7/20/2017 Indian economy: A tale of two narratives - Livemint

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Last Published: Wed, Jul 19 2017. 08 00 AM IST

Indian economy: A tale of two narratives
A weak economic growth narrative sits uneasily with dramatically improved macroeconomic stability, but a traditional counter-cyclical
response is unlikely to be ef cacious

Sajjid Z. Chinoy

The recovery post-demonetisation has been incomplete. Photo: AFP

There are two competing, economic narratives on India at the moment. They sit uneasily with each other. But both are correct.

The first narrative

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The first centres around the dramatic improvement in macroeconomic stability. Just four years ago, India was the poster-child of
emerging market vulnerability. Double-digit inflation, and elevated fiscal and current account deficits (CAD) drove India into a mini
balance of payments crisis in 2013. Four years later, India is widely considered the “safe haven” among emerging markets. The CAD
collapsed from nearly 5% of gross domestic product (GDP) in 2012-13 to less than 1% in 2016-17, and is currently financed twice-over
by foreign direct investment. To be sure, much of the CAD narrowing is because of good luck (lower oil prices) but that is likely to
sustain given the progressively lower break-even for shale. More generally, however, much of the improved balance of payments
reflects distinctly improved macro fundamentals.

Foremost among them is the dramatic reduction in inflation. After averaging 10% between 2008 and 2013, consumer price index
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less than 5% over the last three years, despite charge at the
successive G-20
droughts. To be sure, some of the disinflation is

http://www.livemint.com/Opinion/InzsZLawbt6fzF9Ab3w9gO/Indian-economy-A-tale-of-two-narratives.html 1/5

manifested in the slowing of core inflation and slowing demand in the rural economy. India has lost two important growth engines. With June inflation at 1. needed new growth drivers. the bankruptcy law. but that support has disappeared with oil stabilizing.Livemint likely cyclical. in turn. But slowing growth should not surprise us. who would have thought the first meaningful miss to the Reserve Bank of India’s (RBI’s) inflation band of 2-6% would be to the downside? Second. propelling GDP growth to 9%. Furthermore. the sustained disinflation has likely also begun to soften expectations that have. however. and codification of the new monetary policy framework. high marks for structural reform. goods and services tax (GST). A 15 percentage point slowing for a sector that constitutes 20% of GDP itself slows headline GDP by 2 percentage points (after accounting for the import content of exports).5%. the statistics have finally caught up with the economy. After the latest gross domestic product (GDP) revisions. The sheer breadth of the food disinflation and the reduction in its volatility is likely underpinned by improved supply chains.com/Opinion/InzsZLawbt6fzF9Ab3w9gO/Indian-economy-A-tale-of-two-narratives. with inflation expectations so adaptive.html 2/5 . India. then. This. The productivity enhancing benefits of the former. and core inflation continues to drift down. muted minimum support price (MSP) increases. These are not small gains. Furthermore. many had hoped for a simpler GST. are still below what they would have been had the pre-demonetisation momentum continued. Similarly. But the “twin balance sheet” problem— unsustainable debt on corporate balance sheets and impaired assets of public sector banks—has become a significant headwind. To be sure. they have grown at a meagre 3%. reflecting generalized slack. In the last few years. therefore. high marks for macroeconomic stability. the slowing trajectory conforms with a wide variety of high-frequency indicators that reveal slowing growth for over a year now. revenue buoyancy should hopefully induce the GST council to move to a simpler rate structure. is the first narrative governing the Indian economy: heightened macroeconomic stability combined with stronger medium-term growth prospects. The rising challenge of vector-borne diseases Taking charge at the G-20 http://www. and the new monetary framework will ensure that inflation never again gets entrenched at 10%. and proactive import management. who would have thought that by 2017 the RBI would potentially be able to ease rates even when all the major central banks are headed the other way? Therefore.7/20/2017 Indian economy: A tale of two narratives . the recovery post-demonetisation has been incomplete. against the backdrop of the 2013 interest rate defence of the rupee. Core GVA (gross value added adjusted for agriculture and government spending)—capturing the private sector business cycle—slowed from nearly 11% in March 2016 to less than 4% in March 2017. Share The progress on inflation can be seen best in two ways. the bankruptcy law should eventually help facilitate the much-needed “creative destruction” of capital. the collapse in oil prices boosted growth by more than a 100 basis points (bps) in 2015-16. for example. Over time. but at least we finally have a common market and a value-added tax that spans the entire base. Exports grew at nearly 18% a year for five years between 2003-08. SUBSCRIBE TO OUR NEWSLETTER » Enter your email Subscribe The second narrative There is.livemint. While deflator-related issues may exaggerate the levels. and the compliance-inducing benefits of the latter. Equally. Aadhaar is transforming the way the state interacts with the citizenry. The year 2016 witnessed four transformational pushes: Aadhaar. The seasonally adjusted levels of industrial production and auto sales. But to attribute this purely to weak demand is to do injustice to policymakers. contributed to the disinflation. In addition. cannot be overstated. It’s clear now that growth had begun to slow well before demonetisation. a second—more sobering—narrative: of a near-term slowdown that may be hard to reverse using traditional fiscal and monetary policy. No wonder then that pricing power remains weak.

html 3/5 .livemint. but corporate bond yields fell only 30 bps. squeezing real purchasing power for farmers. Several states have promised farm-loan waivers to alleviate the rural distress. The increase in state bond spreads suggests markets are struggling to absorb more issuances. Take fiscal policy. counter-cyclical fiscal or monetary response warranted? I will argue any such response will be highly inefficacious. We find that every 100 bps increase in state bond spreads pushes up corporate bonds spreads by 60 bps. Keeping corporate bond yields higher than they need to be. the RBI is likely to intervene aggressively to prevent more rupee appreciation (particularly since surging imports are creating concerns of import substitution with the rupee having strengthened 12% against the Chinese yuan since 2016) and then The rising challenge of vector-borne diseases Taking charge at the G-20 http://www.The consolidated state fiscal deficit has widened by 1% of GDP over the last five years and largely undone the Centre’s consolidation. at a time when the banking system is in such a logjam.com/Opinion/InzsZLawbt6fzF9Ab3w9gO/Indian-economy-A-tale-of-two-narratives.7/20/2017 Indian economy: A tale of two narratives . The RBI has cut policy rates by 175 bps in the current cycle. State market borrowing has doubled in just three years. faced with a large balance of payment surplus. and not the cause. state finances are on a perilous path. it addresses the symptom. wages and MSPs. spreads of state bonds yields over government bonds have tripled in just the last two years. With food inflation slowing much faster than non-food inflation. Second. But reacting by sharply increasing MSPs—which the government has wisely restrained from— would simply re-stoke a vicious cycle of higher food and headline inflation. The real policy challenge is how to keep food inflation contained while providing a remunerative margin for farmers? The answer is well-known: increased agricultural productivity. The latest collapse in prices is likely the straw that broke the camel’s back. First. government bond yields declined 90 bps. This sustained relative price shock has been exacerbated by successive droughts.Livemint Share This has been accompanied by concentrated stress in agriculture. Furthermore. Higher spreads spill directly into the corporate bond market. The policy challenge The broader policy challenge is how to respond to the economic slowdown? Is a large. and between March 2015 and March 2017. risks crowding out private investment. the terms of trade have moved sharply against agriculture for the last five years (see chart 1). This increase in spreads has meaningfully impeded transmission from the rate-easing cycle into corporate bond yields. Consequently.

5% of GDP of the consolidated deficit will cause debt-to-GDP to start rising again.livemint. Chinoy is chief India economist at JP Morgan. But is monetary easing efficacious in the current environment? Monetary conditions have generally eased over the last two years. transmission in the corporate bond market has been impeded by state fiscal dynamics. and keep plugging away on reducing infrastructure bottlenecks. A sustained slowdown combined with limited efficacy of a standard. So fiscal space has been exhausted. Finally. which are poised to get worse. Double down on asset resolution in the banking sector. Furthermore. banks have slashed marginal cost-based lending rates by 90 bps post-demonetization.Livemint sell government bonds to sterilize the impact. an increase of just 0. How should policy respond? The key is not to panic. given the tougher task of keeping inflation at 4% across the entire business cycle.com/Opinion/InzsZLawbt6fzF9Ab3w9gO/Indian-economy-A-tale-of-two-narratives. liquidity has gone from a deficit to a massive surplus. implementation bottlenecks) are at play. but keep fixing the economy’s plumbing. This clearly suggests other factors (balance sheets. Unfortunately. not just at the bottom ebb.html 4/5 . there are no quick fixes at the moment. plow stronger tax-revenue from demonetisation/GST into higher public investment. Comments are welcome at views@livemint.7/20/2017 Indian economy: A tale of two narratives . is the second narrative. These are his personal views. hang in till the growth dividend from deleveraging and productivity-enhancing reforms (GST. Share What about monetary policy? The inflation decline is certainly opening up space for some easing. then. and private sector borrowing costs. the RBI may well cut policy rates. Therefore. Furthermore. The RBI has cut rates by 175 bps. Jul 19 2017. notwithstanding some increase in recent months (see chart 2). Put differently. overreacting to the second narrative (slowing growth) simply risks jeopardizing the first one (macro economic stability).com http://www. Against this backdrop. the benchmark yield curve has flattened materially over the last year. rein in state deficits to push down the private sector cost of capital. 07 55 AM IST TOPICS: INDIA MACROECONOMICS INDIAN ECONOMY GST IMPACT DEMONETISATION EDITOR'S PICKS » ONGC’s HPCL acquisition gets cabinet approval Supreme Court observes Right to Privacy cannot be seen without limitation Tata group is said to mull moving most tech ops under TCS You May Like Sponsored Links by Taboola Buy Your next Car Using This Smart Algorithm Tool Orange Book Value Leftover iPhone stocks worth $619 selling for under $40! The rising challenge of vector-borne diseases Taking charge at the G-20 Madbid. counter-cyclical response. given the recent evolution of state finances. any further fiscal relaxation by the Centre/states is likely to put significant pressure on bond yields.com First Published: Wed. and yet credit growth continues its inexorable slowing. but will it really move the needle? That. Aadhaar) kicks in. but markets are expecting 25-50 bps of cuts at most. Sajjid Z.

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