The economic risks in 2018
Political uncertainty is set to reach a crescendo in Q4 this year
One swallow does not make a summer, just as one more bypoll election loss does not a political rout predict. But there have now been multiple by-poll losses for the Bharatiya Janata Party (BJP) and its allies in 2018. A symbolic no-confidence motion is being lobbed at the government by its own erstwhile ally. The Opposition parties are seen capitalising on the momentum and plotting a grand coalition, while the government’s allies are getting restive. Five states are headed for elections this year, the most immediate one being Karnataka in May. Battle for the key agrarian states of Chhattisgarh, Madhya Pradesh and Rajasthan is scheduled later this year. They are likely to be reminiscent of the uphill task the BJP faced in renewing its mandate in Gujarat in December, mainly due to a lack of support in rural constituencies. One cannot deny an undercurrent of seismic activity and the sum of parts suggests a sizeable whole in terms of political risk.
These shifting political dynamics will have important economic implications. From a strictly arithmetic perspective, there is little for the government to be concerned about as of now. The BJP coalition, even without the Telugu Desam Party, still maintains a majority in the Lok Sabha. There are no major shocks in the Rajya Sabha numbers either. The National Democratic Alliance was always far from the half-way mark and most big reforms have been passed already. So the government is on a stable ground and the immediate political threat is trivial.
However, in such a climate, the days of swashbuckling reforms like goods and services tax (GST), demonetisation and banking sector overhaul; may be largely behind us. Rather the focus is likely to be on the better implementation of existing ones — especially around bad asset resolution, bank recapitalisation, privatising Air India and ironing out GST glitches.
The political backdrop would also mean ‘restrained populism’ by the Centre. We believe there are likely to be populist overtones by the government to burnish its pro-farmer, propoor credentials. The BJP is already taking pro-active steps to intervene in agriculture markets via higher minimum support prices (MSP) for farmers by at least 50 per cent over input costs, although there is still ambiguity regarding the production cost that will be chosen. Additionally, more aggressive trade policy measures (on both import and exports) have been announced to prevent domestic prices from falling sharply, especially in sugar, pulses and edible oil, where a glut is depressing local prices. Food inflation is currently under check, but the politics around food inflation are changing, which suggests inflationary risks ahead.
Then, there are the fiscal risks. MSPs have not always been an effective floor price and policies that ensure that farmers receive the committed MSPs are in the making, which will entail a direct fiscal transfer to farmers. In a pre-election year, the government will look to exhaust its budget allocations on rural development, agriculture, electricity, affordable housing and healthcare.
State will also partly bear the burden. Earlier in March, over 30,000 farmers marched from rural pockets of Maharashtra to Mumbai to protest against crippling farm loans and deteriorating terms of trade for agriculture. Maharashtra joined a growing list of states that have acquiesced to farm loan waiver demands and other populist measures aimed at farmers and the common man. A common unhealthy trend in a number of recent state budgets has been the substitution of capital spending with revenue in an effort to accommodate these political demands while maintaining fiscal discipline. Not to mention that the capital requirement of public sector banks has only increased since the large bank recapitalisation announced late last year.
Finally, there are the external risks. The current account deficit has been widening on a rising merchandise trade deficit, and we expect it to deteriorate to 2 per cent of GDP in 2018 from 1.5 per cent in 2017. We believe portfolio investments will play an important role in covering the gap, given that the basic balance of payments (current account deficit plus net foreign direct investment) is likely to be negative. Increasing domestic risks — political, inflation and fiscal — in the backdrop of global risks — the US rate hikes, unwind of global quantitative easing, trade war — has the potential to disrupt these capital flows.
To be fair, the India’s economic fundamentals are in a much better shape today and the reforms enacted over the last few years bode well for the mediumterm growth prospects. However, after four years of prudence, the path over the next one year appears to be laden with multiple risks.
Historically, elections in India have been quite unpredictable, and the correlation between the state and the Centre electoral fortunes may not always hold. The only certainty is that political uncertainty and the noise surrounding it are only set to rise in the year, with it reaching a crescendo in Q4 this year and spilling onto the next. Prime Minister Narendra Modi has often stated his preference of Center and state elections being held together. We think there is a 25 per cent probability to early general elections to coincide with the December state elections. To quote Game of
Thrones, “Winter is Coming!”