Will the economy emerge from slowdown in 2020?

Any economic recovery in 2020 will largely predicate on the RBI maintaining a benign policy environment. That would mean low rates and sufficient liquidity in the financial system.

Jan 02, 2020 08:01 IST India Infoline News Service

As India embarks on a New Year with the Sensex and Nifty at record levels (or close to it), the real challenge is on the macro front. Apart from GDP, two critical components of GDP growth i.e. IIP and core sector have shown negative growth for 4 months in succession. The negative growth period during 2019 has been shaded in the graph below.

Data Source: MOSPI
 
Even as the IIP growth and core sector growth have been in negative zone, retail inflation has trended higher. Now, that is anomalous because you normally associate higher inflation with higher growth. In economics, this combination of rising inflation and negative growth is referred to as stagflation (which is short for inflation amidst stagnation). Stagflation has been a warning signal and indicates that, unless addressed, it could aggravate into a slowdown. It is in this context that the growth prospects for 2020 must be evaluated.
 
How do we know that the economy is emerging in 2020?
 
That is the million dollar question. Obviously, you cannot expect a V-shaped growth recovery after a sharp deceleration in growth. The focus should, therefore, be on a gradual recovery in the high frequency indicators like IIP and core sector growth. The more important signal will be on the GDP front. GDP growth had fallen to 5% in the Jun-19 quarter and to 4.5% in the Sep-19 quarter. The subsequent negative IIP and core sector hint at a weak GDP growth in the December quarter too. Therefore, the fourth quarter ending March 2020 will be the real test. If India can close the fiscal year 2019-20 with GDP growth close to 5.25% and get to the vicinity of 6% from the March quarter onwards, then it would be the first sign of an economic recovery. The first indications of any such recovery will be seen only around end of May 2020 when the March GDP data is announced. What should be the strategy?
 
Strategy 1: RBI must hold on to a benign rate environment in H1-2020
 
Any economic recovery in 2020 will largely predicate on the RBI maintaining a benign policy environment. That would mean low rates and sufficient liquidity in the financial system. In its December policy, RBI maintained status quo on rates in the light of higher inflation. One line of argument is that rates are already at their lowest since 2003. However, that may not exactly be justifiable. Most of the large economies around the world have kept long term rates well below the pre-crisis levels. India needs to take a page out of this book. Back in 2018, the two rate hikes had a disastrous impact on cost of funds and triggered the NBFC crisis. Such experiments should be avoided if the government is serious about an economic recovery. The RBI can slacken the pace of rate cuts but lower rates are essential to ensure transmission benefits.
 
Strategy 2: Budget 2020 must be a real Big Bang fiscal stimulus
 
If ever India needed another Big Bang budget, it is in 2020. Stock markets are at an all time high and growth is at a multi-year low. Monetary policy has its limitations in driving growth and fiscal policy must step in. India is in a sort of fiscal dilemma. Direct tax and GST revenues are falling and the divestment scenario has been tepid. However, the government needs to think twice before slackening on fiscal discipline as it will lead to rupee weakness and sovereign downgrades. The $15 billion infrastructure package over the next 5 years is a great idea and it needs to be combined with speed of implementation. The infrastructure focus is already having an impact on cement output and that is the best way to create the multiplier effect on GDP growth. For that, fiscal deficit must be approached in a counter cyclical way.
 
Strategy 3: Reap the benefits of the manufacturing tax break
 
The FM had announced a sharp tax cut in September 2019, which triggered the last leg of the Sensex rally. Tax cuts have cost the government Rs145,000cr but they have only impacted profitability of Indian companies, not sales growth. For that to happen, the concessional rate of 15% must be extended to new investments made by existing manufacturers too. Such relief can be time-bound but it would go a long way in enhancing output. These may put pressure on government finances but it is a risk worth taking for higher growth.
 
Between the Indian economy and a likely recovery stands government policy. A combination of lower taxes, lower GST and growth incentives can set the launchpad for a long term growth recovery. That could  be the sure-shot way to economy recovery in 2020!

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