Insights into Editorial: Sell to Spend
26 January 2016
Economic slowdown in China and strong job growth but weak wage growth in the US, all suggest that 2016 may not be a great year for the global economy.
Amid this storm, the good news is that India remains the emerging market (EM) deemed most resilient to global shocks, underpinned both by good policy (fiscal and monetary) and a lot of good luck (collapse in oil).
- The depreciation of the rupee over the last week may have jangled some nerves but the fact is that it continues to be among the best performing EM currencies.
- The current account deficit is also less at 1% of the GDP.
Why India is better placed?
- The collapse in oil prices has been the biggest driver of growth, boosting it by more than 1% point in 2015-16.
- It has increased the household purchasing power, corporate margins, and created budgetary space to increase expenditures.
It should be noted that fall in oil prices is a one-time boost because it’s the change in oil prices — not their level — that creates the growth dividend.
- If the oil price stabilises, India will lose this growth dividend next year.
- Further, with balance-sheet stress still not alleviating, and the export outlook not improving, India’s economy could get worse.
- The real policy challenge, therefore, is not guarding against a rupee collapse (like in 2013), but ensuring that it doesn’t appear too strong on a trade-weighted basis as other currencies depreciate even faster.
- India’s worry is not external preparedness but growth risks that have increased in recent months.
How should India prepare itself to face the slowdown?
The continued correction of oil has increased the possibility of some more monetary easing this year. But, it would be more prudent for the country to concentrate on inflation targeting. Core inflation in the country has stubbornly remained above 5.5% in 2015. Inflation targeting has provided a much-needed anchor to monetary policy, creating credibility, enabling consistency, and anchoring medium-term inflation and rupee expectations.
- Amid concerns of a slowdown, few experts have advised the government to follow a fiscal-consolidation path. They have also asked the government to reduce the fiscal deficit further from 3.9 to 3.5% of the GDP. However, doing so would make fiscal policy procyclical (tightening when growth is slowing) and potentially suboptimal.
- Another way to protect against adverse dynamics is to reduce the primary deficit as soon as possible. Experts also suggest that the government should also be ready with a counter-cyclical policy and implement it if required.
How can the government avoid procyclicality?
Now, asset sales are the only way for the government to protect credibility while avoiding procyclicality. There are no easy policy choices in India. Hence, it is time for the government to prioritize asset sales (disinvestment).
What happens if we deviate from the fiscal path?
It could impinge upon India’s hard-earned credibility. This would also increase the overall borrowings. A larger-than-expected borrowing programme could further pressure benchmark G-sec yields, pushing up private-sector borrowing costs and risking some crowding-out of private investment.