Director in Fitch’s Asia-Pacific Sovereigns Group

Newsroom24x7 Staff

New Delhi: Macroeconomic effects of the present cash crunch in India include a temporary delay of consumption and investment, disrupted chains, farmers being unable to buy inputs, and some loss in productivity due to time lost to deal with cash issues.

There, according toThomas Rookmaaker, Director in Fitch’s Asia-Pacific Sovereigns Group , are many elements to the demonetisation, which makes it difficult to quantify the impact on real GDP growth and explains the wide range of forecasts by different analysts.

The impact on GDP growth is clearly going to be negative in the short run and depends to a large extent on how long the cash crunch is going to take, points out Rookmaaker. A significant decline in the growth number for this quarter is highly likely, but for the fiscal year as a whole the decline may still be relatively moderate, he goes on to underscore adding “People find inventive ways around the cash crunch as well – there is always the art of jugaad. At the same time, this seems to suggest that demonetisation is a one-off event and is not likely to generate a significant structural shift of activity from the informal to the formal sector.”

Rookmaaker further states: “We still expect India’s GDP growth to trend higher than China’s in the medium term. In India we expect GDP growth to accelerate in FY2018 on the back of reform implementation, monetary easing of the past year and infrastructure spending, while in China a continued increase in leverage in the broader economy is more and more becoming a burden for growth. In China we forecasts real GDP growth of 6.4% in 2017, down from a projected 6.7% in 2016, due to the impact of recent macro-prudential tightening measures targeting the housing market.”

On the positive side, according to the Fitch Director, the demonetisation may improve the fiscal position to the extent more earnings will be declared and a transfer is possible from the RBI to the government of the seigniorage earned from unchanged notes. A stronger revenue intake would be positive from a rating perspective, as the fiscal position forms the Achilles’ Heel in India’s sovereign credit profile, given the high general government debt burden and fiscal deficit compared with peers. Beyond the immediate policy issues of managing the cash crunch as best as possible and trying to mitigate the worst side-effects, it would be interesting to see what further steps the government will take to formalise the economy and structurally generate higher government revenues. “

Newsroom24x7 Desk

The Indian budget released this past Saturday contains both positive and negative elements from a sovereign perspective. While the budget shows this government’s continued orientation on implementation of structural reforms, it could have been more ambitious on the fiscal front, especially given India’s high public debt burden.

Making this observation Thomas Rookmaaker, Director in Fitch’s Asia-Pacific Sovereigns Group adds the central government has projected a budget deficit target of 4.1% for FY2015. It seemed quite a difficult task to reach this target as the revenue targets were overoptimistic from the start – even though India uses cash-based accounting, so bill payments can more easily be deferred to the next fiscal year than in an accrual-based system, Rookmaaker points out.

The targets in the budget, according to Rookmaaker, generally look more credible than in last July’s intermediate budget. Disinvestments are targeted to be more than double this year’s realization, so may again prove difficult to reach, but the government should be able to reach the tax revenue target, as it rises by only 1.3% in nominal terms. The tax revenue drive could have been more ambitious, for instance as this government has chosen additional benefits for the middle class instead of a strategy to generate more revenues, for instance by broadening the income tax base.

Rookmaaker further states that the medium-term fiscal consolidation strategy is less aspiring than in the past, which is negative from a sovereign rating perspective. Gradual consolidation towards a central government fiscal deficit level of 3.0% of GDP is still the aim of the government, but in FY16 the targeted deficit reduction is just 20 basis points to 3.9%. If disinvestment would be treated as a “below the line” financing item – as is international best practice – instead of a revenue item, the fiscal deficit would actually rise from 4.3% in FY15 to 4.4% in FY16.

Instead of fiscal consolidation, the government has chosen to increase capital expenditures to stimulate investment, and subsequently, GDP growth. We see some merit in this approach, states Rookmaaker adding as the government’s capital expenditure can crowd in private investments. At the same time, the fiscal position is a longstanding key weakness in India’s sovereign rating profile. The public debt burden in India – which has a ‘BBB-‘ sovereign rating – is close to 65% of GDP, much higher than in many of its peers. The median of the ‘BBB’ category – of the sovereigns with a ‘BBB-‘, ‘BBB’ or ‘BBB+’ rating – is 39% of GDP.

Rookmaaker points out that the budget undescroes continuation of the reform process set in motion when the Modi led Central government came to power with a focus on getting the economy to take off again. This includes the aim to improve governance and the business environment, and to reach structurally lower inflation levels. A gradual implementation of many small reforms is likely to have a significant impact on growth. At the same time, many persistent obstacles to higher growth remain in place, including labour market rigidities and infrastructure bottlenecks. The budget aims to reduce these bottlenecks.

The budget, according to Rookmaaker, mentions a new monetary policy framework agreement with the RBI. While the impact of such a framework will depend on the exact details, it shows this government’s greater focus on bringing down inflation. The budget speech mentions the objective of keeping inflation “below 6%”. A target of 6% would be on the high side compared with the levels in a number of India’s peers.