October 2017


Perspectives: The Month Through India’s Eyes

Media coverage in India over the last month was heavily focused on economic issues, including demonetisation, India’s recent GDP growth numbers and the possibility of an interest rate cut by the Reserve Bank of India.  While demonetisation and the interest rate cut were both polarising subjects that yielded divergent views amongst various columnists, reactions to India’s GDP numbers were uniform, with most publications adopting a cautiously optimistic stance over the country’s economic recovery.


Demonetisation, One Year Later

On November 8, 2016, the Indian government announced the demonetisation of all high value currency within the Indian economy.  The move, designed to curb corruption and black-money, had a significant impact on the Indian economy.  On the one-year anniversary of this event, several publications weighed in on whether this policy action was beneficial to the country.  Writing for the Hindustan Times, S.K. Ghosh, the Group Economic Advisor for the State Bank of India (India’s largest public sector bank) outlined four clear benefits of demonetisation.  “I would like to mention four clear benefits of this move.  First, post demonetisation, registration of companies with a smaller capital is gaining pace.  Second, the trend in income tax e-filing shows that for the five-year period ended FY14 approx 5 million people were filing returns on an annualised basis — that has increased to 7.7 million (FY14-FY17) and could have expanded further.  Third, the share of small currency notes in circulation that was 28% in FY09 (54% in FY04) and declined to 13% in November 2016 has now increased to 28% by March.  A larger percentage of smaller notes improves transparency in cash dealings.  Fourth, gross financial savings has increased from 10.9% of gross national disposable income (GNDI) in FY16 to 11.8% of GNDI in FY17, a notable climb of 90 bps.”

A counter-view was offered by former Prime Minister, Dr. Manmohan Singh.  In an op-ed in Live Mint, Dr. Singh was critical of demonetisation, and in particular the government’s decision to override large institutions in the country.  “India’s demonetisation saga is also a saga of institutions and their entrenched place in our society.  The Reserve Bank of India (RBI) is an institution of utmost importance with carefully nourished independence and credibility.  The demonetisation decision was an impingement on RBI’s institutional authority.  It is quite likely that RBI was not given a chance to exercise judgement or opine in the decision to demonetise currency.  I am not insinuating complicity but am merely highlighting the importance of institutions to act as checks and balances to executive power.  I have the utmost faith and confidence in the governor of RBI and sincerely believe that he will uphold the highest levels of integrity, trust and credibility of the institution in the remainder of his term.  Recent incidents, such as the inexplicable delay by the Election Commission in its announcement of election dates for the state of Gujarat, further add to growing concerns about the solidity of the nation’s institutions.  Institutions such as the Election Commission are the very foundation of our republic with a rich and storied legacy.  Any attempts to thwart the freedom of such institutions portend grave dangers for the nation…  I sincerely hope demonetisation was just an economic blunder and not a harbinger of institutional erosion.  Overriding institutions, circumventing consensus, and haste are what made the demonetisation decision possible.  Therein lies the lessons of governance and nation-building.   A truly liberal society is one that strives to ensure that not even a single innocent is punished unfairly.  The role of institutions is vital in ensuring such order. It is indeed time to move on from demonetisation but not move away from institutions, procedures and processes.”

An editorial in the Hindu offered a more balanced approach.  The publication argued that one year out, it was still too early to tell whether demonetisation had benefited or harmed the Indian economy.  “A year after demonetisation was announced, the questions seem to outnumber the answers.  Electorally, voters may judge the policy in terms of intent rather than outcomes.  Economists may quibble over the undue costs owing to the debilitating impact on the momentum of economic growth, even as damage to the vulnerable informal sectors remains unmeasured.  The government’s spokespersons may extol the shrinking cash economy and growing digitisation.  But an assessment of demonetisation on Anti-Black Money Day can be complete only if its deliverables on the state of corruption and the corrupt are established.   Missing from the jumble of successes, data and analyses to be exhibited today will be conclusive proof of reduced corruption with evidence-backed answers to questions like: Are fewer bribes being paid and demanded than a year ago?  Is corruption down? Are Indians evading less tax post-demonetisation? It would seem India is all set to celebrate what has probably not — can possibly not — actually be measured.”


India’s Latest GDP Growth Numbers

Economic data released by India’s Central Statistics Office revealed that the Indian economy grew by 6.3% for the quarter ended September 2017.  With economic growth having fallen to a three year low of 5.7% in the previous quarter (largely on account of demonetisation and the rollout of GST), this rebound in growth was cited by the government as a sign of longer-term economic recovery and growth.  The narrative amongst most major publications, however, were a little more cautious.  

Live Mint argued that despite the improvement in growth, it was still too early to tell whether a longer-term recovery was underway.  “Overall, data suggest that the economy has bottomed out and growth in the remaining part of the fiscal is likely to get better, partly because of a low base.  Encouragingly, growth during the second quarter was driven largely by the private sector and not government expenditure, as was seen in the previous quarter.  While this is a welcome development, it is important to note that the growth in economic activity is still below potential and is not guaranteed to move to a sustained higher growth path in a hurry for at least four broad reasons…  First, the dip in first-quarter growth was partly explained by destocking before the implementation of the goods and services tax (GST).  Therefore, it is likely that growth in manufacturing is in part due to restocking, which will not happen every quarter…  Second, private-sector investment continues to remain weak and until it picks up significantly, it will be difficult to argue that growth will rebound to higher levels in a sustainable manner…  Third, exports continue to disappoint.  At a time when the global economy is witnessing a synchronized recovery after many years, exports during the quarter went up by just 1.2%…  Fourth, the economy is unlikely to get much support from either fiscal or monetary policy in the foreseeable future…  Overall, it is satisfying that the slide in economic growth has ended, but the actual strength of the recovery will only become clear after a few quarters.”

The Hindu adopted a similar narrative, explaining that while this increase in GDP growth was welcome, the challenge for the government would be to sustain this, particularly in light of expected macro-economic events over the coming months.  “Sustaining and building on this reversal of momentum may be more challenging in the coming months, given other economic data that are a cause for concern and some external headwinds.  Specifically, agriculture remains in a slump, and this in a ‘normal’ monsoon year — GVA growth in the sector, which includes forestry and fishing, slowed to 1.7%, from 2.3% in the first quarter, and was considerably weaker than the 4.1% pace posted in the year-earlier period.  Agriculture is a significant contributor to rural incomes and consumption demand, and the impact of a protracted agricultural slowdown on the larger economy cannot be overstated.  Worryingly, the foodgrain output in the kharif season contracted by 2.8%, compared with a 10.7% expansion in the year-earlier period.  This could portend a resurgence of inflationary pressures on food prices that would limit the room for growth-supportive monetary action by the Reserve Bank of India.  Consumption spending by households also remains in a stubborn rut: the second-quarter growth at 6.5% was a tad slower than the 6.6% seen in April-June; it was 7.9% a year earlier.  With global oil prices having risen appreciably, and the fiscal headroom for more pump priming by the government having narrowed drastically — the fiscal deficit at the end of October has already hit 96.1% of the budget estimate for 2017-18 — the coming quarters could well test the real mettle of the economic recovery.”

Finally, a column in the Print was cautiously optimistic, stating that India’s GDP would likely grow gradually in the medium-to-long-term.  “On the positive side, the global economy and global trade have recovered, providing the setting for domestic expansion. If the government banks get recapitalised, they will be in a position to start lending again — provided new projects are presented to them.  The problem of debt-laden corporate balance sheets will persist for a while longer but, with the bankruptcy law having been written into the books, the future should see more careful behaviour by company promoters.  A good credit culture can only help the economy, since it will cause less dead investment.  There comes the inevitable question: Can we look ahead to eight per cent growth on a sustained basis? On present reckoning, it could happen in the recovery phase of the business cycle (we’ve seen it in three of the last nine years).  But it is doubtful if that pace can be sustained through the cycle, although optimists like Mukesh Ambani predict much better.  The only period when India did see sustained growth of more than eight per cent was in 2003-08, when the global economy was on fire and India’s exports soared.  Bear in mind also that domestic savings and investment rates today are well below the levels that prevailed then.  Yet, the economy needs to do significantly better than its 15-year average of 7.5 per cent growth, creditable as it is — in order, most importantly, to offer a solution to the jobs crisis. The take-away message has to be that we need more reform, without the shocks.”


The Potential for an Interest Rate Cut

In light of recent economic data, there has been much debate over whether the Reserve Bank of India to cut interest rates in an attempt to increase liquidity and stimulate economic growth.  Ahead of the central bank’s monetary policy meeting in early December, various media outlets weighed in on the matter.

Live Mint, which has regularly advocated for an interest rate cut reiterated its position in a recent editorial.  “The constellation of recent economic data has led to the consensus view that the monetary policy committee (MPC) of the Reserve Bank of India (RBI) has no room to reduce policy interest rates this week.  It is a compelling argument. Inflation has climbed rapidly after hitting a low in June, and is likely to overshoot the 4% mark by the end of the current fiscal.  Core inflation is sticky. Global commodity prices—especially crude oil—have hardened.  Economic activity picked up in the September quarter.  Many other central banks are likely to tighten monetary policy in the months ahead if the worldwide economic recovery strengthens.   This newspaper continues to stick to its October call that there is a cautious case for a rate cut.  In our view, the persistence of the output gap is currently a bigger worry than inflation going out of control.  Actual output is at least one percentage point below potential, at a time when most other major economies are gaining momentum. Macro policy has to respond to the effects of two successive policy shocks—demonetisation and the transition to the goods and services tax (GST)—given the risk of hysteresis.  The fiscal policy option has already been exhausted.  Does the output gap matter?   The new monetary policy framework defines the loss function that a central bank has to minimize in terms of deviation from the inflation target on the one hand and deviation from potential growth on the other.  There is reason to believe that the latter is more important than the former right now.  This would be a good time for the MPC to signal that its commitment is to flexible inflation targeting rather than pure inflation targeting.”

The Hindu Business Line, on the other hand, argued against a rate cut, stating that it wouldn’t achieve anything at this stage. “Going by the market sentiment and political mood, a policy repo rate cut in December 2017 and February 2018 will be a welcome move.  But the moot question is what purpose this will achieve.  Evidence suggests that the growth rate currently is predominately consumption-led and household debt is looming large.  Any rate reduction could fuel private consumption and household debt even more.  Investment-led growth depends more on healthy balance sheets of private corporates, which can fuel an appetite for credit. Right now, no one is particularly hungry except consumers, who are often blind to bigger headwinds.   Therefore, any rate cut at this juncture becomes a burden rather than a benefit. It is now time MPC moves to a medium-term projection for policy repo rate from a crisis management approach for revival of growth. Now the policy repo rate is 6 per cent. Taking into account an average 4 per cent inflation and 7.5 to 8 per cent growth, what could be the sustainable policy repo rate? Since fiscal policy is rule-based, it is appropriate that the MPC should come out with a rule-based policy repo rate and a medium-term path to achieve it.”

Finally, Quartz, a rapidly growing online publication in India chose to focus on the implications of the interest rate cut debate on the relationship between the Indian government and the country’s central bank.  “Before the policy meeting in June this year, finance ministry officials had summoned the MPC in what was believed to be an attempt to coax the committee to cut rates.  However, asserting their independence, all MPC members, including the RBI governor himself, refused to attend the meeting.  The MPC has six members, three independent experts who were appointed by the government and the remaining from the RBI.  This committee was formed to ensure that the RBI could take a broader view on rate cuts, ending the earlier regime where the central bank’s governor was the final authority on this subject.   This time, too, there is no reason for the RBI to succumb to arm-twisting.  “As a central bank, you need to be extremely cautious about inflation and, therefore, it’s very natural for the RBI to be more conservative about inflation,” argued an economist with a private sector bank, requesting anonymity. “Global commodity prices and oil prices are high, which can further fuel inflation.  Also, there is concern about the government’s fiscal position considering tax collection under the goods and services tax. Therefore, any cautious institution will hold on to rates.”



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