Economy likely to do better in 2019: Business Line 31 Dec 2018

Even as consumer demand remains a constraint, investment is showing signs of revival. Lending by banks is set to improve

The new year for sure will be an interesting one for the country for several reasons. First, 2019 will be an election year where economics takes on a different face as promises are made and partly invoked when the new government is formed.

Second, farming is now the main burning issue not on account of a drought, but because it has been presumed that the recent State elections were decided on the basis of low farmer income. Therefore, agriculture focus will be a centrepiece of the government.

Third, this will be the year when the so-called unresolved issues between the RBI and the government will find utterance and a roadmap would be in place.

And, fourth, while there is a lot of comfort from oil prices coming down, it should be remembered that the US has given a six months reprieve and the oil economics can change, which can be the expected external shock.

Monsoon effect

So, how is the economy likely to look in the coming year? To begin with it is always assumed that the monsoon will be normal. This is a precondition for the economy to be on the growth path because any failure will upset all calculations as 60-65 per cent of the kharif crop is rain-fed.

Econometricians would argue that the possibility of a sub-normal monsoon is high this time given that we have had successive good monsoons (though these have also been punctuated by drought conditions in certain parts of the country) in the last few years.

Consumption, investment

Two things that one will look at closely are consumption and investment. Consumer demand is the driving force of any economy in the long run, and so far the picture has been quite mixed with consumption not really taking off. Demonetisation, GST and fall in agri prices (which gave the CPI inflation number the right push downwards) has come in the way of consumer demand, which is required to buoy the economy. Typically, this should grow at a higher rate than GDP and would depend on two factors.

The first is employment. While there have been differing views on job creation, at the end of the day this gets reflected in consumer demand. Demand for automobiles, consumer durable goods and better living services like travel and tourism cannot be sustained in the absence of new job creation or increase in spending power.

There is a degree of stagnation in consumption, with only high level goods and services witnessing continued momentum. It has to percolate downwards to work for the economy. With several industries going in for technology given the stringent labour laws, job creation will hold the clue.

The other factor is farm produce, and this is where there is is a conundrum. The solution so far has been to announce higher MSP (minimum support price) without paying much attention to the productivity part of the story which involves irrigation. Hence, an adverse monsoon means lower output. A good monsoon and high production means lower prices and income and the MSP is quite meaningless unless there is a front-end procurement scheme in place. This will be crucial this year, too, in driving rural demand which is linked to demand for products like FMCG, white goods, tractors, two-wheelers, fertilisers, seeds, etc.

Investment is the other critical piece of the puzzle where manufacturing and infrastructure matter. For the former, it is expected that as consumption increases the capacity utilisation rates improve, which will lead to higher investment. The picture till the first quarter of 2018-19 is positive; capacity utilisation may move towards the 75 per cent mark and lead to higher investment in some sectors.

Infrastructure investment will still be driven largely by the government as the private sector may not come in a big way until the NPA (non-performing asset) issue is sorted out. Given the predilection to address the issues on agrarian stress, the Central and State governments may be constrained in such spending given the FRBM compulsions.

Fillip for banking

The new year will definitely be better for the banking system. It does appear that the recognition exercise is complete and new NPAs that emerge will be based on present performance of assets rather than legacy ones. The government has announced a large recap plan, which will place banks under PCA (prompt corrective action) in a better state to lend.

While the focus will be more on retail and SMEs to begin with, one may expect them to return to normal by the end of the year. Also, the mega merger of three public sector banks will be executed this year and will hold a clue to further such amalgamations as the areas of conflict are also resolved.

The interest rate scenario can be assumed to be tending downwards provided the assumptions of a normal monsoon and stable oil prices hold. However, one may not expect an accelerated lowering of rates as core inflation will continue to be firm, which will be positive for the corporate sector as it indicates regaining of pricing power.

A calibrated lowering of rates can be conjectured, which will probably not be more than 25-50 basis points (bps). This would still keep the 10-year yield above the 7 per cent mark and in the 7-7.25 per cent range.

Currency movement

Currency pressures will still be an unknown as it was observed in 2018 that a stronger dollar kept all currencies weak. With the US Fed likely to only increase rates even though the signal is that there would be fewer rate hikes, a stronger US economy will signal not just a stronger dollar but also guide foreign investment inflow, which is critical for the balance of payments situation and forex reserves. A range of 70-72 to a dollar looks likely and sustainable given these conditions.

On the whole, the economy seems poised for higher growth in 2019 notwithstanding the election results, as it can be largely assumed that the thrust on reforms and growth will continue as most of them are irreversible. This is definitely the good part of the story.