Economists caution FM Arun Jaitley: Don't go Pranab's way with stimulus

Just when it looked like good going, the Modi government faces an existential crisis: red lights are blinking on the country's major macroeconomic parameters.

Pressure is mounting on the government for policy support to pump-prime the economy, but analysts are prescribing patience.

Going for quick fixes could undo the good work done so far and cause long-lasting damage, they warn.

Finance Minister Arun Jaitley on Wednesday dropped hints that a package to boost the economy could be on the anvil.

Economists express apprehensions that the government might be going the same way as the then finance minister Pranab Mukherjee had done during the post-2008 downturn, which ended up causing more damage to the economy than good.

June quarter data showed major slippages in India's current account deficit (CAD) and GDP growth while August inflation print showed a spike, raising alarm bells over the state of the economy.

In June quarter, India's GDP growth unexpectedly slumped to a three-year low of 5.7 per cent, the slowest pace since the January-March quarter in 2014, as manufacturers halted production and went for massive destocking ahead of GST rollout while the lingering effect of demonetisation continued.

Data released by the Reserve Bank of India last week showed CAD swelled to $14.3 billion, or 2.4 per cent of gross domestic product (GDP), in June quarter from $0.4 billion a year ago.

Meanwhile, tax collection for the first month under GST showed distress signs, as it turned out to be just a little over half of the targetted monthly run rate at $7.8 billion.

The depressing macro numbers can dampen investment sentiment at a time when corporate earnings have not been very promising.

After a major rally for most part of this year, stocks have stagnated at peak index levels, which analysts attribute to lack of market-driving triggers.

Current rich valuations of stocks across sectors would require earnings support as macros turn less favourable. But earnings have generally disappointed and the economic recovery faces cyclical and structural issues, said Sanjeev Prasad, Co-Head and Managing Director at Kotak Institutional Equities.

The Modi government has also been under pressure to create jobs. But after painful job losses caused due to the GST blow to the informal sector, the economic downturn is not helping matters.

"Adopting quick fixes could threaten near-term macro-stability and carry long-term implications. We see limited scope for fiscal pump-priming measures and an aggressive rate cutting cycle to support growth," says Radhika Rao, India Economist, DBS Bank.

Jaitley on Wednesday said he was waiting a go-ahead from Prime Minister Modi to announce some measures, which he said are necessary.

Strong fiscal and monetary policy stimulus announced in the wake of the global financial crisis of 2008 did shore up India's growth initially through higher consumption and investment spending, but they resulted in double-digit inflation and caused wide domestic and external imbalances thereafter.

Prasad of Kotak Institutional Equity says there was a high degree of uncertainty around earnings growth this year given the ambiguity around loan loss provisions of the banking sector, telecom-related losses and short-term disruptions caused by the spike in crude oil prices in the global market.

EPS (earnings per share) growth estimate for India's BSE100 companies has already been pared by 4 percentage points to 11 per cent for this financial year. The extent of downgrade seen after June quarter earnings was sharper than the 1-2 percentage point reduction seen in the previous two quarters, Credit Suisse said in a report.

DBS Bank's Rao said the growth momentum was derailed by demonetisation in the second half of FY17, while GST rollout in July 2017 dealt another shock and led manufacturers to draw down inventories, causing a slack in industrial output. Also, consumption has moderated due to weak rural demand.

A little patience might just work. The government has frontloaded fiscal spending this year, trying to speed up growth. Capital spending and revenue expenditure surged by 43 per cent and 32 per cent, respectively, in April-June quarter, which was well above their corresponding full-year budgeted targets of 11 per cent and 6 per cent. This should help headline growth to recover to above 7 per cent in the second half of FY18 thanks to base effects and a modest post-GST stabilisation, says Rao.

"It is crucial to ensure the growth turnaround is durable and sustainable, even if slower in the short-term. Structural changes (GST, bankruptcy laws, moves to limit corruption, etc) will inflict pain in the short-term, but if implemented efficiently will lift potential growth in the medium-term," Rao wrote in a report.