One can be forgiven for harboring optimism about India’s economic outlook in 2018. An uptick in the GDP growth rate, which recently rose to 6.3 percent from a three-year-low of 5.7 percent, has led to many a catchy headline about the country’s renewed growth prospects. While the increased GDP growth rate may itself be a cause for celebration among many India-optimists, it is accompanied by other significant factors which also point toward a recovery. Exports rose by 30 percent in November, as did the Purchasing Managers Index, and Industrial production rose by 8.4 percent in November, showing the manufacturing sectors largest monthly expansion in five years.
The year of 2017 may have ended strongly for India’s voluminous economy, but all is far from well. The dark clouds of fiscal pressures are looming on the horizon and 2018 might be the year we get a clearer look at the weather that India will face.
The rupee appreciated by close to 6 percent against the dollar, to 63.5. The appreciating currency has made imports cheaper – which increased by 25 percent over the last year, and made exports more expensive – which increased more than 18 percent since January 2017. The current account deficit as a percentage of GDP has been declining since its 2013 high of 4.8 percent to lower than 1 percent last year. This decline in deficit has largely been on the back of low oil prices. A $10 increase in the price of oil has been found to boost current account deficit by 0.4 percent, and inflation by 0.7 percent. The recent increases in oil prices on the back of OPEC production cuts will certainly not bode well for India’s macroeconomic indicators. Crude oil prices are currently at their highest level since 2015, at $67.02 per barrel.
Inflation, which was in double digits in 2013, dropped to below 2 percent during the last year, but is picking up again and has already climbed up to above 5 percent. The Reserve Bank of India has been dropping its benchmark interest rates since the inflationary surge just 5 years ago, but might have to change this stance if inflationary pressures pick up. The bank lending rate is at an unusually high rate of 9.45 percent, an increase in which would be a detriment to consumption and business lending.
The RBI is likely betting on the $32 billion bank recapitalization in 2017 to prop up lending in addition to the relatively declining interest rates. An additional $7.8 billion in debt were borrowed by the government, further pushing the fiscal deficit.
The government is set to announce its budget for the financial year on February 1, 2018, and is likely to dedicate more than the usual share to populist measures, such as farm loan wavers. Previous administrations have had no problems in being consistent sources of farmer appeasement – with free water, free electricity, subsidized fertilizers, and minimum support prices. Indian farms, with the government spoon-feeding them sufficiently, have some of the lowest agricultural productivity in the world. Neeraj Kaushal has pointed out in a recent article that China produces 30 percent more rice than does India, using just two-thirds the land. Indian farms would be a lot more productive, and the plight of farmers would be sufficiently ameliorated, if the focus of agricultural policy moved away from subsidies and handouts (which don’t come close to having their desired effect) and towards promoting water-efficient and resource optimizing techniques. 2018 being the lead-up to an election year, however, makes it highly unlikely that Indian agriculture policy will change. It can be expected that the expenditure on handouts and wavers will keep the deficit high.
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Fiscal challenges beyond agriculture still loom. The Economist reports that roughly one in every six rupees in India goes into a State Owned Enterprise (SOE), and one in three of these SOEs withstood losses. Many of these companies are profitable, but incredibly inefficient. The problem with these SOEs is epitomized by the case of Air India, which is currently stuck in an arduous process of dealing with its potential privatization. The decision to allow a 49 percent foreign ownership of the airline is a step in the right direction, but further progress must be made in reducing the burden of SOEs on the government’s balance sheets. Further, the decision to allow complete foreign ownership of retail firms will be a boost to Indian retail and employment standards. There may be problems associated with the complete free flow of FDI, especially as highlighted in a recent paper by researchers at the IMF which documents negative inequality effects of capital account liberalization (Furceri et al. 2017). But allowing foreign firms to invest and participate in the Indian economy with more ease can be the first step in reducing the SOE burden and in rejuvenating Indian industry. The government’s goal of bringing the fiscal deficit down to 3 percent is now impossible, and the lack of fiscal discipline – although not troublesome yet – sets terrible precedent.
According to data from the Center for Monitoring the Indian Economy, just $12 billion of new projects were announced in the quarter which ended in December 2017. This is the lowest level of private capital expenditure recorded since June 2004. This lack of private investment is problematic, especially when considering the scale of employment generation needed in order to provide work for the 17 million Indians entering the job market annually. Currently, only around a third of this requirement is being met. Infrastructure and industrial capacity buildup requires investment, but unfortunately, despite high savings rates, these savings are not translated into capital for business activity. The structure, and flexibility of financial markets need to be addressed to solve this problem.
Indian exports need to pick up as well, so as to close down the current account deficit and reduce import reliance. But the export contribution to GDP in India halved to less than 20 percent last year. Even as global trade picked up over the last few years, Indian exports expanded by a far lower level (12 percent) than did those in other countries such as Vietnam (22 percent) and South Korea (18 percent). The export of commodities such as steel and petroleum account for more than half of this growth, posing another problem for Indian industry. Mint reports of a disturbing divergence between export growth in labor-intensive and other industries, with the growth almost anemic in labor-intensive industries. Many reasons are cited for India’s lagging exports, GST being the most recent of them. But if a recovery in the exporting industries is to be seen in 2018, increased investment in manufacturing operations are needed.
The Indian economy’s development over the next year will be subject to the exogenous effects of oil prices, and the relative value of the rupee. One can expect the deficit to pick up as a result of populist spending, and the unlikelihood of agricultural or industrial reforms. The lack of export growth, unless rectified, will continue to be a burden for the Indian economy, and the lack of job creation in manufacturing will leave millions out of the reach of economic benefits. Policies must be geared toward increasing private and foreign investment, and focusing industrial growth onto exports and manufacturing activity. As we await the next fiscal years’ budget, it’s important to consider the difference between impactful policy that will transform the economy, and more of the same.
The author, Mihir Baxi, is an economic analyst and researcher. His work focuses on international economic affairs.
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