Macro headwinds

There are multiple indicators that India’s prolonged sojourn in a macro-economic sweet spot is coming to an end. Driven by favourable global conditions and commodity prices, the past five years have been fortunate for the Indian macro-economy. Inflation has been brought under control as a partial consequence of these global factors, and the easy availability of global capital has helped finance the current account deficit. Easy inflation and low commodity prices have flattered the fiscal deficit, allowing the government to avoid painful belt-tightening. But that is in doubt now, with the government missing its tax revenue target by 11 per cent in 2018-19 because of lower-than-expected collection from the central goods and services tax, personal income tax and Union excise duties. But government spending has helped support growth rates. This virtuous circle depends crucially on external factors that are beyond India’s control. Some of these factors may now be coming to an end. In particular, crude oil prices — while they are unlikely to return to the $100-130 a barrel range that they had hit prior to 2014 — may well remain in the $70-80 range for some time, pushing the rupee towards or past 70 to the dollar. Oil prices have been a third higher this year than the last. It is partially as a reflection of these concerns that the India VIX, which measures volatility on the National Stock Exchange, hit a three-year high recently.

Domestic headwinds are also visible. In particular, there is no sign of recovery in either corporate earnings or private investment. The pipeline for new projects continues to be subdued, in spite of an increase in capacity utilisation. Most obviously, demand remains sub-par according to many high-frequency indicators of urban and rural demand. Passenger car sales grew only 3 per cent in 2018-19. The fourth-quarter results season is now underway, and the early signals point to a slowdown in the economy. The markets have been propped up by firm inflows from abroad, but this is not an inexhaustible tap. In particular, prolonged weak earnings, a depreciating rupee or a recovery in other emerging markets might cause this flow to weaken. There are some contrary indicators, such as recovery in bank lending to the corporate sector — but the latter indicator might simply be a reflection of the collapse of the non-banking financial sector. The headwinds for finance should also be considered. The NBFC crisis is once again in the spotlight after a spate of downgrades, and the insolvency and bankruptcy process continues to under-perform. Meanwhile, other time bombs are being built in the banking sector, including state-directed lending to micro, small and medium enterprises. 

The government has kept growth alive through its spending, but its fiscal space is now limited after two successive years in which it has altered the deficit reduction path. Private investment will have to recover to substitute for increasing constraints on government expenditure. The next government will have to face up to these macro headwinds as soon as it takes office. It is best if it embarks early on an ambitious reform programme that will not just boost consumer sentiment but also help create the conditions for a revival in private investment and exports.

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