HOW HAPPY WILL 2014 BE? CERTAINLY BETTER THAN 2013
The elections, clearly, will determine how future investments will pan out, the global economy looking up is a big positive and a good monsoon will keep inflation in check
With the Indian economy stuck in a slow lane for over two years now, it is difficult to be optimistic about 2014. But we must also realise that there exists a cognitive bias in our forecasting ability, which psychologists refer to as the ‘recency effect’. We tend to forecast pessimism from a prevailing pessimistic scenario and the same holds for optimism as well. That makes pinning down a turning point extremely challenging.
I believe that the growth outlook for 2014 is set to improve, albeit modestly, from the current lows. A confluence of favourable developments such as continued progress on policy actions (like clearing projects, lifting ban on mining), good luck on monsoons and a widely anticipated improvement in global growth outlook can lift India’s GDP growth to 6%.
There are four things to watch out for in 2014:
Election and reforms: The outcome of the general elections will be critical to shaping India’s economic destiny. Political uncertainty is, therefore, a huge weight on the economy at this juncture. A decisive mandate can speed up the resolution of policy bottlenecks (a big drag on India’s growth), hasten pending reforms, improve private sector sentiment by sending a strong signal and lay the foundation for India’s entry into a phase of healthier growth.
Even with a fragile political outcome, I believe the reforms process that started about a year ago will not be reversed and will begin to bear fruit in 2014. These developments, in conjunction with the low base of last two years, can give a onetime boost to growth 2014-15.
The cost of a fragile mandate will be high over the medium run as we will not be able build on the mild upturn in 2014. The resulting ‘ slow policy action’ and uncertainty can trap India in sub-par growth environment over the medium run. Elections, therefore, would be the most closely watched event of 2014.
Global growth outlook and QE: In an interconnected world, global developments matter more than ever. In addition to global recovery, other developments such as the quantum and speed of QE tapering have material influence on global liquidity and risk appetite and thereby flow of funds into India. Risks remain, but there is now some comfort on both fronts—global growth as well as impact of QE tapering.
Despite mixed developments, the IMF projects global growth to rise to 3.6% in 2014 from 2.9% in 2013. China has slowed after decades of doubledigit expansion, European debt crisis is not over and the US still has high unemployment, but conditions are steadily improving. Europe is expected to move from sub-zero to sub-par, yet a positive growth trajectory in 2014. China is likely to maintain growth around its new normal of 7-7.5%. Even this is good enough to benefit many Asian economies which are tightly integrated into China’s supply chain. This will benefit India too as our trade with Asia has expanded over the last few years.
The strongest growth impulse in the advanced world has been seen in the US and is reflected in the Fed’s decision to begin QE tapering. US thirdquarter GDP was revised up to 4.1% from an earlier estimate of 3.6% and housing starts jumped to a 5-year high of 22.7% in November. The threat of another government shutdown is receding with the Ryan-Murray deal.
Global recovery, particularly in the US, augurs well for India’s exports of goods as well as services like IT and ITeS in 2014.
The beginnings of QE tapering have been faced well by India and the rupee has remained stable. We reduced our external vulnerability by cutting CAD, while improving capital inflows through innovative schemes for attracting NRI deposits and building a cushion against external shocks by entering into currency swap agreements (notable being the $50bn agreement with Japan). This has strengthened India’s defences against possible shocks to global risk appetite and liquidity in 2014.
Monsoon: Monsoons are always a risk. Rainfall data of last decade tells us that only 3 out of 10 monsoons have failed. In the absence of any specific information on 2014 monsoons, I would go by an assumption of normal monsoons rather than a lower probability event of a monsoon failure.
To put things in context, given the falling share of agriculture in GDP, it is no longer the prime mover of overall GDP growth. That is why even an above-trend growth in agriculture cannot crank up GDP beyond 5% in 2013-14. But it matters a lot for inflation control, particularly of food—a major headache for policymakers.
Inflation and monetary policy: Will monetary policy support growth in 2014? This is one of the most difficult questions to answer, and more so without knowing the new monetary policy framework currently being developed by RBI.
Inflation will nudge down definitively if we are blessed with another normal monsoon in 2014. Food inflation would then tend to stabilise at lower levels. The possibility of lower food inflation improves further if the recently announced steps such as the abolition of APMC Act in Congress-ruled states fructify and other states follow.
The demand pressures on inflation will be muted as we are talking of growth recovery to 6% in 2014-15 and not 8-9% witnessed after the Lehman crisis. After many years of strong spending, the Indian consumers have geared down and the mild bounce in the economy will lift household consumption only a tad. This will keep manufacturing inflation low. With lower inflation, interest rates will be capped and can even fall.
How does all this stack up for 2014?
While slipping below 6% is easy (especially if we slip on some of the reforms that have begun), growing faster than that in 2014 is difficult even with an overwhelming political mandate. The books of banks are in tatters with their huge stack of bad loans, which impairs their ability to finance growth. Even with an improvement in private investment climate, the benefits will take time to flow at the ground level because of the long gestation periods involved. Remember also that the project pipeline has narrowed sharply.
Net-net, a 6% growth in 201415 would only be a mild bounce from the trough and not necessarily the beginning of a decisive recovery.