India's economy: Dual dualities

In a large and complex economy such as India's, contradictions and paradoxes are par for the course. But as we start 2018, the economy is characterised by dual dualities – which this year's Economic Survey captures both explicitly and implicitly.

The first duality – which the survey discusses explicitly – is the trade-off between growth and macroeconomic stability. Ever since 2014, India has been considered the beacon of macroeconomic stability. The collapse in inflation and the move to a new inflation-targeting regime, the collapse in the current account deficit, a large accumulation of forex reserves and the centre chipping away at its fiscal deficit reassured economic agents – both inside and outside the country – that the 2013 mini-crisis would never be repeated. But even as the economy was increasingly considered a "safe haven" amongst emerging markets, growth has underperformed in recent years. Much of the growth pick-up in 2015 was driven by the collapse in oil, and growth began to slow once oil stabilised.

Then, the combination of GST and demonetisation – in a bid to formalise the economy – temporarily disrupted domestic supply chains and induced more imports. Net exports should have been a big tailwind to growth in a stronger global environment. Instead, they became a big headwind. All this meant India strongly underperformed the synchronised global economic recovery of 2017. Even as global growth printed at its strongest level since 2010, India's growth in 2017-18 is on course to slow to a four-year low. This has created an impatience for higher growth, accentuated by the stress in key labour-intensive sectors of the economy (agriculture, construction, small and medium enterprises) in a pre-election year.

The good news is that these drags appear to be fading and the high-frequency data suggest growth is recovering in the second half of the fiscal year. The survey forecasts that growth will accelerate from 6.75% in 2017-18 to 7-7.5% in 2018-19. But, to its credit, the survey is simultaneously candid about all the risks – the biggest of which is the 40% increase in oil prices over the last six months. One can, however, at least gain solace from the fact that the growth slowdown has bottomed.

But even as there is some good news on growth, it is juxtaposed by some pressures on the macroeconomic front. The unabated sell-off of bond yields has resulted in the steepest yield curve in years. This reflects fiscal exhaustion, but manifests in pushing up corporate bond yields in sympathy, which pushes up borrowing costs for the corporate sector. Further, oil at $70/barrel has meant that the annualised momentum of core inflation is running at 6%, and the current account deficit could print at its highest level in five years. This could have implications for the rupee down the line. So, the first duality is that even as growth is recovering, India's macro-fundamentals are coming under pressure for the first time in years.

The second duality is temporal: a challenging near-term with much-improved medium-term prospects. 2016 was the year of valour. The implementation of GST, adoption of the Bankruptcy Law, commitment to decisive re-capitalisation, continued focus on physical infrastructure and growing use of technology and direct benefit transfers promise to fundamentally transform the Indian economy in the medium term. But that more sanguine medium term must contend with a variety of near-term challenges. Indeed, rising oil prices, residual transition costs from the large reforms and a packed political calendar are likely to intersect over the next 12-18 months, creating potent political-economy pressures. As the survey honestly concludes, "Economic management will be challenging in the coming year."

Both dualities have the same policy implication: Policymakers must tread very carefully over the next year. A very large fiscal slippage this year and/or inadequate consolidation next year could trigger more mayhem in the bond markets that will eventually show up in other asset prices. The key lesson from 2013 was clear: If macro-stability is compromised for slightly higher growth, the economy will end up with neither.

This is an honest, credible and thought-provoking survey – drawing all the right lessons from the last four years, from co-operative federalism to the role of the state versus that of markets, to India's chronic problem of exit, to how India moved from "crony socialism to stigmatised capitalism." The Economic Survey has done its job. Now it's up to the Budget to deliver.

The writer is chief India economist at JP Morgan