Comforting if the ‘ifs’ hold: Financial Express 6th August 2011

One issue which has been a matter of conjecture even more than whether or not Lady Gaga performs in Mumbai is the true state of the economy. There are a plethora of estimates from various agencies, which, though useful, are utterly confusing, given the wide ranges. Therefore, it is only appropriate that the Prime Minister’s Economic Advisory Council (PMEAC) has come up its forecasts. Coming from the PMO, it appears to be relatively more authentic as the government certainly knows more than others on the data as well as its own finances and policies.

Let us see how we should read between the numbers presented by the PMEAC. Bringing down the GDP growth rate to 8.2% from 9% assumed in the Budget is realistic, but what is important is as to how this number would affect other variables. In particular, the fiscal numbers deserve scrutiny at a time when the fiscal deficit ratio has been increased marginally from 4.6% to 4.7% of GDP. Is this possible? There are two parts to this ratio, the numerator and denominator. The denominator has been assumed to remain unchanged with growth of 14% in nominal terms for GDP at market prices, which can be broken up into 8.2% real GDP growth and 5.8% inflation. But, by the government’s own admission, the inflation rate will remain at 9% till October and come down to 6.5% by March 2012. If this is so, then the average for the year has to be higher at around 8%, which will mean growth of around 16% in nominal GDP.

The slippage in fiscal deficit has been assumed to be just 0.1%, which amounts to around R9,000 crore; this is difficult because of three reasons. The first is that the government has given away around R50,000 crore in taxes on oil products. Second, lower GDP growth will mean lower production too. In particular, industry is to grow by 7.2% now, which will lower excise and corporate tax collections. Third, the Budget talks of R40,000 crore of disinvestment, which may not happen as the market so far has been at best stagnant. Therefore, the fiscal deficit ratio has to be higher than 4.7% if ceteris paribus conditions prevail.

The only way to meet this mark is for further expenditure cuts, which cannot be ruled out as this was also done in FY11. If this happens, then we can see infrastructure growth taking a back seat, as this is normally the area where allocations are reduced to meet fiscal targets. But, based on the GDP sectoral projections made by the PMEAC, the sector, community and personal services, is to actually grow at a higher rate of 8.5%. Therefore, we have the curious case of one part of the trinity—fiscal deficit, government expenditure or GDP (nominal) actually moving out of the loop as internal consistency is difficult.

The growth rates for agriculture and industry appear to be realistic. However, the projection for services is aggressive at 10% as the services sector may not grow at such a high rate when the sectors that it supports, i.e., agriculture and industry, are growing slowly. Intuitively, it may be seen that any slippage here will get reflected quite sharply in the GDP number.

The other interesting projection made is that the investment rate is to increase, albeit marginally, from 36.4% to 36.7% in FY12. This is significant because in a rising interest rate environment, one would have expected investment to take a knock. The resilience of investment to interest rates is a major take away. Further, it also means that the higher interest rate policy followed by RBI is expected to affect consumption more than investment. Therefore, growth of consumer goods including automobiles backed by finance would be affected more by higher interest rates than investment, which, in a way, is comforting as future growth prospects are addressed.

The external sector is to be the flag bearer at a time when the global economy is in a state of flux. Exports are to grow by 32%, which will be awesome as it will come over a high base year number while the deficit will widen. Given that the current account deficit is going to rise only marginally, to 2.7%, there is quite a bit of elbow room here. But the high point will be foreign investment where capital flows through FDI (gross of $35 billion and net of $18 billion), FIIs (muted at $14 billion) and borrowings ($35 billion). This is not bad news except for the higher external commercial borrowings, which will exert pressure on the external debt situation.

So, what are we to make of these numbers? Growth will be subdued and could take a dip if the assumptions made are violated. The interest rate hikes and their impact appear to be factored though the optimism on investment is still significant. The external sector will provide strength, which, prima facie, appears feasible. India will remain a fast growing economy in depressed global world, though periodic review of the fiscal picture will be essential to gauge the progress.