India’s FY21 growth prospects remain open ended and would depend on control over COVID-19, the frequency and spread of lockdowns, and policy options exercised during the remaining part of the fiscal year.
Messages from high frequency indicators
High frequency indicators of economic activities are showing signs of green shoots, particularly in the month of June 2020. Purchasing Managers Index (PMI) at 47.2 in June 2020 showed a significant increase compared to its level at 30.8 in May 2020. The level of 47.2 is encouragingly close to the benchmark level of 50. GST collections in June 2020 rose to INR90,917 crores, which again, is close to the expected monthly benchmark of INR1,00,000 crores. Contraction in power consumption on y-o-y basis was at (-)0.4% during the period 01 July to 20 July 2020 as compared to a contraction of (-)9.8% in June 2020. There is a consistent improvement on monthly basis, in the consumption of petrol and diesel even though these have not normalized yet. In June 2020, petrol consumption showed a reduced rate of contraction at (-)13.6% as compared to (-)35.3% in May 2020. Similarly, with respect to diesel consumption also, there was a reduction in the pace of contraction from (-)29.4% in May 2020 to (-)15.4% in June 2020. IIP also improved to a level of 88.4 in May 2020 from 53.6 in April 2020. Center’s capital expenditure grew by 15.7% during April-May FY21 as compared to a contraction of (-)25.2% during the corresponding period of FY20. This frontloading of government’s capital expenditure augers well for the National Infrastructure Pipeline (NIP). Credit growth has remained positive but subdued at 6.2% in the fortnight ending 19 June 2020. Contraction in merchandise exports also eased to (-)12.4% in June 2020 from (-)36.5% in May 2020. A merchandise trade surplus was observed for the first time in more than 18 years at US$0.8 billion in June 2020. FPI inflows increased to US$3.4 billion in June 2020 as compared to outflows of US$1.0 billion in May 2020. Foreign exchange reserves peaked at US$516 billion as on 10 July 2020, rising from US$481 billion as on 01 May 2020.
Projected contractionary momentum: Has it been overstated?
Many multilateral institutions and rating agencies have revised India’s FY21 GDP growth forecast, taking it from a positive territory to a sharp contraction zone. India’s FY21 growth projections range from (-)3.2% (World Bank) to (-)9.5% (ICRA). The IMF projected India’s FY21 GDP to contract by (-)4.5%, the ADB by (-)4.0%, and the OECD by (-)3.7% in its single-hit scenario. The sharp downward revision in India’s growth projections by various national and international agencies indicates the deleterious impact of the lockdown. Anticipating this, the government of India had already embarked upon significant monetary and fiscal stimuli from March 2020 onwards. These stimuli measures are beginning to show positive impact as reflected by some high frequency indicators.
India’s growth prospects: Key role of infrastructure investment
India’s FY21 growth prospects remain open ended and would depend on the calendar of control over COVID, the frequency and spread of the lockdowns, and policy options exercised during the remaining part of the fiscal year. It may be noted that India’s fiscal stimulus was constrained because of a steady fall in the growth rate of center’s gross tax revenues (GTR) on trend basis. This also led to a fall in the combined tax-GDP ratio of the center and states from 17.6% in FY18 to an estimated 15.3% in FY20. This led to a squeezing of available fiscal space for the central government.
Recovery in India is also constrained by a fall in India’s real as well as nominal GDP growth rates, both on actual and trend basis. In fact, in FY20, that is, before the onset of the pandemic, both real and nominal growth rates fell to historically low levels of 4.2% and 7.2% respectively. This was caused by a persistent decline in saving and investment rates among other factors.
Policymakers must not only overcome the short-term impact of the pandemic, but also reverse the longer-term decline in the saving and investment rates. The recently proposed National Infrastructure Pipeline (NIP), if successfully implemented, may provide a solution to both the short-term and the long-term economic challenges. The investment schedule of NIP is such that investment, particularly investment in construction, peaks in FY21 and FY22. This would come in handy in uplifting the investment demand, employment and incomes. The multiplier associated with the construction sector, estimated at close to 3, will prove to be effective for this purpose. The key consideration is whether the NIP can be successfully financed. In its financing, the central and state governments along with their public sector enterprises as well as the private sector are involved. In this context, the central government needs to play a pivotal role.
It is almost certain that for this purpose, center’s fiscal deficit will have to be uplifted to close to 7% of GDP and the states may need to borrow up to their enhanced borrowing limit of 5% of GDP. Given the compulsions of the economy, some monetisation of center’s fiscal deficit may have to be permitted and recourse to additional borrowing from abroad may also have to be taken. While pursuing this path, care should be taken to keep inflation in check and limit the relaxation in fiscal deficit to not more than one to two years.
In an interaction with the Confederation of India Industry (CII) on 27 July, 2020, the RBI Governor emphasized the role that infrastructure investment can play in reviving the Indian economy in FY21. He acknowledged the role of both the public and private sectors for infrastructure financing. In the first case, greater flexibility in setting the fiscal deficit limits for the central and state governments may be needed and in the second case, innovative market solutions may be called for. To finance public investment in infrastructure, government may consider another round of fiscal stimulus focused mainly on increasing government’s capital expenditure on infrastructure.
Apart from the infrastructure sector, the RBI Governor also identified four other areas where the corporate sector may invest. One, in agriculture, government’s new regulatory initiatives including creation of a genuine all-India market in agricultural products, will make returns to investment in agriculture more remunerative. Two, in the case of renewables, there is a clear scope for taking advantage of progressive cost reductions and substituting imports of solar panels from China by creating domestic capacity. Three, in the case of information and communication technology, Government of India’s initiatives for curbing Chinese technologies and applications opens up competitive space for Indian initiatives. Four, global supply chains are bound to be re-aligned in favour of India and the private sector should invest extensively and take advantage of the space being opened up.
Excessive non-GST taxation of petroleum products: cost-push inflation may hurt growth
In the context of the ongoing pandemic, one development that has favoured India relates to the low level of global crude prices. The expectation was that this would benefit the users of petroleum, oil and lubricants (PoL) products particularly in the industry and transport sectors and the consumers. This expectation has so far been belied. While the global crude prices have remained low since March 2020, the domestic prices of petrol and diesel have continued to remain significantly high.
Given the contraction in center’s GTR in FY20 and the erosion in tax buoyancy in recent years constraining both central and state revenues, there has been a competition between the center and the states for taking advantage of the lower global crude prices by increasing taxes on PoL products under their respective control. This has led to increased retail prices of PoL products leading to the unexpected situation of falling global crude prices with rising domestic prices of PoL products much to the detriment of the industrial users and consumers. Retail prices of PoL products have a potential inflationary impact through transport and energy costs. This issue is discussed at length in the In-Focus section of the July 2020 edition of the EY Economy Watch.
Given the urgent need to finance the NIP, while central and state tax revenue growth remains weak, it may be justified to continue to rely on the taxation of PoL products while keeping a careful watch on the inflationary trends. There may be a case in India’s current circumstances to give relatively higher emphasis on growth rather than inflation until we are able to overcome the pandemic induced contractionary momentum.