New Delhi, (Ind-Ra): Poor gross domestic product (GDP) growth in two successive quarters – 4QFY17 and 1QFY18 – has changed the growth prospects for FY18, says India Ratings and Research (Ind-Ra). The combined effect of demonetisation and introduction of goods and services tax (GST) is proving to be more disruptive for the economy than was expected earlier. While the introduction of GST cannot be faulted on account of its eventual benefit to the economy, the same cannot be said about the impact of demonetisation.
Ind-Ra believes GDP growth will recover quarter-on-quarter in 2QFY18 with impact of demonetisation waning, teething problem arising out of GST implementation being looked into by the government and the festival season round the corner. However, it is unlikely to meet the agency’s earlier projection of 7.4% and will come down to 6.7% during FY18.
Without getting into the objective of demonetisation, let us first look at its after-effects on economy. Sucking out the high denomination currency while failing to remonetise the economy quickly has in many cases proved fatal for the unorganised sector/small and medium enterprise where business transactions are heavily cash dependent. As these enterprises have still not been able to recover fully, their pain is finding a reflection in overall economic growth.
Although the roll out of GST was fairly smooth and the first month revenue collections were encouraging, some stress points have emerged. The destocking by manufactures and the loss of liquidity for exporters due to delayed GST refund have affected business activities in the economy.
Some of the initiatives/reform measures taken by the government recently such as insolvency and bankruptcy code, corporate debt restructuring mechanism, re-capitalisation of banks, GST etc. have the potential to improve the fundamentals of the Indian economy, but their impact will be visible only in the medium to long term. Overall, the current economic landscape is not very encouraging – i) index of industrial production grew at a dismal 1.2% in July 2017, ii) bank credit is showing no signs of a pick-up, iii) consumer price index based inflation at 3.6% in August 2017 is a five-month high, iv) current account deficit at 2.4% of GDP in 1QFY18 is a four-year high.
Also with inflation inching up, despite the clamour for further monetary easing, the Reserve Bank of India (RBI) will have less elbow room to reduce policy rate further. Moreover, a further reduction in policy rate is unlikely to make much of a difference, particularly on the investment front, given the large idle capacities in several manufacturing sectors.
As there is growing realisation within the government that economy is in serious trouble, the union government is planning a stimulus package, essentially targeted towards reducing the woes of small and medium enterprises and exporters. But, the availability of fiscal space with the government is questionable.
Let us look at the fiscal arithmetic of the budget. The likely shortfall in revenue will mainly emanate from the non-tax side. RBI’s dividend this fiscal is INR275 billion less than budgeted. Similarly there is likely to be a shortfall of: i) INR50 billion in telecom account, ii) INR200 billion on disinvestment account (factoring in Oil and Natural Gas Corporation Limited buyout of Hindustan Petroleum Corporation Limited in FY18), and iii) INR110 billion in GST account. Although Ind-Ra expects the direct tax mop up to exceed the budgeted figure by INR200 billion and public sector units’ dividend to be higher by INR100 billion, the revenue shortfall for the government from the budgeted figures works out to be INR335 billion.
If we include INR100 billion of supplementary budget expenditure passed in the parliament so far, then the shortfall increases to INR435 billion. This will push the fiscal deficit by 26bp of GDP, meaning the fiscal deficit would escalate to 3.46% of GDP in FY18. The likely fiscal stimulus which the government is contemplating would push the fiscal deficit further. This indicates that that the government is likely to invoke the ‘escape clause’ mentioned in the report submitted by the N.K. Singh Committee to review India’s fiscal discipline rules. One of the triggers for taking recourse to escape clause is ‘far-reaching structural reforms in the economy with unanticipated fiscal implications’.
