Why the World Bank Feels that Indian Economy is in a Sweet Spot?

The recent India Development Report (IDR) update released by the World Bank has identified some key economic, financial and environmental parameters that could position India in a sweet spot with respect to growth. In fact, the World Bank has expressed surprise that the Indian economy had recovered quickly from the liquidity effects of demonetization. On the other hand, the World Bank has observed that post-Jan 2017, the impact of remonetization was clearly visible in the rapid pick-up in growth. While the World Bank feels that the GDP growth may stabilize at around 7.2% in fiscal year 2017-18, it is likely to move up gradually to 7.9% by the end of fiscal year 2019-20. World Bank has made some very interesting observations pertaining to the Indian economy…

10 Reasons why the World Bank feels that Indian economy is in a sweet spot…

1. The World Bank is of the view that the favourable monsoon in the year 2016 has put the Indian economy firmly on the growth path. With the monsoon likely to hit India on time in 2017, the Indian economy should consolidate the gains of the previous year.

2. While the services and the manufacturing sector saw pressure due to the impact of demonetization, the sharper growth in agricultural output largely cushioned the impact of demonetization. This was evident from the fact that the Kharif Output in 2016 was nearly 9% higher than the previous year resulting in record levels of agricultural production.

3. With government tax collections buoyant, the government did use higher revenues to increase its contribution of services provided. In fact, other than agriculture the government spending on services was what actually held GDP growth buoyant. Within the services space, it was government led services that showed the highest growth.

4. The higher Kharif output led to a sharp increase in agricultural incomes during the financial year 2016-17. The higher agricultural output combined with higher public spending by the government led to a boost in rural consumption. This partially compensated for the weak growth in urban consumption and sustained rural demand and growth.

5. Real GDP growth was also supported by low inflation. The monsoon in 2016 was at 101% of the Long Period Average (LPA) and the substantial growth in food production led to a fall in food inflation. In fact, during the year, food inflation fell to a level much lower than non-food inflation and applied downward pressure on overall CPI inflation. Low inflation created a higher spending power effect in the overall economy leading to growth and consumption staying buoyant through the year.

6. In a challenging year, rural wages and rural consumption played an important role in driving growth for India. In fact, rural wages accelerated in India post October and that largely compensated for the negative impact of demonetization. The increase in rural wages combined with greater rural allocations by the government in the Union Budget resulted in a virtuous cycle of higher wages and incomes leading to higher rural consumption. While rural consumption was hit in the immediate aftermath of demonetization in November 2016, the recovery of demand in rural areas was equally rapid.

7. Unlike rural consumption, urban consumption was not really impacted by demonetization. To an extent, the higher payouts to army personnel under OROP and to government servants under the 7CPC were instrumental in keeping urban consumption buoyant. Also in the post-demonetization scenario, the urban people were able to manage the transition more effectively.

8. Government spending, which was a key driver of growth during the year was actually dominated by spending by state governments rather than by the central government. States are already accounting for over 60% of total government spending. As a result, the fiscal deficit of states has gone up considerably, but it has surely been instrumental in sustaining consumption and demand in India during the year.

9. While investment by the government remained buoyant, it was private investment that actually lagged during the year. One of the reasons for weak private investment was the low level of capacity utilization by Indian industry which still languishes at around 72%. These capacities were created during the investment boom of 2003 to 2007 and production levels still have not come up to the capacity. Hence private investment is likely to remain muted.

10. While there were early signs of an investment recovery, the NPA levels of Indian banks continued to be the overhang. The Gross Fixed Capital Formation (GFCF) actually expanded by 3.5% in the 3^rd quarter after contracting for 3 consecutive quarters. However, this GFCF may face difficulty in sustaining at higher levels due to the overhang of banking NPAs which has led to all-time low levels of credit growth.  In fact, most banks preferred to invest in government securities rather than to expand their credit portfolios.

11. The World Bank has underlined that the incremental growth during the year has come largely from domestic consumption (both by individuals and the government). While the exports have showed signs of growth, imports have grown much faster. This is because the strong rupee has been conducive to imports rather than to exports.

12. Lastly, the World Bank has pointed that the Indian economy has reached a situation where the current account deficit is almost being funded entirely by the inflow of Foreign Direct Investment (FDI). For the fiscal year 2016-17, India emerged as the largest recipient of FDI overtaking China and therefore does not have to depend on volatile portfolio flows to bridge the deficit.

In a nutshell, the World Bank India Development Report update clearly highlights the green-shoots of recovery on the economic front. The challenge from here on will be to consolidate and build on the gains in the coming year.