Impact of demonetisation, GST fizzing out: FICCI Economic Outlook Survey

NEW DELHI: The slowdown in the economy due to demonetisation and the adjustment impact of the Goods and Services Tax (GST) implementation seems to be bottoming out as the new indirect tax regime stabilises, the economy would see an improvement in its performance, according to the results of FICCI’s latest Economic Outlook Survey.

The survey also notes that GDP growth is expected to improve to 6.2 percent in Q2 of 2017-18 and further to 6.7 percent in Q3 of 2017-18.
 
The steps taken by the government to reduce the compliance burden related to GST and make its implementation smoother, the comprehensive plan announced for recapitalisation of the banks and the thrust laid on the infrastructure sector have been acknowledged by the survey participants as an indication of the government’s clear resolve to address the key issues that are hobbling growth.
 
Even as these steps are taken by the government, the economists emphasised that reviving consumption particularly in the rural and semi-urban areas will be important to give a boost to overall demand in the economy. With the supply chains being impacted more in these areas compared to the urban areas, greater attention here was called for.
 
In this context it was emphasised that projects such as ‘housing for all’ and ‘electricity for all’ should be expedited as these would improve employment prospects in the rural areas and thereby help improve demand. Strengthening of the agri-supply chains and diversification in the rural areas in terms of the economic activities pursued were also mentioned as steps to improve performance of the economy. 
 
The participating economists also mentioned that government should continue with its emphasis on productive capital investments in the social and physical infrastructure space, even if this requires some calibration of the fiscal deficit target. 

The projected fiscal deficit number for the current year is likely to be slightly higher at 3.3 percent, according to the economists polled by FICCI.
 
Additionally, there is a need to address the issues related to factors of production particularly land and labour. It was mentioned that unused surplus land along railway lines and stations, major transport corridors and housing schemes can be utilised for undertaking commercial activities.
 
The participating economists also commended the role of the Reserve Bank of India (RBI) in addressing the issue of stressed assets. It was however suggested that recapitalisation plan must be accompanied by reforms in the banking sector and support extended to banks should be linked to their performance.
 
As for the inflation outlook, the survey results show that WPI-based inflation for the year 2017-18 is likely to be around 2.8 percent, while CPI-based inflation would be a bit higher at 3.4 percent. Given this outlook and the fact that supply side issues are largely responsible for the inflation movement in case of India, some of the economists mentioned that inflation targeting by the central bank may not be the correct approach.
 
While asking for a review of the inflation targeting stance of the central bank and calibration of the policy rate giving equal importance to growth and inflation considerations, the participating economists also highlighted how a higher rate of interest leads to greater capital flows thereby putting pressure on the country’s currency exchange rate. An overvalued exchange rate hurts exports and on this account too there is a case for the RBI to look at moderating rates.
 
Furthermore, it was suggested that the RBI can undertake a reassessment of various loan rates and other ratios based on their historical trends and corresponding economic impact to identify a possible way of promoting credit take-off across various sectors.  Some of the economists suggested the need to initiate targeted interventions like reducing standard asset provisions.
 
For instance, while the RBI has already made a 0.25 percent cut on individual housing loans, a further cut may help in improving consumer demand for housing loans. The LTV (loan to value) ratios, risk weights and standard asset provisioning rate for individual housing loans are some of the targeted interventions that the RBI can include in its policy measures to push credit growth.
 
The survey further noted that linking the pricing of loans to an external benchmark will make the monetary transmission mechanism more effective. In the current MCLR regime, loan pricing decisions by banks are based on internal factors such as cost of funds which are not sensitive to changes in the policy rates. It was felt that the shift to an external benchmark will improve the response time and will bring greater flexibility in the lending rates of banks.
  
However, while the economists supported the idea, it was also felt that it may not be the right time to introduce this change in context of the underdeveloped money market in India. It was pointed out that while selection of an external benchmark (T-bill, CD or repo rate) could improve the transmission, the pricing of long tenure loans based on these short-term rates needs to be discussed thoroughly as this may not portray market dynamics clearly.
 
Additionally, the current level of depth in T-bill and CD markets can potentially make such benchmarks susceptible to manipulation according to the surveyed economists.
 
Further, to enable banks to manage the pricing of their assets and liabilities in case of a move-over to an external benchmark, economists suggested that the RBI should consider allowing deposit rates to be linked to such an external benchmark as well. 
 
It was mentioned that loans of different tenors should be priced against appropriate tenor benchmarks. In other words, India needs to develop a genuine term money market that will also enable the proper pricing of the benchmark.  The RBI could ask banks to price loans on market benchmark plus an appropriate spread rather than a bank specific benchmark, the survey suggested.