Continuing uncertainty: 2017-18 saw return of growth but not of stability

Partly as a consequence of a flood of government and quasi-government paper, the bond markets turned bearish in the second half of FY18

As the financial year 2018-19 begins, it is worth examining what the data available for the year just ended, 2017-18, reveals about the state of the Indian economy. The past financial year was marked by the great disruption of the introduction of the goods and services tax (GST), a change which not just affected government revenues but the operation of much of the private sector. Teething troubles aside, it seems clear that the introduction of the GST has not only been successful, at least in terms of achieving the targeted revenue, but has also remained non-inflationary, contrary to apprehensions. In fact, inflation was lower than expected for much of 2017-18, although there have been signs towards the end of the financial year that inflationary pressures are again building up. This lends a little more uncertainty than previously understood to macroeconomic indicators. In late January 2018, global crude oil prices rallied to over $65 a barrel, which has implications for both the fiscal and current account deficits. The government’s decision to relax its plans for fiscal consolidation is a sign of macro concerns returning to the forefront.

Partly as a consequence of a flood of government and quasi-government paper, the bond markets turned bearish in the second half of 2017-18. The headline yield on 10-year government securities rose sharply for much of the year — the longest such rise in decades. The government has now restored some stability to the bond market by reworking its borrowing schedule. But the underlying drivers of this bond rout remain in place. Medium- and long-term gilt funds thus suffered in 2017-18, and there is no certainty that they will perform better in the new financial year. Money, especially from retail investors, continued to flow into systematic investment plans, or SIPs, in spite of their poor performance in the past year. 

Does this reflect a good year for the equity markets? The Nifty gained almost 12 per cent over the year. Yet, there are concerns that the market is now “too expensive”, in spite of a correction of about 10 per cent towards the end of 2017-18. Corporate earnings have continued to underperform expectations. While realty stocks have done well, real estate as consumer investment continues to be bedevilled by regulatory and other concerns in spite of the introduction of a new law governing the sector. It is clear that a search for reliable investment vehicles continues. While the government has sought to channel more household savings into the formal economy, there do not appear to be enough destination instruments. Partly, this reflects a lack of bankable projects. Although both credit growth and new investments are up over 2016-17, the former is still anaemic and the latter is driven largely by government spending. Most importantly, the continuing mess in the banking sector sets an effective ceiling for credit growth.

Certainly, the worst of the disruptions are over, and growth has returned to the Indian economy. But there is still too much uncertainty for a revival of private investment. Uncertainty in the markets reflects broader uncertainty about the state of the Indian economy, with indicators pushing in different directions and with several possible causes of economic instability on the horizon.