OECD Economic Outlook, Volume 2019 Issue 2

India

Economic growth is projected to recover to just under 6½ per cent in FY 2021 as election‑related uncertainties fade and monetary and fiscal policies have become accommodative. The new income‑support scheme for farmers and a good monsoon are supporting private consumption. The cut in corporate income tax will support corporate investment. Inflation and the current account deficit will remain moderate given the relatively large spare capacity in the economy and low oil prices. Job creation remains a challenge.

With inflation below target, some room for further accommodation in monetary policy remains. The large cuts in policy rates since the start of 2019 have not yet been fully reflected in lower lending rates, reflecting still high non-performing loans and public sector borrowing needs. Further reforms to improve financial sector soundness and the ease of doing business are needed to revive corporate investment. Re‑building fiscal space will be key to finance better infrastructure and public services. Tax reforms are needed to broaden the property and personal income tax base. Borrowings from public enterprises and banks also need to be restrained.

The economy is bottoming out

Growth has slowed from a rapid pace. Stress in non-banking financial companies, coupled with changes in insurance regulations, has affected car sales, while volatility in fuel prices has weighed on consumer confidence. Construction has been hurt, as non-banking financial companies contribute a large share to its financing, weighing on job creation, income and consumption. Industrial production and related imports have weakened. Exports have suffered from the slowdown in foreign demand. However, they have benefitted from improvements in the Goods and Services Tax (GST) administration, enabling exporters to get faster tax refunds, while efforts to improve trade infrastructure, logistics and processes are starting to pay off. Overall, India has succeeded in seizing some of the market shares lost by other countries and exports have proved relatively resilient.

Economic growth and inflation: India

Source: OECD Economic Outlook 106 database.

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India: Demand, output and prices

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Lending rates and public sector borrowing requirement: India

1. The repo rate is the rate at which the Reserve Bank of India lends money to commercial banks.

2. The lending rate refers to the marginal cost of funds based lending rate (MCLR), the minimum interest rate below which a bank cannot lend.

3. Data for FY 2019-20 are budget estimates.

Source: OECD Economic Outlook 106 database; Reserve Bank of India; and Union Budget Expenditure Profile (Resources of Public Enterprises).

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Headline consumer price inflation has remained close to the 4% target and core inflation is adjusting down. Spare capacity, a good monsoon, the steady rupee, relatively low oil prices and modest increases in minimum support prices for summer crops are all contributing to keep price pressures low.

The current account deficit has declined. Moderate oil prices have helped, together with hefty remittances from abroad. Foreign exchange reserves stand at a healthy 8 months of imports of goods and services and almost four times short-term external debt. Overall, India’s external vulnerability remains limited, with a low level of external debt compared to many emerging-market economies and predominantly long‑term maturities.

Fiscal and monetary policies are accommodative

The Reserve Bank of India has cut policy rates by 135 basis points since early 2019 and maintains an accommodative stance. Lending rates have adjusted only partially and with a lag, as still large non‑performing loans are weighing on banks’ profitability, and high public sector borrowing has put pressures on lending rates. The August 2019 decision to link lending rates for new loans to an external benchmark should help speed up monetary policy transmission. Reducing the spread between administered rates on small savings – used to finance government debt – and market rates should also be considered. Given sticky inflation expectations and uncertainty around food price developments because of local floods, further cuts in policy rates should remain prudent.

Several structural reforms have been introduced, with a large fiscal cost. On the revenue side, the government has reduced corporate income tax rates from 30% to 22% (plus surcharges) and streamlined exemptions. The reduced 15% rate (plus surcharges) for new manufacturing companies created before 2023 is improving India’s competitiveness and could attract companies considering relocating production. The estimated revenue loss is high (0.7% of GDP) while revenue from the Goods and Services Tax has disappointed.

On the spending side, the government has extended an income-support scheme for land‑owning farmers (145 million beneficiaries), with a cost equivalent to 0.4% of GDP. This scheme could support rural consumption and help finance investment in the agricultural sector. Its impact on productivity in the agricultural sector remains uncertain given land fragmentation. It may not help much to reduce poverty for tenant farmers and daily labourers. The government is stepping up public infrastructure projects, which will contribute to improve wellbeing and competitiveness (including water and electricity provision, rural roads and ports).

A record transfer from the Reserve Bank of India will help contain the general government deficit for FY 2019‑20. At the same time, the increasing reliance on off-budget transactions, often through public enterprises, weighs on the overall public sector borrowing requirement and the debt-to-GDP ratio remains relatively high. Raising more revenue from property and personal income taxes and improving the financial situation of public banks and enterprises will be key to finance better public education and health services. To boost job creation and reduce informality, efforts to modernise labour regulations should continue.

Growth is projected to rebound

Economic growth is set to climb to just under 6½ per cent by FY2021. Private investment will bounce back as capacity utilisation rises and the cost of borrowing for the corporate sector declines. The ongoing resolution of distressed assets of non‑financial corporates under the Insolvency and Bankruptcy Code is expected to unlock resources for new investment projects. Recent reforms to improve the ease of doing business – including measures to liberalise FDI, lower corporate income tax rates and efforts to improve judicial services and contract enforcement – will also help. Rural consumption will pick up, thanks to the good monsoon, the full implementation of the new income support scheme for farmers and measures to reduce liquidity stress in non-banking financial companies.

The increased ability to pass and implement reforms, as illustrated with the recent liberalisation of FDI and disinvestment plans, represents a positive risk to the outlook. On the other hand, renewed stress in the banking or non‑banking financial sector would create a credit crunch and affect growth. Higher oil prices would put pressure on inflation, the current account and public finances and would reduce households’ purchasing power. An aggravation of trade tensions would further affect business sentiment and investment. The impact could be limited by the fact that India has specialised more in services than in merchandise trade.