Economic Survey 2016-17: Chapter-1: Economic Outlook and Policy Challenges

This is a summary of the chapter 1 of the Economic Survey 2016-17.

Key Economic Reforms in 2016

At domestic front, year 2016 was marked by two major policy developments viz. passage of GST bill and demonetisation.  The GST will create a common Indian market, improve tax compliance and governance.

The government enacted demonetisation of higher currency notes as a radical governance-cum-social engineering measure with four major aims viz. curbing corruption, counterfeiting, terror finance, and accumulation of black money. Demonetisation is expected to give long term benefits despite of its short term costs. However, the public debate on demonetisation has raised three questions viz. design and implementation of the move; its economic impacts in short and long term; and future conduct of the economic policy.

Apart from this, the government has:

• overhauled the bankruptcy laws to address the exit problem that pervades Indian Economy.
• Codified the institutional arrangements on monetary policy with RBI {Monetary Policy Committee}.
• Solidified the legal basis of Aaadhar by passing the Aadhaar law to realise long term gains from JAM {Jan Dhan-Aadhar-Mobile}.
• Enacted a package of measures to assist the export oriented clothing sector.
• NPCI successfully finalized the Unified Payments Interface (UPI) to unleash the power of mobile phones in achieving digitalization of payments and financial inclusion, and making the “M” an integral part of the government’s JAM initiative.
• Implemented FDI reforms which allowed India to become world’s one of the largest recipients of FDI.

At international front, Brexit and Trump victory in US Presidential elections may herald a tectonic shift in global environment with “darker possibilities” for Indian economy.

The follow up to these policy actions are fast and demand-driven remonetisation; further tax reforms {which include bringing land and real estate into GST}, reducing tax rates and stamp duties, and allay fears of tax administration.

Dubious perception of the ratings agencies

They survey has questioned the role of rating agencies and accused them of biased perception towards India’s sovereign ratings. The key arguments given are as follows:

• The role of rating agencies was questionable in US financial crisis also when some of them had given AAA ratings to dubious mortgage-backed securities.
• The rating agencies They could not warn in advance the financial crisis.
• Often, they downgrade the ratings “post-facto“, which means that they fail to identify the problem in advance.
• Their perception of India has also been questionable. In 2016, the S&P had ruled out possibility of rating upgrade for India for considerable period. It was not clear what methodology was followed to come at this conclusion.
• They have been unimpressed by the strong fundamentals, fiscal discipline and growth trajectory of India.

Current Structural challenges for Indian Economy

The Key structural challenges faced by Indian economy at the moment are:

• reducing inefficient redistribution
• strengthening the state capacity in delivering the essential services and regulating markets
• dispelling ambivalence about property rights; and embracing the private sector.

Government needs not only political will but also overcome the vested interests to address these challenges.

Reducing inefficient distribution

The survey points out that there are 950 central sector and centrally sponsored schemes and sub-schemes run by central government alone. There are rationales for many of them but then there are intrinsic limitations for many of them in terms of effectiveness of targeting. The government has been making efforts to improve redistributive efficiency and one of the vital components towards this is JAM {currently pilot scheme for DBT transfer in fertilisers is on}.

Strengthening the state capacity

In terms of state capcity, the survey points out that the delivery of services such as health and education, which are mainly in domain of state governments, continue to remain impaired. The survey notes that “while competitive federalism has been a powerful agent of change in relation to attracting investment and talent, it has been less in evidence in relation to essential service delivery“. But there are exceptions as well, for instance, improvement in PDS in Chhattisgarh, incentivisation of agriculture in Madhya Pradesh, power sector reforms in Gujarat, efficient social programmes of Tamil Nadu and so on. However, there are no good models on delivery of health and education, that can be replicated throughout India. The survey says that: “Competitive populism needs a counterpart in competitive service delivery.”

dispelling ambivalence about property rights and embracing the private sector

For decades, there are no signs of political dynamic to remove the ambivalence towards private sector and property rights. Some of the major issues in this context are inability to advance in strategic disinvestments, over-indebtedness if the corporate and banking sectors, issue of retroactive taxation and litigations, intellectual property rights in seeds; reforms on civil aviation sector etc.

Key Global Developments and Their implications for India

There are three main external developments that are of significant consequence for India. First is the implications of US elections on that country’s fiscal / monetary policy and its implications for India.  Second, the world appears to have reached to political carrying capacity  for globalization in the wake of recent events. This hints towards a stagnant of declining trade at global level. Third, the developments in US may lead to rise in Dollar and will have implications for China’s currency. Implications on India will depend on how China handles this issue. If China successfully rebalances its economy, it will have positive spill over impacts for Indian economy. However, if Chinese Yuan further declines, it will have negative impacts for India. China has to handle its domestic credit expansion, which is posing as a threat to it for short as well as long term.

Political Carrying Capacity of the West for Openness and Impact on India

The economic survey has highlighted the fear of rise of anti-globalization and protectionist trends in US and other countries in west. It says that “world cannot bear too much globalization.” and has tried to link stagnant Indian exports with this. The key things which survey has pointed out are as follows:

• The political backlash against globalization and China’s difficulties in rebalancing its economy may have major implications for Indian exports.
• The political carrying capacity for globalization is not only relevant for India’s goods exports but also services exports.
• India is a service based economy. Currently, global service-exports/GDP ratio is 6.1%. If India’s service exports grow rapidly, this ratio can increase by 0.5% which shall be substantial. Thus, India’s service exports growth would test the globalization carrying capacity in services.
• World’s carrying capacity may be much larger for India’s services exports in comparison to China’s goods exports. This is a positive aspect of inherent strength of Indian Economy.

We note here that this statement comes at a time when Trump was preparing executive orders on H1-B and other visas and stringent curbs on them.

Outlook on GDP

The baseline forecast for 2016-17 for GDP is 7%. As per economic survey, this is expected to slow by 0.25-0.5% showing the after-effects of demonetisation. The survey says that economic will recover in next fiscal and could grow between 6.75 to 7.5%. The below graphics shows the relative growth of various sectors in recent years in terms of GDP.

As per the survey, the main highlights of sectoral growth outcome in first half of 2016-17 are as follows:

• There has been a moderation in industrial and nongovernment service sectors
• There was modest pick-up in agricultural growth on the back of improved monsoon; and
• strong growth in public administration and defence services.

Trends in Inflation

As per the survey, Retail inflation is likely to be well below RBI’s target of 5 per cent in the current fiscal mainly because demonetization would discourage any price rise.

Trends in External Sector

In the first half of FY 2017, the current account deficit is 0.3% of GDP. Foreign exchange reserves are at comfortable level at USD360 billion at December 2016 end. Net FDI inflows grew from 1.7% of GDP in FY2016 to 3.2% of GDP in FY2017. These have helped India in balance of payments. The trade deficit has declined in first half of 2016 mainly because of contraction of imports as well as exports whereby fall in imports was much steeper. The ongoing rise in oil prices would put upward pressure on the import bill in medium term.

Trends in Fiscal Sector

The survey has been a bit pessimistic over fiscal sector. It says that government is committed to achieve its fiscal target of 3.5% of GDP.  The key points highlighted by survey are as follows:

• Government committed to contain fiscal deficit within targets
• There was an increased consumption in petroleum products (gasoline/ diesel) and this helped to get more excise duties.
• The scene in non-tax revenue is not so bright because there was a shortfall in spectrum and disinvestment receipts also.
• The public sector enterprises are still stressed and thus have given out lesser dividends.

The scene at states is also not encouraging as their consolidated deficit has increased from 2.5% to 3.6% of GDP {from 2014-15 to 2015-16}.

Economic Outlook for 2017-18

The economic survey presents an outlook for Indian Economy in the light of pangs of demonetisation. While the short terms effects of demonetisation are clear viz. aggregate demand shock and aggregate supply shock, the survey is not very clear on long term impacts. The GDP outlook as mentioned earlier is 25 basis points lower than earlier projected. The exports may recover in the wake of increased global activities. Fiscal position of the government would strengthen  due to rise in Tax-GDP ratio and oil windfall {due to fall oil prices}. Also the survey hopes it best that government would get high profits from high denomination notes which don’t return to RBI {though stats show otherwise that most of these notes have already returned}. It also emphasises improvement in fiscal position of the government due to increases collection of taxes in Pradhan Mantri Garib Kalyan Yojana. It also underpins the importance of smooth transition to GST but also cautions the central government about its commitment to states for any shortfalls in GST collections. With respect to exports, it cautions the government to increase India’s competitiveness, particularly due to rise in competitiveness of the countries such as Vietnam, Bangladesh and Philippines. With respect to trade, survey cautions the government about the possible resurgence of protectionist pressures in west and makes a case for need for reaching to open markets aboard. It says that events such as US withdrawal from TTP may result in increased relevance of WTO. Thus, there is a need for India to proactively pursue for “multilateralism” and revival of WTO.