Rally in stocks due to demonetisation

■ Cautions FM against setting ambitious targets for fiscal consolidation on optimistic forecasts ahead of polls ■

The Economic Survey on Monday suggested a modest consolidation in fiscal deficit that credibly signals a return to the path of gradual but steady deficit cut.

The government aims to contain the fiscal deficit for FY18 to 3.2 per cent of the GDP, and 3 per cent in FY19.

“Reflecting largely fiscal developments at the center, a pause in general government fiscal consolidation relative to FY17 cannot be ruled out,” said the Survey.

There have been some analysts who have been suggesting that India postpone its fiscal consolidation roadmap to focus on growth.

“A key policy question will be the fiscal path for the coming year. Given the imperative of establishing credibility after this year, given the improved outlook for growth ( and hence narrowing of the output gap), and given the resurgence of price pressures, fiscal policy should ideally have targeted a reasonable fiscal consolidation,” said the pre- budget survey tabled in the Parliament by the finance minister.

However, it cautioned setting overly ambitious targets for consolidation — especially in a pre- election year- based on optimistic forecasts that carry a high risk of not being realised. It will not help garner credibility either. “Pragmatically steering between these extremes would suggest the following: a modest consolidation that credibly signals a return to the path of gradual but steady fiscal deficit reductions,” it said.

The Survey said that against this overall economic and political background, economic management will be challenging in the coming year. If the obvious pitfalls ( such as fiscal expansion) are avoided and the looming risks are averted that would be no mean achievement, it said.

“Persistently high oil prices remain a key risk. They would affect inflation, the current account, the fiscal position and growth, and force macroeconomic policies to be tighter than otherwise,” it said. The Economic Survey attributed the boom in stock markets to note ban as it played a major role in influencing investors’s expectations on return from other asset classes.

Explaining the rationale behind a sharp spike in equity prices over the last two years despite weak macro- economic factors and corporate earnings growth, the survey noted that the government’s campaign against illicit wealth over the past few years — exemplified by demonetisation — has in effect imposed a tax on certain activities, specifically the holding of cash, property and gold.

Cash transactions have been regulated and reporting requirements for the acquisition of gold and property have been stiffened.

In addition, rupee returns to holding gold have plunged since mid2016, turning negative since mid- 2017.

According to it, stock prices were at the receiving end as the reporting requirements were higher on shares than purchases of other asset.

“But the attack on illicit wealth has helped to level the playing field. All of this has caused investors to re- evaluate the attractiveness

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of stocks. Investors have accordingly reallocated their portfolios toward shares, with inflows through stock mutual funds, in particular, amounting in FY17 to five times their previous year’s level,” it said.

Since December 2015, the survey highlighted that the S& P 500 index in US has surged 45 per cent while the Sensex gained 46 per cent in rupee terms and 52 per cent in dollar terms. The stock market surge in India coincided with a deceleration in economic growth while growth in US accelerated.

Similarly, India’s current corporate earnings/ GDP ratio has been sliding since the global financial crisis, falling to 3.5 per cent, while profits in the US have remained a healthy 9 per cent of GDP.