<b>Shankar Acharya</b>: Speculations for 2017 in an uncertain world

After Trump win and Modi's demonetisation move, uncertainty at home and abroad could be very high

Predictions and forecasts are inherently uncertain and subject to gross errors. 2017 is fraught with abnormally high uncertainty because of two recent major events, both of which occurred on November 8, 2016. At the global level, it was the unlikely election of the mercurial Donald Trump as President of the United States, the world’s largest national economy and the strongest (by far) military power. In India, it was the unprecedented, economic experiment of 86 per cent demonetisation announced by Prime Minister Narendra Modi. Before turning to specific speculations, it is reasonable to ask how my predictions for 2016 fared (Business Standard of January 14, 2016). By my (admittedly biased) assessment I got about three-quarters of my 20 forecasts right but flunked ignominiously on two big ones: Brexit and the US presidential election. 

An uncertain world 

1. Thanks mainly to the recent strength of the US economic recovery and the apparent plateauing of China’s growth slowdown (at around 6 per cent), world economic growth is likely to be a little faster than in 2016, at 2.5-3.0 per cent at market exchange rates.

2. But world trade volume growth will remain sluggish, at below 2 per cent because of the cumulation of restrictive measures since 2008 and the likelihood of protectionist actions by the new Trump administration. Thus the ratio of global trade to output will decline. 

3. The US economy will grow at around 2.5-3.0 per cent, helped by recent momentum and a likely Trumpian fiscal stimulus. Inflation will rise and the Federal Reserve is likely to increase policy rates by about 0.75 per cent by the year-end. 

4. The European Union will remain stressed by the incipient banking crisis, unresolved problems of the Euro Zone, the continuing refugee influx and ongoing swing towards nativist, anti-Union parties and governments. Growth will stagnate at around 1 per cent and two or three bail-outs of major European banks in southern Europe are likely. 

5. As predicted last January, Brent crude was trading above $50 a barrel by December. Barring unforeseen crises, the price is likely to remain in the range of $50-65 during 2017. 

6. US-Chinese economic relations will worsen, with some likely anti-China trade actions by the US, followed by calibrated retaliations. Despite some risks, a full-fledged trade war will be avoided by mutual self-interest. 

7. US-Chinese politico-strategic relations will also deteriorate, with growing frictions over Taiwan, the South China Sea, North Korea and the spill-over from economic ructions. 

8. There will be some improvement in US-Russia relations, but much less than presaged by the pre-inauguration comments of Mr Trump. A key indicator will be the trends in existing economic sanctions deployed by the US. 

9. There will be substantial stress on the Iran nuclear deal, but it will hold, at least through 2017. 

10. There is perhaps greater risk of US military action against North Korea’s nuclear missile capabilities. 

11. Although Britain is likely to trigger the notorious article 50 for Brexit by March, the objectives and course of the ensuing negotiations will remain opaque to the British population and perhaps the country’s negotiators. 

12. West Asia will continue to bleed from its many deep wounds and Israel will ensure the death of the two-state plan.

India outlook 

1. Whatever the long-run benefits of demonetisation, the short-run economic consequences are clearly adverse and substantial. Based mostly on data up through October, the recent official Advanced Estimates indicate gross domestic product (GDP) growth of 7 per cent in 2016-17. More recent indicators and numerous field-level reports suggest substantial damage to the heavily cash-reliant informal sector production, which accounts for over 40 per cent of India’s GDP. When official GDP estimates for the October-December and January-March quarters become available by end-May, the full year growth estimate may well be revised down to markedly below 6 per cent. Recovery in 2017-18 may only pick up after June 2017. 

2. With over 80 per cent of India’s employment in the cash-dependent unorganised sector, job-losses are likely to be high. Data are patchy and unreliable. The All India Manufacturers’ Organisation projects job losses in micro, small and medium manufacturing enterprises at over 50 per cent by March. This seems high. Besides, a key issue is the duration of such job losses. Either way, job growth has clearly suffered and needs to be reversed soon to avoid large-scale social discontent (and crime), given India’s growing and under-educated labour force. 

3. Even the official Advanced Estimates foresee a marked decline in the rate of gross fixed investment to below 27 per cent of GDP, the lowest since 2003-04.  The trend reversal is unlikely to occur until consumption recovers from the cash crunch and bullish sentiments are restored, perhaps not till the latter half of 2017-18. 

4. On the positive side, consumer inflation is likely to remain below 5 per cent throughout 2017. 

5. However, after three comfortable years, we may see some build-up of pressure on India’s external finances, given sluggish exports of goods and services, recent declines in remittance inflows, subdued levels of net foreign portfolio investment and a significantly higher average price for oil imports. Accordingly, the rupee is likely to depreciate to perhaps 72-75 per dollar by the year-end. 

6. While the central government’s fiscal deficit target of 3.5 per cent of GDP is likely to be met in 2016-17, there is a high probability that the goal of further consolidation to 3 per cent for 2017-18 will be deliberately “paused” to provide some fiscal stimulus to counter the deflationary impact of demonetisation. 

7. The political strife triggered by demonetisation may also lead to delays in passage of the key Bills to implement the goods and services tax (the government’s flagship reform) beyond April. There remains a good chance (but no certainty) of achieving this by September. 

8. The stressed balance sheets of public sector banks will continue to be a challenge in 2017. It is possible that, with new leadership in the Reserve Bank of India, a “bad bank” approach may be tried to deal with the problem. 

9. In politics, the forthcoming Uttar Pradesh elections are the big thing, especially as the result will be widely viewed as a verdict on the national Modi government. With three major contending parties (Samajwadi Party, Bharatiya Janata Party and Bahujan Samaj Party), it is too difficult to call. 

10. Finally, in foreign policy, the biggest challenge for India will be to forge a viable and productive relationship with the new Trump administration. The perennial challenges of Pakistan and China will continue. Watch out for new forms of aggression, such as cyber warfare.

Happy New Year!

The author is honorary professor at ICRIER and former chief economic adviser to the Government of India. 

Views are personal