For the Year July 1, 2014 to June 30, 2015*
I.1 Over the year gone by, the Indian economy
remained resilient in a global environment
characterised by falling macroeconomic risks
but rising financial stability risks. While a modest
recovery is tentatively gaining foothold in advanced
economies, activity slowed across a broad swathe
of emerging economies as commodity prices
fell, financing conditions tightened and structural
constraints started building. India is a notable
exception. Globally, financial risks increased
as investors reached for yields, expecting US
monetary policy to normalise more slowly.
Incipient threats to financial stability were also
evident in rising corporate indebtedness in both
advanced and emerging economies, stretched
asset valuations in some sectors, marked
increase in exchange rate volatility and the debt
crisis in Greece in the closing months of 2014-15.
Spillovers from these external shocks impacted
various segments of the financial markets in India,
asset prices and capital flows, although the latter
remained by and large buoyant.
I.2 Even as banking sector risks remained
elevated domestically, the macroeconomic
fundamentals of the Indian economy improved
gradually over the year, anchored by some easing
of inflation and continuing fiscal consolidation. Notwithstanding deterioration in export
performance brought on, inter alia, by weak
external market conditions, the current account
deficit narrowed in 2014-15 from its level a year
ago on terms of trade gains and weak import
demand. With fiscal consolidation firmly underway
and with buoyant business optimism, the stage
is now set for unshackling stalled investments
and for boosting new capital spending in order
to accelerate the pace of growth. Drawing on
the experience of 2014-15, it is now time to
implement an agenda to take the economy to
higher growth in 2015-16 and over the medium-term.
Concomitantly, recent gains in reducing
inflation pressures need to be built upon so that
disinflation continues along with higher growth.
Importantly, resolute actions are needed to ease
stress in financial assets, mitigate/resolve debt
burdens so that stranded assets are put back
to work quickly wherever feasible and capital
buffers are built to enable financial intermediaries
to provide adequate flow of credit to productive
sectors.
ASSESSMENT: 2014-15
I.3 While the pick-up in the growth of GDP at
market prices in 2014-15 was largely sustained
by private consumption, the decline in the rates of saving and investment for the second
consecutive year to 2013-14 emerged as a matter
of concern. The improvement in the financial
saving of households and the expected decline
in government dissaving in 2014-15 should work
towards releasing the financing constraints on
investment, especially when seen in conjunction
with the step-up in capital goods production in the
latter half of 2014-15.
I.4 On the production side, the weather-induced
slowdown in agriculture impacted rural
demand and also necessitated policy interventions
to manage food price pressures. In the industrial
sector, a turnaround in manufacturing in the latter
half of the year was essentially driven by upbeat
business sentiment, some unclogging of stalled
projects and a robust improvement in electricity
generation and coal production in the closing
months. A durable upturn in new capex, capacity
utilisation and new orders – both domestic and
foreign – holds the key to a sustained revival of
industrial activity. In the services sector, only a
few sub-sectors, such as finance, real estate and
construction, grew at a higher pace.
I.5 From June 2014, inflation declined faster
than initially anticipated. A combination of favourable
factors such as the collapse of international
commodity prices, particularly of crude, and
loss of pricing power among corporates due to
weakening demand as well as pro-active supply
management and deregulation of key fuel prices
worked in alignment with a disinflationary monetary
policy stance that was set from September 2013.
Accordingly, inflation expectations eased to single
digit for the first time since September 2009 and
wage pressures moderated.
I.6 A significant factor influencing the evolution
of monetary conditions during 2014-15 was the
large surge in capital inflows, which necessitated
active and nimble liquidity management operations to sterilise flows in accord with the stance of
monetary policy. Still sluggish demand, receding
inflation and risk aversion stemming from stress in
financial assets restrained bank credit growth and
also incentivised substitution of bank lending to
take advantage of competitive pricing conditions.
I.7 The revised liquidity management
framework introduced in September 2014, and
in particular intra-day fine-tuning operations,
improved, over time, the alignment of money
market rates with the policy repo rate. Notably,
large spikes in rates hitherto associated with
advance tax payments and balance sheet closure
were muted. Gilt yields declined, reflecting the
improvement in macro-fundamentals. In the
foreign exchange market, two-way movements
were associated with lower volatility. Stock
markets rallied strongly throughout the year on
buoyant investor optimism, both foreign and
domestic, stretching valuations before some
correction in the closing months of the year.
I.8 While the committed path of fiscal
consolidation was adhered to by the central
government for the third year in succession,
slack revenue mobilisation – particularly through
disinvestment – necessitated cutbacks in
productive capital expenditure towards the end of
the year. This highlights the need for more realistic
assessment of revenue targets and expenditure
allocations. Furthermore, states need to remain
committed to fiscal consolidation.
I.9 The contraction in merchandise exports
since December 2014 emerged as an area
of concern, sapping aggregate demand and
increasing external vulnerability, notwithstanding
terms of trade gains and a large saving on POL
imports helped contain the current account deficit.
Buoyant capital inflows in excess of the external
financing requirement raised international
reserves to an all-time high by the end of the year.
PROSPECTS: 2015-16
I.10 Turning to 2015-16, the outlook for the
global economy has been adversely impacted
by the contraction in output in North America
in the first quarter of 2015. In the second and
third quarters, there are indications of demand
picking up in advanced economies; however,
the continuing slowdown in emerging economies
holds back a fuller global recovery. At the same
time, with hardening bond yields and risk premia,
emerging economies are contending with volatile
currency movements and capital flows. Going
forward, these factors could pose risks to the
global recovery. Accordingly, the IMF has pared
its forecast for global growth in 2015 to 3.3 per
cent in its July update, marginally lower than in
2014.
I.11 For the Indian economy, the outlook
for growth is improving gradually. Business
confidence remains robust, and as the initiatives
announced in the Union Budget to boost
investment in infrastructure roll out, they should
crowd in private investment and revive consumer
sentiment, especially as inflation ebbs. While the
progress of the monsoon has allayed initial fears
of moisture shortfall, uncertainty surrounding
the progress and distribution of the monsoon
remains a risk to the outlook for both growth and
inflation. Comprehensive and pre-emptive food
management strategies need to be put in place
to contain these spillovers. In the first four months
of 2015-16, indicators of real activity have broadly
tracked the Reserve Bank’s baseline projection
of output growth (at basic prices) at 7.6 per cent
for the year as a whole, up from 7.2 per cent in
2014-15.
I.12 Taking into account initial conditions,
including the prospects for the monsoon and
for international crude prices, the Reserve Bank
projected in April 2015 a baseline path for inflation in 2015-16 in which it would be pulled down from
current levels by base effects till August but is
expected to start rising thereafter to below 6.0 per
cent by January 2016. So far, inflation outcomes
have closely tracked these projections. The risks
to this trajectory are balanced as the weather-related
uncertainties are offset by falling crude
prices. Inflation developments will warrant close
and continuous monitoring as part of the overall
disinflation strategy that requires inflation to be
brought down to 5 per cent by January 2017.
I.13 As regards fiscal policy, the Government’s
resolve on fiscal consolidation should propel
efforts to reach the target for the gross fiscal
deficit for 2015-16 at 3.9 per cent of GDP. In the
early months of the year, indirect tax collections
have been robust and set to achieve budget
estimates, though contingent upon a recovery in
manufacturing and services. Furthermore, plans
for disinvestment need to be front-loaded to take
advantage of supportive market conditions, and
also to forestall cutbacks in capital expenditure to
meet deficit targets. Such cut backs compromise
the quality of fiscal consolidation. States need to
take advantage of the greater fiscal autonomy
stemming from higher devolutions and prioritise
capital and developmental expenditure so that
the quality of sub-national fiscal correction is
maintained.
I.14 In the external sector, merchandise exports
have contracted through the first four months of
2015-16, rendering the economy vulnerable to
external shocks. Imports have remained subdued,
primarily reflecting softening of crude and gold
prices. Non-oil non-gold imports have also
moderated due to muted domestic activity. Over
the rest of the year, some savings may accrue on
account of POL and bullion imports; on the other
hand, the gradual pick-up in activity anticipated
over the rest of the year may revive non-oil non gold import demand. Remittances from Indians
working abroad have weathered the slowdown in
global growth and should continue to lend support
to the balance of payments. Along with a surplus
expected on trade in services as in the past, from
software exports and travel earnings, the current
account deficit for the year as a whole should be
contained below 1.5 per cent of GDP. The outlook
for capital flows is highly uncertain, with the
widely anticipated normalisation of US monetary
policy later in 2015 expected to generate capital
outflows from emerging markets and also to
harden financing conditions as bond yields rise.
In this context, the level of reserves at over US$
350 billion and equivalent of about nine months of
imports should provide a buffer and smooth out
normal import and debt servicing requirements
over the year.
I.15 Key to the realisation of these expectations
is a durable pick up in investment, supported by
sustained efforts to alleviate supply constraints.
The proposal to introduce a Comprehensive
Bankruptcy Code of global standards by 2015-
16 and replacement of the existing multiple
prior permission procedure for investments
by a pre-existing regulatory mechanism is
expected to improve the business environment
in India. Easing the doing of business has
now become a widely cited constraint on the revitalisation of manufacturing. Areas that require
significant changes include legal and regulatory
environment, labour market reforms, tax regime
and administrative environment.
I.16 Gaps in distribution networks and
deteriorating financials of power discoms need to
be addressed expeditiously for demand to keep
pace with the ongoing easing of supply constraints.
Focusing on renewable and clean sources of
energy should be accompanied by conservation
of energy as a medium-term strategy.
I.17 Expansion of the avenues for gainful
employment opportunities is vital for efforts to
harness the demographic dividend. This calls
for careful identification of skill gaps, providing
vocational and technical training, and building
of new skills. The National Mission for Skill
Development which aims at consolidating skill
building initiatives spread across several ministries,
is relevant in this context. As self-employment
holds out greater employment opportunities, the
SETU (Self Employment and Talent Utilisation)
initiative for supporting all aspects of start-up
business and other self-employment activities is
crucial. Other initiatives like Digital India and Make
in India will also help to enhance the employment
potential.
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