The multi-year slowdown of 2QGDP at 4.5% (GVA at 4.3%) continues to highlight the challenges faced by the Indian economy and the policy responses, accordingly, requires immediate course corrections. The growth in 2Q has largely been led by unsustainably high government spending, with all other indicators continuing to remain lacklustre. In fact, GVA, excluding government spending, fell to 3.2% in 2QFY20, with broad-based weakness witnessed across industries and services. On a slightly positive note, growth in private consumption improved from 3.1% in 1QFY20 to 5.1%, probably reflecting the gains from improved terms of trade for the agricultural sector as witnessed by the rise in food prices over the past few months. However, the continuing stress in non-banking financial companies (NBFCs) may make it difficult to revive consumption demand meaningfully. The high-frequency data for October also suggests that festive season demand remained largely missing. While favourable base effects, lower short-term rates amid lower policy rates and easy liquidity conditions could provide some support, we see the ongoing headwinds to play out further before some stability sets in towards the middle of next year. We, thus, have revised down our FY20 GDP estimate by 30 basis points (bps) to 4.7%.
On the policy front, the monetary policy committee (MPC) may be faced with a dilemma given that their mandate is to manage the headline CPI inflation to around 4%, which seems to be deflecting from its medium target. However, we expect the MPC to take note of the expected reversal of the transient spike in food prices, which should ease the headline inflation after a few months. In any case, the October CPI inflation, excluding vegetables, remains fairly stable and benign at 3.2%. With widening negative output gap and weakening core inflation, we expect the MPC to assign higher weightage to addressing growth and deliver a 25 bps rate cut this week. After the December action, we also see room for an additional 25 bps rate cut in FY20. Beyond that, the MPC will likely stay on hold and focus on transmission as the impact of the already 135 bps of rate cut has not been witnessed just yet.
Notably, with monetary actions nearly approaching an end of the easing cycle, given that inflation begins to overshoot 4%, we believe that the next set of heavy lifting will need to be done by the government. The economy is expected to remain below potential for a prolonged period in the absence of fiscal support. Although the government’s fiscal room remains limited, it also remains a function of self-defined FRBM (Fiscal Responsibility and Budget Management) goals. First, we believe that the government should refrain from any spending cuts and let the fiscal deficit slip if needed. Also, the recent privatization drive is a good start to bridge some shortfall. Beyond the fiscal, we believe that the government may need to focus on non-fiscal reforms to revive the already chocked economic channels of lending and healthy competition.
To begin with, the government will have to aggressively start recapitalizing public sector banks (PSBs), maybe without much conditions. This should be followed by moral suasion by the authorities on PSBs to lend.
Additional capital should bring back the missing credit channel and help in driving down lending rates. Accommodative monetary stance can only provide a necessary boost, but cannot be a sufficient condition to revive a slowing economy. The government should continue to use its political might to further undertake structural reforms in areas of land, labour and capital, to improve the productivity of the economy in the medium term.
*Upasna Bhardwaj is an economist at Kotak Mahindra Bank.