Indian Economy- A deer transfixed by headlights

Demonetised notes

The PMI data is suggesting that we are seeing ‘sluggish demand and lower customer turnout’ but does this mean that the long-term impact of demonetization and GST are finally showing?

Why do deer get transfixed by headlights and just stand frozen? The mandarins the economy are behaving like a deer, standing in the middle of the road, transfixed by headlights, standing and waiting, hoping that trouble will just pass by. Mr Murphy would advise the deer to run but the deer is transfixed.

There is trouble coming our way. Ratings agency Fitch has lowered its growth forecast, saying that India’s growth in 2017-18 would be lower than 2013-14, PMI figures show that the services sector is contracting due to lower demand and the RBI left key rates unchanged as they expect inflationary pressures. The three numbers, seen together, point to a storm building up on the horizon.

The data put out by Fitch is of the great significance. It says that the Indian economy is expected to grow at 6.7% in 2017-18, which is lower than the 2013-14 growth rate of 6.9%. Fitch records that though growth has picked up after the Q1 lows of 5.7% but the rebound has been “weaker than expected.” The ratings agency has also brought down its 2018-19 growth expectations as well, from 7.4% to 7.3%. The decline may not be much, but it points out that it expected a further loss in momentum.

What Fitch means to say is that they expected demonetization and GST to have some impact, considering structural nature of these decisions, they expected a sharper bounce back in the second quarter. They expected a temporary blip post GST and hoped that consumer demand will get back to normal and the PMI data for Services in November points to a much deeper problem- contracting demand.

We need to take a closer look at the Services PMI to understand why this drop is significant. Data indicates that PMI for October 2016 was around 54 and it plummeted to around 47 after demonetization was announced. We see a steady increase the next few months until GST is brought in and it went down to around 46 in July, after which it begins to pick up again. The services PMI dropped to 48.5 (November 2017) from 51.7 in October. Why did the PMI fall when we did not have a big-ticket event to explain this fall?

The Mint reported- The PMI survey said, ‘Of the 15% of the survey panel that reported a decline in new work, a number commented that recent government policies (GST) had contributed to sluggish demand and lower customer turnout. Four of the five categories monitored by the survey—transport & storage, consumer services, information & communications and real estate & business services—recorded reductions in new work.’

The PMI data is suggesting that we are seeing ‘sluggish demand and lower customer turnout’ but does this mean that the long-term impact of demonetization and GST are finally showing? Is the pain of the unorganized sector finally being reflected in data from the formal economy?

Data from Fitch and PMI point towards a slow-down in demand but RBI’s six-member MPC voting for a status quo on repo rate only points out that there is little the government can do, except stand transfixed with the headlights. In a market where demand is low, the RBI is worried about the possibility of retail inflation going up. RBI would definitely have its reasons but there are clearly other factors at play here.

While the government clearly has its backs to the wall on fiscal deficit, the RBI has acknowledged that there is a serious risk of oil prices going up, which could add to the problems of the government. Between August 1 and November 29, the price of the Indian crude basket has gone up by close to 22% and the government is losing its fiscal space and needs to raise revenue to narrow down the fiscal deficit and RBI seems to be indicating that given the fiscal situation, the government may be forced to raise taxes and end up pushing inflation in the 4.3-4.7 per cent range (retail inflation 3.58% in October 2017) . It may be too early to say but that is what it looks like as of now.

Looking at the way things stand today, we might see a hike in the prices of petroleum products after the Gujarat elections as the government has blocked out information about the price of the Indian crude basket on the PIB website. GST collections slipped 10 per cent in October and we can expect a further decline in the November as more rate cuts were announced last month.

So what does this add to. The rebound post demonetization and GST has not been strong enough, we are seeing a decline in demand and since the government’s finances are in a mess, the government may be forced to increase taxes, which could further hit demand and push us further down a slippery slope.

And then there is the Murphy’s law which states- Left to themselves, things tend to go from bad to worse. If the deer keeps standing transfixed, chances are that the vehicle would come and hit the deer. Ladies and gentlemen, lets brace for impact. Or will the deer finally gather its wits and save itself?

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