H I G H L I G H T S
• Worrying signs in state finances
• State Budgets shrinking with expenditure cuts
• Stimulus II, but with negligible impact on the fisc
• LTC measures may benefit 850,000 govt staffers
• 6 % rise in Central capex, but states may be worried
• Confusion over GDP contraction estimates
• Implications of near-zero growth
• Nominal versus real may hold the key
• Drawing comfort from higher inflation & growth
• RBI bets on growth, ignores inflation worries
• A mixed picture on early signs of recovery
• Pick-up in automotive sales and core sector
• Non-oil, non-gold imports contraction slows
• New projects and industrial output still a worry
Worrying signs in state finances
The latest report from the Reserve Bank of India on state finances has important messages for the Indian economy and its revival challenges in a post-Covid world. The consolidated gross fiscal deficit of all the states was projected at 3.2 per cent of gross domestic product (GDP) for 2019-20, as per the revised estimates. But the provisional actuals released by the Office of the Comptroller and Auditor General of India show that the deficit for last year has been shrunk to 2.6 per cent. In the normal course, the states would be deserving of compliments for having achieved such a significant degree of fiscal correction. But the worry in the current context is that this correction has been achieved through sharp cutbacks in both the states’ revenue and capital expenditure by 11 per cent and 15 per cent, respectively, and not by a revenue increase. Indeed, it is because of a shortfall in revenues of over 6 per cent that the states had to cut their expenditure in a big way and achieved a fiscal deficit level of 2.6 per cent, that is lower than what the revised estimates had indicated.
State Budgets shrinking with expenditure cuts
This does not augur well for the Indian economy. The expenditure squeeze by the states may have negated the fiscal impulse from the central finances to counter the cyclical slowdown, as the RBI report notes. In 2018-19 also, such cuts were imposed. The fiscal deficit was, therefore, reined in, but the squeeze on expenditure to achieve fiscal consolidation was a cause for concern. For 2020-21, the states have projected a fiscal deficit at 2.8 per cent of GDP. The fear is that the states may strive hard to achieve this target by cutting expenditure in view of a fall in revenues in the current year. This will once again run contrary to the requirement of the states to spend more to revive demand after the devastating impact of the lockdown on the economy. The shrinking size of the states’ expenditure reflects the growing weaknesses in their finances. In 2018-19, the combined size of the states’ budgets was 35 per cent more than the budget size of the Centre. In 2019-20, the states’ budgets were 36 per cent more than that of the Centre. But in 2020-21, the states’ budgets would be only 30 per cent more than the Union budget size. This is a trend that must be viewed with caution.
Stimulus II, but with negligible impact on the fisc
The Union government announced on October 12 a package of measures that it believed would generate Rs 73,000 crore of additional consumption demand in the economy. The measures, however, did little to satisfy the markets and industry, which continue to eagerly wait for a bigger stimulus than what was announced by the government in May and now in October. The size of the additional government expenditure announced in May was about Rs 21 lakh crore, but its fiscal impact on the Budget was less than 2 per cent of gross domestic product. In October, the Budgetary impact of the schemes announced would be even more negligible.
LTC measures may benefit 850,000 govt staffers
There are two components in the measures that were announced in the second round. One pertained to a special dispensation under which central government employees could avail themselves of their unused leave travel concession (LTC) before March 2021 without undertaking any travel, provided they spend three times that amount on goods and services that attract a GST rate of over 12 per cent. An additional facility was that an interest-free festival advance of Rs 10,000 would be available to them. The advance has to be paid back in a maximum of 10 equal instalments. The government estimates that about a fourth of the Centre’s 3.4 million employees (about 850,000 employees) would be eligible for use of the LTC facility as the four-year block period for the scheme ends in March 2021. The cost for the government on account of the scheme would be less than Rs 6,000 crore, but the Budget had already provided for this. Also, by introducing the condition of purchases drawing a minimum GST rate of 12 per cent, the government has made sure that its employees will use this money to purchase consumer goods, whose GST rates are more than 12 per cent, and, therefore, boost demand in this sector of the economy. Equally significant, the employees cannot invest the LTC money in gold, whose GST rate is about 3 per cent.
6 % rise in Central capex, but states may be worried
The second component of the government measures pertained to the release of about Rs 37,000 crore by way of capital expenditure. Of this, Rs 25,000 crore would be spent by the Centre and Rs 12,000 crore would be given to the states by way of an interest-free loan to help them fund existing projects or settle pending bills. States could repay the amount over the next 50 years. An additional Rs 25,000 crore for the Centre would mean a 6 per cent increase in the capital outlay of over Rs 4.12 lakh crore already provided in the current year’s Budget. The entire burden of the capital outlay provision would have to be borne by the Budget. However, states that are likely to be free of their debt to the Centre in the next few years may be in two minds. Under Article 293 of the Constitution, states without any outstanding Central loans can borrow without the Centre’s clearance. But by entering into a 50-year loan arrangement, they might lose that potential advantage.
Confusion over GDP contraction estimates
Finance Minister Nirmala Sitharaman’s announcement on October 27 that the Indian economy would record near-zero growth in 2020-21 has triggered a new debate on the impact of Covid-19 on India’s GDP. Addressing the CERA Week India Energy Forum, Sitharaman said while India’s GDP growth in the current year would be “near zero”, it would record a smart recovery in 2021-22 making the country one of the fastest-growing economies in the world.
Implications of near-zero growth
The surprise was not on account of the finance minister’s growth projections for 2021-22. All international organisations, domestic agencies and analysts have forecast a sharp growth revival next year with the International Monetary Fund having indicated that India could be the fastest growing major economy at about 8.8 per cent, a notch higher than China’s at 8.2 per cent. But what was the basis of expecting a “near-zero” growth rate in 2020-21? After all, just a few weeks earlier, the Reserve Bank of India had projected a contraction in the current year’s growth rate by 9.5 per cent. The International Monetary Fund had projected a contraction of 10.3 per cent for the Indian economy in 2020-21. What was the puzzle behind the sharp revision in the projection?
Nominal versus real may hold the key
The only possible explanation is that the finance minister was perhaps expressing growth in nominal terms without adjusting for inflation. Growth rates are usually expressed in real terms, which is calculated after adjusting for inflation. These are calculated on the basis of constant prices, as they existed in the base year. For instance, the GDP estimates in India at present are calculated at constant prices (without the impact of inflation), with 2011-12 as the base year. These are also calculated at current prices (including the impact of inflation). Nominal growth is higher than the real growth rate when the economy is expanding, on the assumption that the economy has also been impacted by inflation. For instance, India’s GDP growth in 2019-20 was 4.2 per cent in real terms (at constant prices), but higher at 7.2 per cent in nominal terms (at current prices). But when the economy contracts, along with an inflation rate, the pace of contraction in nominal GDP is lower than that in real GDP. That’s why, the Indian economy contracted in the April-June quarter of 2020 by 24 per cent in real terms, but by a lower level of 22.6 per cent in nominal terms.
Drawing comfort from higher inflation & growth
Could it be then that the finance minister was merely expressing the hope that, riding on higher inflation, the nominal size of the economy in 2020-21 would just manage to retain the size that prevailed in 2019-20? Retail inflation in September hovered at around 7 per cent. But such inflation alone would not be adequate to keep the nominal GDP growth to a “near-zero” level. The inflation rate has to be higher and the economic contraction level too has to be much lower than the projections made public so far. The finance minister, therefore, seems to be betting on both higher inflation and a much lower contraction in the economy in the current year. Will she be proved right? The pace of the economic activity and the inflation rate in the coming months would hold the key.
RBI bets on growth, ignores inflation worries
The Reserve Bank of India remained unmoved by the upward movement of retail inflation and made no changes in the repo rate, at which it lends to commercial banks to help meet their funds shortfall. Since repo rate is traditionally used to control inflation, which in September had moved up to 7 per cent, the dilemma before the RBI’s Monetary Policy Committee, with three new members on it, was to whether raise the repo rate from the existing 4 per cent. But after its three-day deliberations, the Committee announced on October 9 that the repo rate will remain unchanged and the monetary policy’s accommodative stance will be maintained “as long as necessary – at least during the current financial year and into the next year – to revive growth on a durable basis and mitigate the impact of Covid-19, while ensuring that inflation remains within the target going forward.” This was a unanimous decision of the Committee. After evaluating domestic and global macroeconomic as well as financial conditions, the Committee relied on its projections that inflation would ease closer to the target (4 per cent retail inflation within a band of 2 per cent movement either way) by the fourth quarter of 2020-21. At the same time, the RBI was encouraged by early signs of a pick-up in economic activity and gave that a further boost by providing new windows for releasing additional liquidity in the system. This was a policy review that did not cut rates, but eased liquidity conditions to help boost the sentiments.
A mixed picture on early signs of recovery
In early October, there were reports that indicated a revival in the pace of economic activity in various sectors. After six months of contraction, the collection of goods and services tax or GST was up for the first time in September 2020, although the increase was quite small at 4 per cent, compared to the collection of the indirect tax levy in the same month of 2019. On a month-on-month basis, the overall GST collection of Rs 95,480 crore in September was about 10 per cent more than the August 2020 mobilisation of Rs 86,449 crore. For economists and analysts, the revenue uptick was a signal as much for a return to normalcy after months of disruption caused by the lockdown from March to June as for restocking of goods by the trade ahead of the festival months.
Pick-up in automotive sales and core sector
Sales of vehicles by manufacturers to dealers also saw a marked year-on-year increase in September 2020. Barring Mahindra & Mahindra and Toyota Kirloskar, all other major automotive vehicle producers recorded decent growth in their sales, led by Maruti Suzuki at 31 per cent. The September print for the Purchasing Managers’ Index, compiled by IHS Markit, was at an 8-year high at 56.8, staying at above 50 for the second consecutive month. Any number above 50 according to this index indicates prospects of growth. The Indian Railways’ freight movement in September was up by 15 per cent to 102.2 million tonnes by volume and by 14 per cent to Rs 9,903 crore by value. For the first half of the current financial year, however, the railways freight performance was still in the red at a contraction of 9 per cent by volume and 17 per cent by value. India’s largest coal producer, Coal India, reported a 13 per cent increase in its production in the July-September months of 2020, up from a contraction of 12 per cent in the April-June 2020 period. Power generation by NTPC too witnessed a sharp jump of 10 per cent in the second quarter of 2020-21, compared to a marginal increase of less than 1 per cent in the first quarter.
Non-oil, non-gold imports contraction slows
In September, India’s exports of merchandise goods recorded their first growth after six consecutive months of decline. It was an increase of just 5.27 per cent at $27.04 billion, but an increase that was driven by high-value items like electronic and engineering goods. Imports too continued to contract – at about 19 per cent to $30.31 billion in September 2020. But there was some relief in the import data as well. Non-oil and non-gold imports, which broadly indicate industrial demand in the domestic economy, contracted by around 13 per cent in September 2020, a pace lower than the 30 per cent fall recorded in the previous two months. This is an indication of a rise in domestic demand from industry.
New projects and industrial output still a worry
However, the pace of activity with regard to the setting up of new projects in the July-September quarter of 2020 was down by 81 per cent to Rs 0.59 lakh crore, according to the Centre for Monitoring Indian Economy (CMIE). Even when compared to the April-June quarter of 2020, the value of new projects in July-September 2020 was lower by 14 per cent. There was also no sign of revival in the August 2020 numbers on industrial production, released by the National Statistical Office on October 12. Overall industrial output fell by 8 per cent in August, but the worrying feature was that all sectors that make up the Index of Industrial Production reported contraction in August, led by mining (-9.8 per cent), manufacturing (-8.6 per cent) and electricity (-1.8 per cent). In terms of the use-based segments contributing to the IIP, all sectors reported a contraction with the steepest fall coming from capital goods at over 15 per cent. The IIP’s September 2020 print may show a revival, but for that one has to wait till November 12. The unemployment rate, compiled by the CMIE, fell to 6.67 per cent for September, but in October, it began inching up again and was reported at over 7 per cent on October 29.
(The views expressed are personal)