Subir Gokarn: Nothing's going to spoil the party

Both private investment and exports will lose some of their momentum, but rising incomes and affordability will ensure consumption-spend continues, leaving growth marginally lower.

The fact the fiscal year is different from the calendar year makes life somewhat inconvenient for forecasters. At the end of each calendar year, we are asked for our assessments for the next calendar year, whereas the standard operating procedure for most of us is to update forecasts for the fiscal year, beginning in April. Sometimes, one quarter can make all the difference between being on and off target! Nevertheless, the broad trends that will influence macroeconomic performance over the next 12-15 months are visible now and predicting the course of the economy during 2007 shouldn't be too difficult.

The high growth rate being seen in the current year is the combination of substantial contributions from domestic consumption spending, private investment and exports. Of these three, the consumption spending momentum will persist into the next year, driven by rising incomes and affordability. However, the other two drivers are likely to see some moderation. Investment spending has been buoyant over the last three years, as businesses expanded capacity across a range of sectors. Investment cycles are relatively sharp and typically last around three years. Of course, past experience isn't a particularly good guide, simply because the current growth pattern is itself unprecedented. Investment spending could well continue to rise into the next year and beyond. However, forecasting as a profession necessarily relies to an extent on historical precedents. On this basis, we should expect to see some slowing of the private investment momentum. Exports will also, very likely, see a bit of softening as a result of the anticipated slowdown in the US economy, however, mild though this may be. Taking these probabilities into consideration, we do expect some reduction in the GDP growth rate next year, when it will fall slightly below 8 per cent. This tendency could, of course, be offset by a substantial increase in public investment as well as acceleration in consumption spending, but we will wait and watch for these factors to kick in.

Given the expected slowdown in growth, inflation should pose less of a threat from the demand side. In other words, the "overheated" economy will cool down somewhat, reducing inflationary pressures. From the supply side, or a cost-push perspective, slower US and overall global growth will reinforce the current downward trend in oil prices as well as those of other commodities. Some sectors are, of course, facing enormous pressure on their salary bills, which is going to be both a deterrent to growth and a spur to rising prices. However, the combined impact of both demand and supply side forces should be neutral. Over the next year, inflation rates will remain pretty much where they are in the current year, that is, in the 5-5.5 per cent range as measured by the Wholesale Price Index. The current spurt in the Consumer Price Index is largely being driven by higher prices of a number of food articles. These are, typically, temporary surges and should not have any significant influence over price movements in the coming year.

Interest rates are clearly on the rise as a result of the policy stance of the Reserve Bank of India over the last couple of years combined with the growth acceleration we have seen during this period. This may seem like a contradiction, but the counter-factual is that growth would have been even faster if monetary policy had been more accommodating. Be that as it may, the slowing growth and stabilising inflation scenario that we anticipate will have a moderating impact on interest rates. This will be reinforced by the persistence of large capital inflows, which I address a little later in the article.

The fiscal deficit has remained the one somewhat negative manifestation in an otherwise supremely positive macroeconomic scenario. Even here, the direction of change is unambiguously positive. Rapid growth has translated into a significant surge of tax revenues this year. Even if the growth rate slows as anticipated, it is still high enough to support the parallel efforts in expanding coverage and improving tax administration to keep revenues growing at healthy rates. We certainly expect the deficit target for this year to be met and also expect that the finance minister will not have any difficulty in adhering to the annual milestones laid out by the Fiscal Responsibility and Budget Management (FRBM) Act. This confidence, however, is more in relation to the overall deficit target. The revenue deficit component, for which there is a distinct target, may be a somewhat more difficult variable to control, but revenue buoyancy of the magnitude that we have seen this year will certainly help to bring that gap under rein. As the revenue deficit is bridged, it will allow more room for capital spending by the government.

Finally, on the external front, the decline in oil prices will ease the current account deficit, which had grown to a size that worried quite a few people this year. Softening export growth and healthy imports resulting from a growth rate that will still be quite close to 8 per cent will, however, somewhat offset the favourable impact of oil prices on the deficit. However, this should not at all be a matter of concern. Capital inflows have been healthy and, to the extent that they are being driven by the very positive growth prospects of the economy, will continue in that vein. Even if GDP growth drops below 8 per cent next year, India will still be a firm number two in the global growth hierarchy and global investors cannot and will not ignore this. We expect overall balance of payments to remain comfortably in the black, as capital inflows will far outweigh the current account deficit. This will hold even as capital outflows as a result of foreign acquisitions by Indian companies continue to grow.

A balance of payments surplus necessarily means that the rupee will tend to appreciate. However, we see exchange rate policy as being driven by the need to protect exporters and the jobs that they generate from being harmed by an appreciating currency, particularly when all our major competitors will do everything that they can to help their own exporters. Although opening up on the capital account for resident Indians will help a bit, the exchange rate will be maintained in a narrow band close to where it is now with the help of reserve accumulation.

Overall, then, 2007 will be a relatively tame year as far as the macroeconomy is concerned. There are really no significant risks that are currently visible on the radar screen. We forecasters will have to turn our attention to a different set of outcomes; who will win the World Cup, for instance, or the UP elections? More on those issues next year!

The author is Chief Economist, Crisil.