Adverse macro winds ahead for economy

The economy is heading into adverse macro winds. Next year, we will also have general elections, which are always a disruptive factor for the economy. The current adverse macro winds have four reasons. First, the rupee is depreciating against the dollar. Some of this is correction for its over-valuation. It was too strong, as borne out even by calculations of the Reserve Bank of India. The overly-strong rupee made imports attractive and cheap, to the detriment of locally produced goods.

The strong rupee also is a negative factor for our exports. So, the falling rupee is beneficial, somewhat, to domestic industry, for exports and jobs. But a steep fall is certainly bad news. We must also note that the rupee is falling even as the dollar itself is losing value against major global currencies. Hence, this is a double depreciation for the rupee. The second adverse macro factor is oil prices. Brent crude has crossed $80 a barrel, and there is talk that it could even be headed to $100.

Second, the reimposition of US sanctions on Iran might mean lesser global supply, causing oil prices to remain high. Many of the oil producers may side with the US on the Iran issue, so that an easy resolution seems unlikely. India’s import of oil may go up by $50 billion more than last year, and the total bill could be as high as 8% of GDP.

The third, related adverse macro factor is higher inflation. This is mainly on account of oil prices, which feed into general inflation due to the cost of transport and logistics. Additionally, if monsoon rainfall is not adequate, it can aggravate food inflation.

The fourth adverse factor is higher interest rates. The policy benchmark rate is set by the RBI, which will certainly be influenced by higher oil prices and inflation. The US Federal Reserve Bank has also begun to raise interest rates, which means global rates are moving upwards. Higher interest rates make investments costlier, since bank loans become expensive. In particular, housing loans and the real estate sector are affected negatively. Housing and construction are major drivers of economic growth, and rising interest rates can slow down these sectors.

The consequence of these four adverse macro factors — sliding rupee, rising oil prices, inflation and interest rates imply that the current account deficit will deteriorate. If it crosses more than 3% of GDP, that is a danger mark. It can put further pressure on rupee depreciation, causing foreign investors to panic and flee. This can have a negative consequence for stock and bond markets. Defending a sliding rupee requires RBI intervention and, thankfully, the country’s foreign exchange reserves look fairly adequate. Another consequence is that the oil subsidy will increase.

In the three years between 2014 and 2017, the country saved nearly 180 billion dollars in the oil import bill cumulatively, amounting to nearly 9% of GDP. This made it possible to stabilise fiscal deficit due to big savings in oil subsidy. The retail price of petrol and diesel was not allowed to decrease despite a steep fall in international oil prices. Domestic taxes (excise) were raised by almost 150%, and hence the fiscal bonanza of the steep fall in oil prices was partly diverted to infrastructure and welfare spending, rather than passed on wholly to the consumer.

Now that oil prices are rising quickly, there is the question of whether excise can be reduced to cushion the blow. But the fiscal situation may not permit such generosity. The fiscal situation is also getting stretched, especially at the state level (where half the petrol/diesel excise is applied) due to extra fiscal obligations. These include farm loan waivers and additional burden of running centrally sponsored schemes. So, fiscal strain is a third consequence of the adverse macro factors. And finally, as we head into general elections next year, the fiscal pressure due to populist measures is unlikely to subside.

Micro-indicators positive

So, clearly, we are heading into a challenging macro-economic scenario. Thankfully, many micro indicators are encouraging. Corporate results show an improving trend across many sectors, excluding telecom and public sector banks. The fall in the rupee seems to have given a shot in the arm for exports. Engineering exports rose by 17% last year, of which exports to the US alone rose by 44%. Agriculture production was at record levels last year (even though prices were subdued), so farm exports also may go up.

India can negotiate a rupee trade with Iran, and pay for oil imports in rupees, thus circumventing the sanctions. That may save some foreign exchange. Non-bank finance, including equity and bond financing for small firms, is showing robust growth. To the extent it can fill the gap left by slowing of bank credit, it is a good development. The bankruptcy process is also showing some early success, which can relieve some of the load of bad loans on banks. As the distressed assets go to new owners, it will lead to the kickstarting of stalled companies and projects, which is heartening.

Consumption spending is showing momentum and, especially, civil aviation traffic is still growing at over 20%, now almost three years in a row. The huge valuation received by Flipkart in its sale to Walmart will hopefully bode well for e-commerce, in particular, and start-ups in general. There is much buzz among start-ups in fintech, e-commerce, digital and telecom, some of which can be quite transformative.

So, it is turning out to be a story of adverse macro factors and strengthening micro performance. The policy-makers are going to be a busy lot in the coming months, steadying the ship of the economy.

(The writer is an economist and Senior Fellow, Takshashila Institution)

(The Billion Press)