The Survey’s estimate for FY18 real gross domestic product (GDP) growth at 6.75 per cent is slightly higher than our (6.6 per cent) and Central Statistics Office’s estimate of 6.5 per cent, whereas its projection of growth to rebound to 7-7.5 per cent range in FY19 is conditional on various potential risks – sustained higher global oil prices, tighter interest rates, and sudden stops in capital flows – not materialising through the next fiscal year.
Our baseline growth forecast for FY19 at 7.5 per cent is in the upper band of the Survey’s forecast range, but we too remain cautious about downside risks, just like the ones highlighted in the Economic Survey. We see primarily four risks, which we categorise as ‘FROG’, that can potentially slow down or delay India’s expected growth recovery through FY19. These are: i) Inability to meet Fiscal deficit targets; ii) Earlier than anticipated Rate hikes from the Reserve Bank of India (RBI) and faster pace of rate hikes from the Fed; iii) Higher global Oil prices; and iv) Potential escalation of Geopolitical risks.
The Economic Survey states that if macrostability is maintained, ongoing reforms are stabilised and global growth recovery is sustained, then growth in the Indian economy should start recovering towards its medium-term economic potential of at least eight per cent. This indicates that even if India achieves 7.5 per cent growth in FY19, it will still be lower than the potential growth rate of the economy, and therefore, from an output gap perspective, there is not enough justification for the RBI to start hiking rates in 2018. Our view is that rate-easing cycle has ended in India, but the economy is not ready yet to absorb the shocks of interest rate hikes in 2018, especially after experiencing demonetisation in 2016 and the goods and services tax in 2017.
Regarding the fiscal path for FY19 and beyond, the Survey recommends the need for sustaining “reasonable consolidation” which is based on credible projections, rather than resorting to “over-ambitious” targets which later could become difficult to achieve. In our view, fiscal prudence at this stage will help to prevent market interest rates from rising to higher levels and thereby can play an important role to sustain and accelerate the nascent recovery in growth that is underway. From this viewpoint, we expect the FY19 fiscal deficit target to be set at three per cent of GDP, which is achievable in our view, even under realistic assumptions.
The Survey noted that the Indian economy’s competitiveness has had to contend with the real effective exchange rate appreciating by about 21 per cent since January 2014 and further highlighted how exchange rate and interest rate movement affects various stakeholders in the economy differently. Precisely for this reason, the RBI does not target a particular level for the rupee, but tends to use FX operations for management of volatility and improving reserves adequacy strength. We expect such a stance to continue through FY19 as well.
The writer is the India Chief Economist at Deutsche Bank