumbai-based Darwin Platform Group and AdiGro Aviation. Recently, the Hindujas said they were evaluating opportunities to bid for the beleaguered airline.

After the IL&FS board was superseded by the government and replaced with the new one, some new information came to the fore. It was reported that the crisis was much more complex than thought earlier, because the number of subsidiaries and associates have more than doubled to 348, and most have negative networth.

Also, one of the companies --  IL&FS Financial Services (IFIN)--had gross non-performing assets amounting to 90 per cent of its loans as of December 2018. Gross NPAs had stood at 61.8 per cent in the previous quarter and just 5.3 per cent in the January-March 2018 quarter.

As the board and the government seek to turn the company around, the ministry of corporate affairs said IL&FS entities will be sold individually instead of as a whole group.

The issue of IL&FS emerged at a time when the NBFC and housing finance sectors are facing a liquidity crisis. The new government will have to resolve IL&FS to prevent the crisis from having a chain effect on other areas.

RBI's next monetary reivew meeting:

The next meeting of the monetary policy committee (MPC) on June 3, 4 and 6 would not only indicate the steps being taken by the central bank to spur the economy, but would also provide a beacon to the government on fiscal policy. It is yet to be seen whether the MPC would go for another rate cut or wait for clear cut picture on inflation, particularly food prices.

While the index of industrial production (IIP) contracted in March for the first time in 21 months and this, along with concerns on larger GDP growth could weigh on RBI's mind, it also has to address building pressure on food inflation.

Though consumer price index (CPI) inflation is still low, the wholesale price index (WPI) inflation was over seven per cent in April. Early pressure on inflation is first seen in WPI and then in CPI. The exact trajectory of the monsoon would play a key part in it.

RBI's monetary review would also indicate how is it planning to deal with the NBFC and housing finance company liquidity crisis, even as the central bank believes liquidity shortage is not a systemic issue.

Srivastava of EY India said one more rate cut by MPC might be on the cards.

Devendra Pant, chief economist at India Ratings, said there are even chances for a rate cut in the June monetary review to spur slowing down demand. However, any such move would be data dependent. Before the monetary review, GDP and fiscal deficit data for FY19 will be released. Besides core sector data for April and PMI data for May will also be out.