Growth may pick up, but concerns remain

Sectoral trends in the economy:

Agriculture:

• This year’s  monsoon has been somewhat below expectations — the overall rainfall deficiency was 3% (as of July 25). 11 meteorological divisions (of a total of 36) were deficient.
• The area sown has come down. Rice-producing Bihar, for instance, has been severely affected.
• Though the monsoon may pick up, agricultural growth may at best be equal to what it was last year — 3.4%.

Services sector:

• The services sector may perform better because public expenditure will be maintained at a high level.
• This is to be expected, as this happens to be the year before the elections.

Industrial sector:

• As for the industrial sector, the data for the Index of Industrial Production (IIP) for the first quarter shows substantial improvement over the corresponding period of the previous year.
• The combined revenues and profit of 370 large companies have shown better performance in the first quarter.
• The problems of the goods and services tax (GST) may have been largely overcome, but it is still a work in progress.
• A pick-up in the growth rate in the manufacturing sector is likely.

 

Overall Growth Rate:

• Looking at the overall GDP, after several quarters of low growth, there was a strong pick-up in the last quarter of 2017-18.
• If this momentum is maintained, the growth rate (2018-19) will certainly be above 7%.
• International financial institutions have forecast a growth rate of 7.3%.
• The Reserve Bank of India (RBI) expects it to be 7.4%.

 

Factors that can come in the way of faster growth:

1. External environment and the impact:

• The external environment is far from reassuring.
• Trade wars:
  • Trade wars have already started and can get worse.
  • The U.S. has raised duties on several products such as steel and aluminium, and on certain products imported from China. In turn, China has retaliated.
  • India has also been caught in this exchange.
  • It is difficult to forecast how much worse this will become.
  • Besides these, there are country-specific sanctions such as those against Iran, which have a direct impact on crude oil output and prices.
• Current account deficit:
  • India benefited from the fall in crude prices earlier but this position has reversed.
  • There has been some lull in crude prices. But, as a net importer, India’s balance of payments can take a beating if crude prices rise again.
  • India’s current account deficit, which was as low as 0.6% of GDP in 2016-17, rose to 1.9% of GDP in 2017-18, mainly because of crude price rise.
• Trade deficit:
  • India’s trade deficit has always remained high.
  • In 2016-17, the merchandise trade deficit was 4.8% and rose to 6% of GDP the next year.
  • In 2017-18, India’s export growth rate was 9.78%.
  • There is an inescapable need to raise our export growth rate.

Measures needed:

• Managing the value of rupee:
  • Despite a current account deficit, India’s rupee had remained strong because of capital flows.
  • With a rising trade deficit and some outflow of capital, the rupee has depreciated. This is not unnatural.
  • The RBI should act only to ensure that the adjustment is smooth and there are no violent fluctuations.
  • We need to ensure that the rupee does not appreciate in real terms.
• Improving export competitiveness:
  • What is really important is to make our exports competitive.
  • Improved efficiency in production and better infrastructure are important in this regard.
• Others:
  • Maintenance of domestic stability also plays a key role.
  • Over the medium term, we also need to search for an alternative fuel.

 

1. Reviving the banking system

High NPAs:

• The banking system continues to be a source of concern.
• The RBI’s latest report on financial stability shows that the gross non-performing asset (NPA) ratio of scheduled commercial banks rose to 11.6% (March 2018).
• The ratio for public sector banks was 15.6%.
• This is indeed a very high level of NPAs.
• Some part of the increase is also due to the adoption of a more rigorous definition of NPAs.
• Effect on new credit:
  • The high NPA level has a dampening effect on the provision of new credit.
  • In fact, credit to the industrial sector has slowed down considerably.

Resolving the issue:

• Recapitalisation of banks has become an urgent necessity, even though this will impose a burden on the fiscal position.
• Many suggestions, which include asset reconstruction companies, have been made to resolve the NPA issue.
• Unless the banking system recovers fast, it is difficult to sustain a high growth of the industrial sector.
• Medium-term banking reforms will have to wait until the immediate problem is resolved.

 

1. The fiscal position:

• So far in the current year, the Central government’s fisc has been within limits.
• At the end of the first quarter, the fiscal deficit as a percentage of total deficit for the year as a whole was 68.7% — a strong improvement over the deficit in the corresponding period last year.

Two issues of concern in this regard:

• GST:
  • It is estimated that GST revenues are currently running behind budgetary projections.
  • Any significant shortfall can put the fiscal position under stress.
• MSPs:
  • Another concern relates to the impact of the proposed minimum support prices (MSPs) for various agricultural commodities.
  • The MSPs have been raised sharply in the case of some commodities.
  • The burden on the government as a result of the new MSPs is uncertain and needs to be watched.
  • The possibility of cutting expenditures if revenues fall below projections is remote in a year before elections.

 

Conclusion:

• The expected growth rate of 7.3-7.4% may be reassuring. It may even be the highest in the world economy.
• Nevertheless, it falls short of our potential.
• It is below of what is needed to raise job opportunities and reduce poverty.
• It is true that the external environment is not helpful.
• But a stronger push towards a much higher growth is very much the need of the hour.

 

Importance:

GS Paper III: Indian Economy