India govt does not have fiscal space to spend too much: Sonal Varma, Nomura

Sonal Varma
Sonal Varma, managing director and India chief economist, global markets division (Asia ex-Japan), Nomura Holdings Inc. Photo: Mint

India is in the midst of a cyclical recovery that is set to continue into the next few quarters. But with oil inching up and interest rates moving up, there may be a slowdown in growth in the second half of FY19, said Sonal Varma, managing director and India chief economist, global markets division (Asia ex-Japan), Nomura Holdings Inc.

She, however, said global investors continued to remain positive on the medium-term outlook for India. “Given the increasing oil prices, and with emerging markets facing capital outflows, clearly there is renewed focus on twin deficit economies across the region. At the same time, there’s a recognition India in 2018 is not India in 2013. Things are significantly better. That differentiation is there… there is some caution due to higher oil prices, and the political uncertainty does not help,” she added, during an interaction on the sidelines of the Nomura Investment Forum, 2018. Edited excerpts:

With crude at current levels, is it time for India to start to panic about fiscal and current account deficits and inflation? In terms of global risks, if and when the trade wars happen, how much of a risk will it have on India?

I think yes. Even if you ignore oil, on the domestic curve front, we have seen a fairly solid growth recovery. The latest number is 7.7%—core inflation has also picked up, which is sort of consistent with domestic demand pick-up. And, in the month of April, the increase we’ve seen in core inflation is very significant—it is one of the highest reading in many months. Domestic picture in any case is pointing to an economy that is potentially growing at a fast pace to a level where the output gap is starting to close, and it is reflecting in the inflation cycle picking up. Then, you superimpose that with the external sector picture, where you have risks from oil, the risks from weaker forex—both of which are an upside risk to inflation. You have the minimum support pricing increase which will be announced by the government very soon, which will also add to inflationary pressures on the food side. The local and the global dynamics are both pointing to the need to reverse the monetary policy cycle. The challenge for India is that the banking balance sheets are not yet completely repaired. So the challenge is to ensure the balance sheet correction process does not get derailed because of significant monetary policy tightening.

In terms of global risks, I think from a trade protectionism point of view, right now, it is focused on what is happening between the US and China. When you are comparing the impact on India, I think, in the relative regional context, it is not as big a deal for India, as it would be for some of the open economies in Asia. Ultimately, China is sort of an intermediary—the factory house through which the final demand of the developed economies is met. For countries such as Korea, Taiwan, Vietnam, China is part of the supply chain, and a lot of raw material input might be coming from these countries. So, if there is a trade tension between US and China, then some of these open economies will be more exposed than India. But at the end of the day, if the global trade volumes go down, India will end up getting hurt as well.

Four years into the Modi-led government, is the NDA’s legacy under threat due to unfavourable global conditions and a sluggish rural economy? Combined with recent political developments, Karnataka results as well as the setbacks faced by BJP in the by-polls, do you fear it could lead to the government compromising fiscally in the run-up to the general election in 2019? What is your reading of the recent election results?

One cannot compare (today to) the optimism four years ago, partly due to the government change. Incidentally, it was also when oil prices started to fall. It is interesting that four years out, both the issues are reversing—on the political side, there’s a bit of uncertainty that has cropped up because nobody knows what 2019 results will be, and oil prices have reversed—because of that, the macro-picture at the margin is looking a lot more challenging than it was 3-4 years ago.

Having said that, I would also like to emphasize that reforms that have been done in the past 3-4 years cannot be underestimated in terms of the impact they will have going forward. GST and the progress we are seeing on rail and road infrastructure, power connections for everybody—these will all have a positive impact. They’ve not had much of an impact so far because we are also trying to simultaneously correct the balance sheets of the banking system. So I don’t think the medium-term positive view will change; but yes, given there is political certainty and oil prices have moved up, it does cloud the near-term macro outlook.

So far, this government has been extremely prudent in terms of most of its economic policies. At the end of the day, this government wants to come back to power, and therefore, there could be a shift of policy from extremely prudent to being a little less prudent. It could mean that you become outright populist, or have shades of populism, and that is the risk that people are anticipating.

I think for us, the main takeaway from the Karnataka and by-election results is that the opposition believes, and there is some level of growing confidence, that if they come together, they can put up a strong force against BJP. Therefore, the third front coming together to challenge BJP in 2019 is clearly looking like a very high possibility now. What this means and how many seats BJP gets in 2019, it is difficult to say. Most people are assuming BJP will remain the single largest party, but it will come back with fewer seats, compared to the majority it had last time.

Second, against that backdrop, what kind of policies will the BJP undertake in the next year? If you look at the last budget itself, they had announced MSP (minimum support price) will increase 50%. They also announced fiscal transfer mechanisms linked to MSP. We’ve seen states go into elections where they’ve announced farm loan waivers in those specific states. The insurance programme and there might also be a few other things that might be announced. The fact of the matter though is that the government does not have the fiscal space to spend too much. Either they cut down on expenditure to make room for the additional spending, or all of these could end up as announcements with not much allocation being put on the table.

What are investors asking you about India, compared with last year?

I don’t think people are questioning the medium-term outlook for India. There is still a belief that it will continue to be one of the fastest growing economies, and that reforms are moving in the right direction. But yes, given the increasing oil prices, and with emerging markets facing capital outflows, there is clearly a renewed focus on the twin deficit economies across the region.

At the same time, there’s a recognition that India in 2018 is not India in 2013. Things are significantly better. That differentiation is there. Focus is back on the twin deficit economies, and to that extent, there is some caution. On the questions on India, the focus is on oil and the macroeconomic impact due to higher oil prices, and what’s the political situation, how will it evolve, how will the government respond to the upcoming election cycle. There’s also a lot of focus right now on RBI, and how they will react to this changing global and local dynamics. There is also focus on the banking balance sheets on how things are moving on the resolution side, there are questions on the sustainability of growth, the interest is on how the entire macro picture is playing out, and essentially to assess if the risks are on the upside or downside from here.

How big is the issue of rural distress? Are we confronted with an agricultural crisis?

I honestly don’t know. What I struggle with is, when I look at the hard data and I see a 15-20% growth on both two-wheelers and tractors sales, which are supposedly a proxy for rural demand, we are actually doing well. So, if there is so much distress, why exactly are people buying two-wheelers and tractors?

In terms of macro data, the rural demand seems to be okay. Maybe my suspicion is that, when we say rural, you’d imagine a farmer tilling the land; but fact of the matter is that, in the past 20 or 30 years, rural is increasingly non-agriculture. About 30 years back, rural was 70% agriculture. Today, it is 70% non-agricultural activities. Maybe the agriculture side in rural is seeing a lot more stress. Of course, food prices have come down, so that must be hurting disposable incomes. But where the non-farm rural economy is concerned, a lot of construction workers will get hired in road construction and other government-led activities. The power scheme and power connectivity could be benefitting the non-farm community, too, but this is just a hypothesis. Like I said, I am surprised with the disconnect we are seeing in terms of hard data versus what you are reading in the newspapers.

So, with investments and export not taking off, can we sustain the current growth rates with just consumption and government expenditure?

Investments have come back, and not come back, too. What it means is that the investment numbers are increasing, but it is not new investments. For exports, it is not in our hand. It is a function of global growth. On the export side, what exactly is India’s competitiveness? What is our niche on the export side? We need to have a long-term strategy on the segments that we want to focus on because the demand is changing on the world exports scene—so we’ll keep that aside.

It comes back to consumption. Purely consumption-driven growth is typically not sustainable. I might have savings and may keep drawing down on my savings and keep consuming to the point where there is no savings left. Consumption as a strategy for growth can backfire, it is not sustainable. It comes back to investment. Within investment, the private sector does not have the capability, or willingness to invest, given the balance sheet stress. Now it boils down to government having to lead the investment cycle. We need the infrastructure—private sector cannot do this given the balance sheet issues—so government needs to take the first steps to drive the infrastructure sector. The constraint we’re working with, there are limited finances. Either we cut down on unnecessary expenditure and make way for money to get into infrastructure spending, or we look for other ways to raise more money. In 2-3 years, we have seen a lot of off balance sheet infrastructure spending by government. For instance, GST is supposed to raise revenues. So, don’t use the extra revenues for consumption spending, but to focus on infrastructure.

The government has tried to revive investments by easing business regulations. But has this really led to any changes on the ground?

When you are setting up a plant in India, you’re dealing not only with the central government, but also with the state and local governments. So, you need to see comprehensive reforms across the chain. It cannot be just at the top level. If you look at land acquisition or labour laws, the state has a big say in them as well. So, the initiative needs to come from the state to basically make it easier for firms to invest. On land and labour laws, very few states have taken the lead to reform, but not all states have done it. A comprehensive attack on the ease of doing business from all level of government is still a work in progress.

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