Risks to revival

The spread of coronavirus adds to significant uncertainty

Economic activity is not recovering in the second half of the fiscal year, as most analysts initially expected. According to the official data released on Friday, the Indian economy grew by 4.7 per cent in the third quarter, compared with the revised estimate of 5.1 per cent in the previous quarter. Second-quarter growth was earlier estimated at 4.5 per cent. Estimates have also been revised for 2018-19 and the first quarter of the current fiscal year, which now shows growth of 5.6 per cent, compared with the earlier estimate of 5 per cent. Although the full-year growth projection for the current year has been retained, the estimate for output in absolute terms has been lowered by over Rs 95,000 crore. This has not disturbed the growth projection because output has also been revised for the previous year by a similar magnitude. Growth in 2018-19 has been revised from 6.8 per cent to 6.1 per cent. As a result of significant revisions, economic activity is estimated to grow at a slower pace in the second half of the fiscal year, though it may be revised at a later date.

While the agricultural sector expanded by over 3 per cent in the third quarter of the current fiscal year, output in the manufacturing sector contracted. Worryingly, investment showed a sharp contraction in the October-December quarter and is expected to remain in negative territory for the full year. The underlying economic weakness and other emerging challenges suggest that growth is unlikely to recover meaningfully in the next few quarters. For instance, as economists at Nomura have noted, net exports and government expenditure contributed 2.7 percentage points to overall growth in the December quarter. While lower imports reflect weak underlying demand, government expenditure will need to be contained in the current quarter. According to the latest data, the fiscal deficit touched 128.5 per cent of the full-year target in January.

Further, the spread of coronavirus across the world poses significant uncertainty. Apart from supply-chain disruptions in China — the epicentre of the crisis — it can lead to demand compression, which may last much longer than expected. Global stock markets fell sharply last week because of the possible impact of the outbreak on economic activity. India depends on China for supplies in sectors such as pharmaceuticals, auto, and electronics. Besides risks to domestic output, lower global growth will further affect the economic outlook. The only positive for the Indian economy perhaps is lower commodity prices.

The economy is also unlikely to get any significant support from monetary policy in the near term. While food prices, which were pushing up headline inflation in recent months, are likely to moderate, risks could emerge from other areas. Apart from supply-chain disruptions, which are reportedly putting pressure on prices, the rate-setting committee would want to see how developments in the telecom sector affect tariffs and headline inflation. The Reserve Bank of India may want to increase the limit for long-term repo to increase liquidity and lower market rates. 
 

However, given the inflation and liquidity situation, this option has limitations. Therefore, as things stand today, growth is likely to remain weak in the coming quarters. Longer-term prospects, of course, will depend on how quickly the government addresses some of the more fundamental issues, including its own finances.