Home / Opinion / 2016’s legacy of economic uncertainty

Several developments in recent weeks at both the national and international levels have increased economic uncertainty for the near to medium term. Most of these will play out in 2017. For instance, on the international front, the US Federal Reserve is now expected to raise rates at a faster pace than earlier anticipated; the Organization of the Petroleum Exporting Countries (Opec) has managed to secure a deal which is pushing up oil prices; and political uncertainty is rising in Europe and will have economic consequences. On the domestic side, while the actual economic impact of the ongoing currency swap will become clear in 2017, the path of implementation of the goods and services tax (GST) continues to remain uncertain.

Last week, the Federal Reserve raised its policy rates for the second time in a decade and is now expected to raise interest rates three times in 2017 compared with the earlier estimate of two quarter percentage point hikes. However, it is possible that the Fed’s path will be revised once Donald Trump takes office and unveils his fiscal plan. Trump is expected to run a higher budget deficit, which could become inflationary as conditions in the US labour market are tightening. Rate hikes at a faster pace in the US will lead to the tightening of financial conditions in global markets and capital will move from other parts of the world to US assets. In fact, the process is already under way. For example, foreign investors have been net sellers in the Indian equity as well as debt markets since October. The flow of capital to US assets has also pushed the dollar to a 14-year high.

Even though India is in a relatively better position, higher rates in the US can affect other emerging markets such as China and can lead to higher volatility in the global financial markets. Chinese authorities are intervening in the market to maintain stability as capital continues to leave its shores, which is putting downward pressure on the renminbi. The Chinese economy, with its highly leveraged corporate balance sheet, will remain a major risk in 2017 as well.

Apart from interest rates, the possible shifts in US economic policy will be keenly watched in 2017. How the Trump administration will actually approach economic relations with a country like China or trade in general is likely to have an impact on the existing global economic order. Global trade and economic openness will be further tested by growing populism in Europe. After the UK voted to leave the European Union earlier this year, the European project could face more challenges in 2017 as countries such as France and Germany will go to polls at a time when eurosceptics are gaining ground.

The year 2016 started with discussions on the supply glut in the crude market, with prices falling below $30 per barrel. But as the year draws to an end, the oil story has changed completely. With members of Opec and other oil-producing countries agreeing to cut production from the beginning of 2017, the International Energy Agency (IEA) now expects the oil market to move into deficit in the first half of 2017. Consequently, analysts expect oil prices to head towards $60 per barrel, though much will depend on how the deal is actually implemented. As discussed in this space before, India has benefited significantly from lower oil prices and some of those gains could be lost. Among other things, higher oil prices will negatively affect government finances, current account balance and profit margins in the corporate sector.

In the absence of healthy growth in the top line in recent times, companies in a number of sectors benefited from margin expansion due to lower oil prices, which boosted profits. Earnings revival will also be dented by the ongoing currency exchange drive as it is affecting activity in both the manufacturing and services sectors.

However, as things stand today, the biggest uncertainty is the timing of implementation of the GST. The government could not get the enabling legislation passed in the winter session of Parliament as the Centre and states were unable to resolve differences. This has made the implementation from 1 April extremely difficult. But it is important that the GST be implemented from the beginning of the financial year to avoid confusion among stakeholders.

Apart from higher oil prices, which can affect the government’s ability to push capital expenditure, the economic discourse in India in the near term is likely to be dominated by the roll-out of GST and actual outcome of the currency swap.

The result of the currency exchange programme and the drive against black money will have a bearing on the government’s willingness to take the reform process forward. 2017 is likely to be a testing year on several fronts.

What will be the most important factor that will affect the economic outlook in 2017? Tell us at views@livemint.com

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