Back2014, the year in review | The worst may be over but several risks linger
The major equity indices are up by a little more than a third on the hopes that a cyclical growth recovery has begun to take root
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The year 2014 has been a pleasant surprise for the India economy: Early trepidation has given way to a prematurely sanguine mood.
One easy way to capture the changes over the past year would be to look at what has happened in the financial markets. The major equity indices are up by a little more than a third on the hopes that a cyclical growth recovery has begun to take root.
Bond yields are down by around 0.9 percentage points as inflation has begun to lose steam. A shrinking current account deficit has helped the rupee remain stable despite a global dollar rally that has pushed down many other currencies.
India now looks to be in a better position than most of the other countries whose currencies were hammered in the middle of 2013: Brazil, Turkey, South Africa and Indonesia. Meanwhile, Russia is in recession while China is slowing down. Several forecasters have begun to predict that India will soon be able to grow its economy faster than China. Foreign investors coming into Mumbai often say India is one of the few bright spots in a sullen global economy.
Three factors have catalysed the incipient turnaround.
First, Indian policymakers learnt the right lessons after the manic weeks of the taper tantrum in 2013. Corrective action was taken, both in the dying days of the Manmohan Singh government as well as in the first six months of the new regime.
They began to take the need for macroeconomic stability more seriously, after the mismanagement of the economy since 2009 left it exposed to global shocks.
The Reserve Bank of India (RBI) was allowed to increase interest rates in an attempt to quell an inflation fire that had been raging for five years.
The overdue trek towards better public finances began with serious moves to bring down the fiscal deficit. Administrative measures led to the first success in reducing the current account deficit. Foreign exchange reserves were rebuilt.
Second, the strong electoral mandate that Narendra Modi got in the general election held in May exorcised the persistent fear of political instability. The new government has taken some welcome administrative decisions to boost business confidence, though its overall report card for the first six months suggests that it has not yet met the sort of grand reformist expectations that some of its supporters expected after the election victory.
Some of the disappointment was reflected in a sardonic comment by Arun Shourie in an interview to The Indian Express: “The consensus seems to be that when all is said and done, more is said than done."
Much depends on what legislative agenda the Modi government pursues in the winter and budget sessions of Parliament. Economists argue that India needs meaningful structural reforms if the gains from the ongoing cyclical recovery are to be consolidated.
Third, the collapse in global oil prices since October has in effect become a tax cut for the Indian economy. Investment bank Nomura estimates that every $10 decline in the global price of a barrel of crude oil helps the Indian economy in myriad ways: a 0.1 percentage point addition to economic growth, a 0.2 percentage point decline in consumer price inflation, a 0.5 percentage point reduction in the current account deficit and a 0.1 percentage point improvement in the fiscal deficit as a percentage of gross domestic product (GDP). It is worth noting that the July budget presented by finance minister Arun Jaitley had assumed that global oil prices would be around $110 a barrel, while the inflation report released by the Indian central bank in September had assumed oil prices of around $100 for its baseline inflation forecasts.
The worst may be over but there are several risks on the horizon. Most economists agree investment activity by the private sector has to be far stronger if the ongoing recovery has to accelerate in the quarters ahead. India continues to have one of the highest rates of inflation among the major economies while weak tax revenues are putting the government budget under pressure.
The global economy is sluggish while the potential threat from a global financial shock in the coming year cannot be dismissed. The Modi government will have to push important structural reforms that can address the various rigidities on the supply side that will raise potential growth if the economic recovery is to not end up in an inflationary mess.
The view on India is far less glum than it was a year ago. The economy delivered a positive surprise in 2014. The situation could be the reverse at the end of 2015: the current mild optimism could lead to a more glum future than the consensus expects. The rear-view mirror is not always the best guide to help negotiate bends in the road ahead.
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