NEW DELHI: The Economic Survey made a strong case for monetary easing and fiscal adjustments, flagging multiple new risks and deflationary impulses that could hinder the country achieving the higher end of the projected growth band of 6.75% to 7.5% for this fiscal year. A structural reform push to growth will come from implementation of the goods and services tax (GST), privatising national carrier Air India and steps to address the twin balance-sheet problem.
“The balance of probabilities has changed accordingly, with outcomes closer to the upper end having much less weight than previously,” said the second instalment of the Economic Survey for FY17. The first part had forecast FY18 growth at 6.75-7.5%. The second instalment sticks with that but cited multiple downside risks in near term amid fundamental optimism about the medium term.
Lead authored by chief economic adviser Arvind Subramanian, the survey revives the disagreement between him and the central bank over monetary policy. The survey piled pressure on the Reserve Bank of India to cut interest rates, saying the key policy rate is still 25-75 basis points more than neutral. It said there is considerable scope for monetary easing and the sooner it is done, the quicker the economy can reach its full potential.
The survey also suggested that the government should be more flexible and allow fiscal adjustments during the year if required.
It also called for farm sector reforms to counter deflationary tendencies weighing down the economy. The early presentation of the budget this year had forced the Economic Survey to be split in two parts. The first part, the analytical one, was presented during the budget process. The second part, containing more of a backward-looking review, was presented in Parliament on Friday.
The survey warned of “exuberance” in the financial markets, pointing out that the price-earnings ratio of Indian stocks is “substantially greater than the long-run average of 18 and not far from the frothy level reached in 2007”.
The survey said there is “optimism about medium term and gathering anxiety about near-term deflationary impulses”.
Optimism has been rekindled on structural reforms and there is growing confidence that macroeconomic stability has become “entrenched,” it said, attributing this to government and RBI actions and structural oil market change.
GST, put in place on July 1, the in-principle decision to privatise Air India, further rationalisation of energy subsidies and action to address the twin balancesheet challenge — the bad loan burden on banks and companies — have rekindled optimism on structural reforms.
This optimism — and its frothy variant, “exuberance” — is balanced by deflationary tendencies because of which the economy is “yet to gather its full growth momentum” and is “still away from its full potential”, the survey said. Farm loan waivers will disrupt state government finances, the survey said, estimating this at as high as.`2.7 lakh crore. They “could reduce aggregate demand by as much as 0.7% of GDP, imparting a significant deflationary shock to an economy yet to gain full momentum”, it said.
The short-term costs of demonetisation, real exchange rate appreciation, stressed farm revenue because of low cereal prices, lower telecom and power sector profitability causing more stress to banks and transitional friction from implementation of GST are other possible hurdles for the economy.
On the positive side, there is some upside from GST and measures to address the twin balance-sheet issue.
The survey said India may be entering a new era of low inflation, attributing it to the deep, technology driven shifts in international energy markets and improvements in domestic policy and agricultural markets. Good rainfall is expected to keep food inflation in check while GST is expected to reduce prices through the lower incidence of tax.
The survey expects inflation to be well below RBI’s target of 4% by March 2018. Consumer inflation was 1.5% in June. The average inflation is seen at 3% in FY18. It said real policy interest rates are elevated and higher than in other emerging markets.
The survey said the fiscal outlook for the year is uncertain because of reduced revenue from slower-than-anticipated nominal growth, reduced GST collections, lower telecom spectrum receipts and increased expenditure of Rs 30,000 crore on account of the seventh pay commission awards.
“Accordingly, the magnitude and pace of final consolidation relative to the commitments made may need to be assessed going forward,” the survey said.