The Economy In 2017: A Year Of Shifting Sands

Reform depends on the government’s view on public sector banks’ future and an improvement in the credit culture.

2017 began with the economy in the midst of uncertainty. It ends the same way. But for different reasons.

A year which began with questions surrounding the economic impact of demonetisation, ends with questions about the repercussions of the Goods and Services Tax. If at the beginning of the year the question was whether policy makers will power through with the clean-up of bank balance sheets, then the question at the end of the year is how quickly resolution and reform will follow after recognition of bad loans and recapitalisation of banks.

BloombergQuint looks back on some of the big economic stories of the year.

Demonetisation: The Big Event That Was A Non-Event

January 2017. The deadline for exchanging old notes of Rs 500 and Rs 1,000, under the demonetisation plan announced by the government on 8 November 2016, had just closed. The old currency had to be deposited in banks by 30 December 2016.

But new notes were flowing in slowly. And so, the year started with the economy in the midst of a cash crunch. As of 6 January, currency in circulation stood at 5.9 percent of GDP – an all-time low.

Conventional wisdom suggested that such a severe cash crunch was bound to have a significant impact on growth. It did, although the quarterly gross domestic product data for the December 2016 quarter did not reflect it.

The impact started to show up in subsequent quarters, with GDP growth slipping to 6.1 percent in the March 2017 ended quarter, and further to 5.6 percent in the June 2017 quarter.

The growth impact of demonetisation would be transient, said policy makers who chose to focus on the potential positive outcomes from the cash exchange program. Among these was an expectation that a part of the old currency would not return to the system. That, in turn, could lead to a part of the stock of black money being extinguished.

The hope was that this would allow the Reserve Bank of India to transfer a special dividend to the government. It didn’t play out that way. On 30 August, the central bank revealed that 99 percent of the currency that had been scrapped, returned to the system.

As 8 November 2017 – a year to the date that demonetisation was announced – rolled along, BloombergQuint tried to piece together the events that led to demonetisation and how almost all of the currency came back to the system.

Growth: The Twin Shocks

Eight months after demonetisation was announced came the rollout of GST. Together the two, intended to formalise the Indian economy, came as a one-two punch to growth.

To be fair, the Indian economy had started decelerating even before demonetisation was announced. After hitting 9.1 percent in the March 2016 quarter, GDP growth had been on a gradual decline.

As such, the twin shocks of demonetisation and GST hit an economy which was already weakening. Both were the hardest on job creating sectors like manufacturing, which also have a large informal segment.

Growth in the economy plunged to 5.7 percent in the June 2017 ended quarter – the lowest in three years. Weakness in the manufacturing, real estate, and financial services sectors told the story of the impact of demonetisation.

The September-ended quarter saw some improvement with growth picking up to 6.3 percent.

While the trend of weakness appeared to have bottomed out, economists pointed out that levels of economic activity were nowhere close to levels before the twin shocks.

Praveen Chakravarty, fellow at IDFC Institute and consulting editor at BloombergQuint, highlighted the persisting weakness in agriculture, manufacturing and real estate – three of the largest employment generators in the economy. Until these recover fully, the mood in the economy may remain subdued, he cautioned.

To gauge the challenges faced by the informal sector in labour intensive industries, BloombergQuint visited Kanpur – a hub of the leather industry. The tough times faced by those in the leather industry give a glimpse into the pain that will accompany India’s transition from an informal economy to a formal one.

Inflation: The Deceptive Dip

With growth looking shaky, calls for interest rate cuts were loud. They became louder when inflation plunged to unexpectedly low levels. In June, consumer price inflation fell to 1.5 percent.

Not only was this the lowest in the current data series, it was below the RBI’s range of four percent (+/- two percent). The fall was led by a plunge in prices of perishable fruits and vegetables and also pulses.

The calls for rate cuts grew stronger.

The RBI had begun cutting rates in January 2015. In 2017, however, rates had been on hold for most of the year. As inflation remained subdued, in August, the monetary policy committee decided to cut rates by another 25 basis points to six percent. While some economists were of the view that there was still room for rate reductions, the window closed soon for the MPC.

By the time, the MPC met for its last meeting of the year in December, inflation had started to normalise. In November, retail inflation rose to 4.88 percent. Minutes of the December MPC meeting showed rising concerns about a pick-up in inflation.

Most members saw upside risks to inflation emerging from higher commodity prices, a likely revival in demand conditions in 2018 and the possibility of fiscal slippage.

At least one of the risks appear to be materialising already. On 27 December, the government increased its gross borrowing target by Rs 50,000 crore to Rs 6.3 lakh crore.

This could mean that the fiscal deficit for 2017-18 could be higher than the targeted 3.2 percent. In 2018, too, the government may fail to meet the target of three percent set under the Fiscal Responsibility and Budget Management Act, said economists.

Concerns also persist that the government may feel the need to expand spending in 2018, as it seeks to revive the rural economy ahead of elections due in 2019. If it does, risks to inflation would only rise. While calls for measures to boost the rural growth abound, BloombergQuint wrote about the lack of clarity on the issues that face the rural economy.

Banking: Powering Through The Clean-Up

In the midst of disruptive policy decisions, shaky growth and volatile inflation, the Indian economy has had another big problem to address.

That of excess leverage on corporate balance sheets and large stressed assets on bank balance sheets. The twin balance sheet problem, as it has been termed.

The clean-up had started in 2015. But it was not complete. Private banks were still being pushed into recognising bad loans. As the year closes, the recognition cycle seems to be coming to a close.

In the December edition of its Financial Stability Report, the RBI said that bad loans may be close to ‘bottoming’, although gross non-performing assets may still rise a bit further to about 11 percent of all loans by September 2018 compared to just over 10 percent now.

Recognition was only the first part of the four Rs needed to fix Indian banking. Recapitalisation, resolution and reform were the other three.

For most of the year, the government dithered on recapitalising public sector banks. But as it became apparent that under-capitalised banks could hurt prospects of a recovery in the economy, the government decided to bite the bullet.

In October, the government announced a Rs 2.11 lakh crore recapitalisation package. Much of this will go out in the form of recapitalisation bonds to prevent a hit to the government’s finances.

With recognition and recapitalisation underway, the focus in 2018 shifts to resolution and reform.

Resolution remains heavily dependent on the year-old Insolvency and Bankruptcy Code. Reform depends on the government’s view on the future of public sector banks and an improvement in the credit culture.

(The story has been published in arrangement with BloombergQuint.)

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