For the Year July 1, 2015 to June 30, 2016*
I.1 Against the backdrop of a global
environment characterised by anaemic growth and
heightened financial market volatility, the Indian
economy posted gains in 2015-16. Economic
activity picked up pace and the trajectory of
growth was underpinned by macroeconomic
stability embodied in narrowing fiscal and current
account deficits and ebbing inflation. Domestic
financial markets exhibited differential responses
to episodic shifts in risk sentiment on global
spillovers, with money and bond markets remaining
relatively sheltered. In the first quarter of 2016-17,
global risks intensified after remaining dormant
in the aftermath of the turbulence that roiled
global financial markets in January. The Brexit
referendum initially shocked financial markets,
producing overshoots and misalignments of asset
prices and frantic churns of capital, but gave way
to a reach for returns as an uneasy calm returned.
These financial perturbations are increasingly
taking a knock-on toll on real activity in advanced
and emerging economies and present the biggest
risk to their near-term outlook.
I.2 In this turbulent setting, underlying
conditions have been firming up in India for
scaling up the growth momentum. Progress of the southwest monsoon augurs well for agriculture and
the rural economy. The seventh pay commission
award may provide a stimulus to consumption
spending within the targeted fiscal deficit through
the multiplier effects of government consumption
expenditure. On the external front, India became a
preferred destination for foreign direct investment
(FDI), receiving the highest annual net inflow in
2015-16. Indicators of external sustainability
recorded a distinct improvement during the year.
Elsewhere, however, particularly in the industrial
sector, considerable slack and sluggishness
continues to weigh upon the outlook. The capex
cycle remains weak and private investment activity
is listless. Even as the banking sector deals with high
stress emanating from deterioration in corporate
balance sheets and, therefore, loan quality, efforts
have to be redoubled to free up credit flows to the
productive sectors of the economy so that growth
is supported. Alongside, perseverance with
disinflation towards the medium-term CPI inflation
goal of 4 per cent under a new monetary policy
framework, anchoring states to high quality fiscal
consolidation and concerted efforts to reverse
the erosion of productivity and competitiveness
will assume importance as the ambit of structural
reforms widens.
ASSESSMENT: 2015-16
I.3 Looking back at the year gone by, private
consumption remained the mainstay of the modest
acceleration in real GDP growth, as in 2014-15.
Fixed investment and exports were the missing
drivers. Nonetheless, the sustained improvement
in households’ financial saving since 2013-14 has
been a noteworthy development. The ongoing
disinflation is freeing up real incomes, and interest
rates – especially on small savings – turned
positive in real terms. The significant improvement
in corporate profitability, essentially on account of
saving on input costs and more recently on sales
growth, is expected to boost corporate saving and
translate into investment spending going forward.
Record inflows of foreign direct investment and
the surge of initial public offerings after a four-year
lull seem to be providing lead indications of this
tipping point.
I.4 On the production side, agriculture
weathered two consecutive years of drought
conditions and posted modest growth in contrast
to the contraction a year ago. This resilience, aided
by astute supply management, smoothed breaks
in availability of farm output and restrained food
price pressures. Industrial output slowed down
in relation to a year ago, despite a turnaround
in consumer durables. Consumer non-durables
posted a decline after six years of expansion,
mainly on account of contraction/deceleration
in fast moving consumer goods which, in turn,
reflected the subdued state of rural demand. Going
forward, the improvement expected in agricultural
activity could reverse this deterioration and boost
rural incomes. A sustained turnaround in capital
goods output would, however, await a revival of
investment demand. In the services sector, a
deceleration was evident across all constituents
as new business orders slowed and exports were
impacted by weak external demand.
I.5 In the infrastructure space, electricity
generation reached 98 per cent of the annual target,
with the highest ever annual capacity addition in
the solar and wind energy segments. Seventeen
states have given in-principle approval/joined the
Ujwal DISCOM Assurance Yojana (UDAY). The
hope is that as the DISCOMs become debt-lite,
their financial and operating efficiency will improve
and the slack in demand will progressively decline.
However, continuing efforts in these directions,
including on enhancing collections and reducing
line losses, are needed. In the road sector, there
was significant improvement in terms of new
constructions, especially in the national highway
network. While this progress has been mainly
public investment-driven, policy measures such
as ease of exit, injection of funds into languishing
projects at a pre-determined rate of return and the
innovative hybrid annuity model will likely enhance
private interest in the sector. Notable progress
was also achieved in railways in terms of capital
investment, commissioning of broad gauged lines
and electrification of railway tracks. Major ports in
India, especially private ports, also recorded the
highest ever capacity addition in a single year.
I.6 Benign inflation conditions prevailing until
August 2015 were dispelled by the sustained
elevation in prices of pulses. Consequently,
inflation picked up from September and rose month
after month till January 2016, albeit remaining
below the target of 6 per cent set for that month. In
the ensuing three months, inflation eased on the
back of the seasonal decline in prices of fruits and
vegetables but picked up again from May 2016 as
food prices firmed up ahead of the onset of the
monsoon.
I.7 Monetary conditions reflected an interplay
of diverse factors. An unusually high and protracted demand for currency drove up the expansion of
reserve money and muted the money multiplier
which, in turn, moderated the rate of money supply.
Anecdotal evidence suggests several forces at
work – the simultaneous conduct of elections in
various states; a possible response to increases
in the rate of service tax; the jewellers’ strike
protesting excise duty increases in the Union
Budget, which effectively impeded the return flow
of currency. Bank credit was generally sluggish
in the first half of the year, reflecting lacklustre
demand in the economy, asset quality concerns,
the ongoing deleveraging through write-offs,
recoveries and upgradations, and some amount
of disintermediation in favour of relatively cheaper
source of funds outside the banking system. In
the second half of the year, however, bank credit
growth picked up in the retail segment and also
to industry and agriculture. Timely recognition
of the deterioration in banks’ balance sheets
through the Reserve Bank’s asset quality review
resulted in the overall stressed assets ratio rising
marginally by end-March 2016 from its level a year
ago, with a rise in the gross NPA ratio but a fall
in the restructured assets ratio. Banks’ profitability
was affected by provisioning requirements. Going
forward, the stage is set for continued efforts to
declog the banking system and enable credit to
flow to productive sectors.
I.8 With the fiscal deficit declining to 3.9 per
cent of GDP, central finances were revenue-driven
in 2015-16 – additional revenue mobilisation
through cesses; duty revisions in respect of
petrol and diesel; higher dividend and profits; and
earnings from spectrum auctions. Significantly,
there were no cutbacks to budgeted capital
expenditure. By contrast, states overshot the
budgeted deficit, mainly on account of shortfall in
revenues.
I.9 In the external sector, a faster pace of
contraction in imports relative to exports and
large terms of trade gains narrowed the current
account deficit to 1.1 per cent of GDP, which was
comfortably financed along with sizable accretion
to reserves. In terms of financing, a noteworthy
feature of 2015-16 was the highest ever inflows of
foreign direct investment, impervious to the bouts
of turbulence in the international financial markets.
By the end of the year, the level of reserves
was equivalent of 11 months of imports. Other
indicators of external sustainability also recorded
improvement.
PROSPECTS: 2016-17
I.10 In the aftermath of the Brexit referendum,
the outlook for the global economy has weakened,
as reflected in downgrades of projections by
multilateral agencies. Although the extreme
financial market reactions to its announcement
have subsided and financial asset prices have
regained lost ground, high uncertainty regarding
its evolution may shadow the course of a fragile
and slowing global recovery in the year ahead and
possibly even beyond.
I.11 So far, the effects of Brexit on the Indian
economy have been relatively muted, including the
immediate impact on equity and foreign exchange
markets. Yet, in view of the linkages to the UK and
the euro area, spillovers through trade, finance
and expectations channels cannot be ruled out
as events unfold. Abstracting from these external
shocks, the near-term domestic outlook appears
somewhat brighter than the outcome for 2015-
16. While a durable pick-up in investment activity
remains elusive, consumption will continue to
provide the main support to aggregate demand
and may receive a boost from the revival of rural
demand in response to the above-normal and
spatially well-distributed southwest monsoon as well as from the seventh pay commission’s award.
Notably, the impact of the fifth and sixth pay
commissions’ awards on growth was also positive.
Agricultural and allied activities are expected to
benefit substantially from the distinct improvement
in moisture conditions.
I.12 Industrial activity has been in contraction
mode in the early months of 2016-17, pulled
down by manufacturing. Looking ahead, no strong
drivers are discernible at this juncture that could
engineer a turnaround. Export demand also
remains anaemic. Successive downgrades of
global growth projections by multilateral agencies
and the continuing sluggishness in world trade
points to further slackening of external demand
going forward. Some support to industrial activity
may, however, stem from the recent measures
taken by the Government such as 100 per cent
FDI in defence, civil aviation, pharmaceuticals and
broadcasting.
I.13 Service sector activity is likely to receive
a stimulus especially under the category of
public administration, defence and other services
as public expenditure on wages, salaries and
pensions translates into disposable incomes.
Overall GVA growth is, therefore, projected at 7.6
per cent in 2016-17, up from 7.2 per cent last year.
A better than anticipated agricultural performance
and the possibility of allowances under the seventh
pay commission’s award being paid out in Q4 of
2016-17 provide upsides to this projection. On the
other hand, a rise in the implicit GVA deflator as
WPI inflation hardens will operate as a statistical
downside.
I.14 Headline CPI inflation has ranged above
target in the first quarter of 2016-17, driven up
by the seasonal surge in prices of fruits and
vegetables and protein-rich items on top of still elevated prices of pulses and sugar. With the
steady progress of the southwest monsoon,
however, these prices are likely to moderate over
the ensuing months. A heartening development
is the recent softening of inflation excluding food
and fuel, which could sustain if international
crude prices remain soft and, in turn, hold down
prices of petrol and diesel embedded in transport
and communication services. Further, pulses
production may likely increase with a softening
impact on food inflation. Thus, headline inflation
is expected to trend towards the target of 5 per
cent by the last quarter of the year, although at
the current juncture, upside risks are prominent. If
the current softness in crude prices proves to be
transient and as the output gap continues to close,
inflation excluding food and fuel may likely trend
upwards and counterbalance the benefit of the
expected easing of food inflation. It is also important
to take note of the impact of the implementation of
the seventh pay commission’s award on the future
trajectory of headline inflation. The largest effects
are expected to emanate from increased house
rent allowance in the CPI, which may raise headline
inflation in a purely statistical manner. In addition,
indirect effects through demand and expectations
channels could add to the headline CPI’s path. In
aggregate, the impact of the pay commission is
expected to peak by September 2017. Separating
statistical effects from those that impart a durable
upside to inflation will complicate the setting of
monetary policy going forward, especially in the
management of inflation expectations.
I.15 The commitment of the central government
to the path of fiscal consolidation in 2016-17 has
enhanced the credibility of fiscal policy, which will, in
turn, help in anchoring inflation expectations and in
improving the business environment, including by fostering credibility among international investors.
A conducive environment has also been created
through appropriate incentives/penalties for states
to renew their fiscal consolidation. The passage
of the Goods and Services Tax (GST) Bill marks
a new era in co-operative fiscal federalism and a
growing political consensus for economic reforms.
The implementation of the GST would boost
trade, investment and growth by reducing supply
chain rigidities, encouraging scale economies,
cutting down transportation and transaction costs,
as also promoting efficiency gains. By eliminating
the cascading impact of taxes on production and
distribution costs, the GST would also improve
the overall competitiveness of the economy. The
impact of GST on CPI inflation would largely
depend on the standard rate that would be decided
by the GST council; however, the impact is likely to
be low, with around 54 per cent of the CPI basket
exempt from the GST. As regards public finances,
the GST is expected to widen the tax base, result
in better tax compliance and reduce the cost of tax
collection.
I.16 As regards implementation of the
recommendations of the pay commission, it
is noteworthy that nearly 90 per cent of the
estimated payout on account of pay, pension and
arrears in 2016-17 has already been provided
for in the Union Budget. However, states tend to
mimic central pay and pension implementation.
To the extent that states have provided for these
outgoes, no deviations from the budgeted targets
are envisaged at this juncture. For states that
have not made such provisions in their respective
2016-17 budgets, the implementation of the pay
commission’s recommendations may impose a
deviation from fiscal targets in the absence of offsetting
fiscal measures, entailing a risk to general government finances, with spillovers to aggregate
demand.
I.17 India’s external position is viable and
well-buffered to sustain a pick-up in non-oil nongold
imports as growth gathers momentum.
Nevertheless, the external environment continues
to pose challenges stemming from large currency
movements, a rising incidence of protectionist
measures, swift and massive movements of capital
and the amplification of uncertainty by the Brexit
vote. Furthermore, the sustenance of terms of
trade gains would be predicated upon movements
in international commodity prices. Even as the
outlook for capital inflows is optimistic with the
recent liberalisation of FDI policy, the repayment
of FCNR(B) deposits under the special swap
scheme due in September to November 2016 will
need to be managed carefully. In this context, the
level of reserves and covering through forward
assets provide ample resources.
I.18 Turning to the agenda of structural
reforms to reap efficiency and productivity gains,
several important steps that are underway need
to be persevered with and taken to their logical
conclusion. The UDAY scheme has provided
a one-time opportunity to DISCOMs to regain
financial viability. Going forward, it is important to
avoid the recurrence of loss building processes
for DISCOMs. In this regard, the MoUs signed by
the state governments with the Government of
India need to be monitored closely and clauses
with regard to user charges and administrative
reforms need to be enforced. Another important
area of ongoing reforms is the banking sector for
which stressed assets need to be unlocked and
put back to work. The enactment of the Insolvency
and Bankruptcy Code will make it easier for sick
companies to either wind up or turn around, and for
investors to exit. The Parliament has also passed amendments to strengthen the Debt Recovery
Tribunals for speedier resolution of stressed
assets. Efforts need to be made to re-energise
asset reconstruction companies (ARCs) – which
have played a critical role in managing NPAs in
many countries – by resolving issues relating to
their capital requirements and enabling price
discovery for NPAs/security receipts so that they
can be traded in open, competitive markets that
ensure liquidity. In all these issues, harnessing
asset management expertise of foreign investors
could offer synergies with their business models.
The financial landscape is poised to undergo a
significant transformation with the setting up of
new institutions and enabling niche strategies.
On-tap licensing of banks will facilitate expanding
the universal banking network. Furthermore,
the arrival of peer-to-peer lending and other Fin
Tech-leveraged financial entities is expected to
expand the reach of finance through innovative
technological platforms.
I.19 Finally, the need for intensifying structural
reforms in factor markets, particularly land and
labour, is now widely seen as necessary for
realising the potential of the economy and for
avoiding jobless growth. In this context, various
levels of government need to act together for
the best results. First, labour regulations are
often cited to be a significant barrier to growth,
particularly with regard to large and medium scale
manufacturing firms. Initiatives taken by some
state governments to amend labour laws are
a good starting point. Second, land acquisition
processes are another critical factor affecting
the pace of investment. State governments may
consider putting in place a transparent and viable
framework, de-bottlenecking land constraints,
e.g., as in Andhra Pradesh, to drive the capex
cycle. Third, marketing infrastructure is critical.
The National Agriculture Market (NAM) – a pan-
India electronic trading platform – is an important
example towards setting up a common agriculture
market.
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