Brief: The Economic Survey Volume II, FY17 puts forth a contrarian overview of the Monetary Policy as well as the general assumption regarding GDP growth; the survey lauds reforms such as GST and demonetization and shows concern regarding overreaching government expenditure

The fiscal side perspective

The tone of the Volume II of the Economic Survey FY17 has been in line with the Ministry of Finance’s perspective regarding economic growth and sustainability. Also the focus continues to be on the revival of the private investment, which has been crowded out by a robust public capital expenditure; the survey pegs this capital expenditure at Rs. 3.10 lakh crore (1.8% of GDP) as compared to Rs. 2.90 lakh crore last year. Fueling this exuberance is the Revenue Expenditure, which on the other hand is pegged at Rs. 18.37 lakh crore (9% of GDP) as compared to Rs. 16.85 lakh crore last year – the component shares the optimism of macroeconomic stability and is a testament of a robust tax and to an extent, non-tax revenue. The survey however sees these numbers as below expectation due to the fact that production and utilization levels are below normal.

Quantitatively, major items of public expenditure also remained more or less same as compared to the previous year albeit showing a declining trend. Interest Payments, which indicates the sum as well as the yields on the quantum of money raised from the market – is estimated to be at 3.1% of GDP in FY18 (BE), declining from 3.2% the previous year. Salaries and Pension Accounts, which showed an upward trend the previous year has declined to 1.9% of GDP; previously the impact of the 7thPay Commission was apparent as the share of the component increased to almost 2% of GDP. Even though the Government has been constraining itself to maintain the fiscal balance and remain in line with its committed FRBM mandates (3.2% of GDP), the component is estimated to remain still at 1.4% in FY18.

For FY18 (BE), Gross Tax Revenue is pegged at Rs. 19.12 lakh crore (11.3% of GDP) as compared to Rs. 171.17 lakh crore last year. The current scenario has been therefore fruitful for states, which are benefiting from the recommendations of the 14th Finance Commission. The devolution of Central Taxes has consistently increased over the past few years and is estimated to be Rs. 6.75 lakh crore as compared to Rs. 6.08 lakh crore, the previous year. Including Grants-in-Aid, the total transfer of funds to the states is pegged at Rs 10.63 lakh crore in FY18 as compared to Rs. 9.67 lakh crore the previous year. Having said this, the survey has been particularly concerned about the states going overboard with their fiscal space. It is pointed out that the Farm Loan Waiver program will be detrimental to not only state finances but to the overall Indian GDP. If all states resort to such waivers (including those who have already done so), Rs. 2.7 lakh crore will be shaved off from the GDP; considering the multiplier effect, the impact on net demand will be over Rs. 9 lakh crore in FY18 figures. Speaking against certain expected cut downs in deficit spending, the survey however recommends that Government’s continued focus on investment in infrastructure creation is the need of the hour, especially logistics. The logistics cost in India is one of the highest among peers and is estimated that inter-state trade is more expensive than intra-state trade ‘by a factor of 7’. Efficiencies which will accrue with the introduction of reforms such as GST as well as demonetization were lauded as they will increase the tax net and bring about net savings for businesses.

The industry side perspective

There were concerns regarding risk in certain industries especially Power and Telecom. Nearly 60-70% of debt in both sectors is classified having an Interest Coverage Ratio (ICR) of less than 1 – this is a major cause of worry for the industry’s sustainability. While these industries are reeling under poor revenue cycles due to competition and expensive spectrum prices respectively, other industries too are recording low utilization levels and a lack of Capex. Average Revenue Per User (ARPUs) of the telecom sector have been recorded at less than $2 on average, a figure that is at an all-time low level; further exacerbating the situation is the intense competition. The so called, Twin Balance Sheet (TBS) challenge continue to haunt the system and it is up to the Government and the RBI to actuate the markets. The unsustainable investment cycle in Indian equities (from both FIIs and DIIs) has been questioned however and termed ‘bordering frothy’ given the fact that Price to Earnings (P/E) is bordering an all-time high of 24.

The monetary side perspective

The Survey has been critical of the fact that RBI’s expectation of CPI is on a higher side and is at least 25 to 75 bps over the Nominal Neutral Rate of 5.25%. CPI forecast has been consistently higher than actual for the last three years. This in a way has a negative impact on the real yields, which are artificially set higher due to higher Repos. Real yield of Indian sovereign debt at near 4.5% is highest among Asian peers. The phenomenon is said to be against the well-established ‘Taylor Rule’, which suggests that interest rates must be lower than the Neutral Rate whenever the GDP growth and inflation are below their target levels. The current concern is however deflationary impulses and not inflation that threaten to derail India’s growth story. The estimated growth rate in GDP is therefore considered higher than what will be actually achieved given the conditions prevailing.

The survey is optimistic about the fact that the INR is appreciating and this will have a positive impact over India’s exchange rate and eventually on its Current Account Deficit (CAD) as imports become cheaper. The robust FOREX of near $395 billion and a year worth of import coverage was a special mention. Questions were however raised regarding RBI’s stance regarding the core inflation, which the survey expects to come down. From the headline inflation perspective, the survey is of the view that oil prices are no longer a major threat to inflation given the fact that the sector is facing immense competition from high tech sources such as Shale Gas as well as renewables. Also, the demand for food stuff will be satiated by healthy agricultural production (the sector grew by 4.6% in FY17), a fact which is connected to a good monsoon this year as well. Concerns regarding inflationary pressures emanating from the government expenditure, especially pertaining to salary and pension sub-head have been underrated as the surveyors believe that the, ‘Impacts of GST and the Pay Commission may neutralize each other’.