Economy faces tough outlook

Sushma Ramachandran
Senior financial journalist

Appearances are deceptive, they say. It is so true of the economy right now. To all intents and purposes, there are signs of hope and cheer, the most headline-catching being a soaring Sensex. The fact is, however, the economic outlook for the coming year is far from rosy. Some green shoots of recovery are evident, with auto and consumer sales showing an uptick, but there are far more worrying indicators. These are bound to be problematic for a government that has to face general elections after a year.

Inflation a key concern

The first and key concern is inflation. Retail prices rose to a five month high of five per cent in June as compared to 4.87 per cent in the preceding month. This has been a prime issue highlighted by the central bank which has already raised the repo rate by 25 basis points for the first time after four years at its last meeting. If the consumer price index does not show signs of slowing down, there is a possibility of another rate hike in August. The target of keeping inflation at four per cent by the Reserve Bank of India seems a far cry at this stage, with the latest decision to steeply raise the minimum support prices for a wide range of grains.  

The monsoon will play a critical role in this regard. Though the Meteorological Department has projected a normal monsoon, media reports say so far there is an eight per cent rainfall deficit in the northwestern and eastern parts of the country. This has already reduced the area sown during the kharif season by about 10 per cent. In case this is not made up by the end of the month, it will impact output and, in turn, lead to more food inflation. 

Rising fuel prices hurt

The second issue giving policymakers a headache is fuel prices. These are rising relentlessly at the retail level as a result of the deregulated policies that enable oil marketing companies to raise petroleum product prices in line with global rates. International oil markets are staying at highs of 75 dollars per barrel, much more than India is comfortable with for the rest of the year. There are indications that prices may ease, with hints that the US may give waivers to countries that buy oil from Iran like India while supplies from Libya may also increase soon. The US is even reported to be considering drawing on its massive oil inventories in a bid to bring prices down. Even so, India remains in a difficult situation. Higher fuel prices are pushing inflation but reducing taxes, which should be the logical course of action, will make it difficult to keep the fiscal deficit under check. With an election on the way, continuing high fuel prices is not a desirable situation and the government will be held responsible by the electorate for this issue. The Finance Ministry will have to decide whether it wants to stick to fiscal discipline for which it is being commended by investment rating agencies or whether it should reduce consumers’ burden by cutting the inordinately high excise duty on oil products like diesel and petrol.

Rupee depreciation worrisome

The third area of worry is the rapid depreciation of the rupee which is linked to the earlier two issues. The rupee's decline has been hastened by the higher cost of oil imports and has pushed up inflation.  In the current financial year, the rupee has depreciated by nearly seven per cent, raising the cost of imports and leading to a rise in raw material and transport costs for industry. In an ideal scenario, exports should be given a boost by a depreciating currency, but this appears to have so far helped only select sectors like engineering goods and pharmaceuticals. Even so, there has been a spurt in export growth of about 14.2 per cent in the first quarter of the current fiscal as against a rise of only 9.8 per cent in 2017-18. One can only hope that this silver lining of rupee depreciation continues to yield dividends in the coming months.

Industrial production slowdown

At the same time, recent data shows a fourth area of weakness in the economy which is industrial production. The index of industrial production fell to a seven-month low of 3.2 per cent in May. This is being attributed largely to sluggishness in the manufacturing sector, though power and mining seem to be showing some signs of improvement. The RBI made a prediction on these lines recently. It had projected some slowdown in industrial growth in the first quarter of this fiscal in the June monetary policy review, citing higher input prices and softening of demand.

Clearly the outlook for the rest of the year is tentative at best. This assessment seems to be completely at odds with the stock markets which have been rising to record levels in the past week. But the rally has been driven partly by the positive effect of rupee depreciation on services exports by IT majors like TCS and Infosys which have a big weightage in the Sensex.  In addition, the initial flow of corporate results has been positive, which always bring cheer to the markets.

Going by firm indicators, however, the performance of the economy is certainly not on an even keel. Inflationary pressures are mounting due to the external effects of crude oil prices and domestic issues like rise in MSPs as well as rupee depreciation. Agricultural growth has a question mark over it owing to deficiency in rainfall and decline in kharif acreage. Industrial output is sluggish and higher growth will depend on demand in the rest of the year. The only bright spots appear to be auto sales and the recent spurt in exports. Clearly there is need for reappraisal of the economic situation. Policymakers need to become more realistic about the path ahead and ensure that course corrections are carried out before it is too late.