52

Economy Matters - Nov-Dec 2014

Embed Size (px)

Citation preview

Page 1: Economy Matters - Nov-Dec 2014
Page 2: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 2

Page 3: Economy Matters - Nov-Dec 2014

1

FOREWORD

NOVEMBER-DECEMBER 2014

Slowing growth in Japan and Euro Area has increased the uncertainties in global growth, going forward. Support from a favourable external environment is something which India will hope for in 2015. Japan’s economy unexpectedly fell into recession in the third quarter of 2014, as housing and business investment declined following a tax hike, dragging the country into a recession and further clouding the outlook for the global economy. The only positive results were received on the inflation front as the country emerged out of a decade-and-a-half long period of deflation. Similarly, the GDP growth figures in the Euro Area too hovered in the negative region during the second and third quarters of 2014, mainly on account of weak investment and exports. Although this partly reflected temporary factors, the recovery has been slowed by the crisis legacies and low potential growth. With the US economy per-forming well, the dollar has been strengthening sharply against most currencies.

Domestically, index of industrial production (IIP) moved into the positive territory in Novem-ber 2014, signalling improvement in growth momentum. We hope that going forward, the incipient signs of revival would transform into a firm recovery especially as there is some progress in investment intentions and business confidence is on the ascendant. Inflation continued its downward trajectory, with WPI based inflation dipping to 64-month low in No-vember 2014. CPI inflation too continued to decelerate, helped by falling crude oil prices. Going forward, the continuing slowdown in global commodity prices as well as the govern-ment’s resolve to rein in the fiscal deficit would prevent prices from moving upwards. This should induce the RBI to rethink its cautious monetary stance and urgently move towards a growth propelling monetary policy. The RBI should not wait till the next monetary policy an-nouncement and reduce interest rate substantially, as industrial production is in the red and investment and consumption demand are yet to show visible signs of a pick-up. On the fiscal front, the situation remains precarious, with the fiscal deficit reaching 98.9 per cent of the annual budget estimates in the first eight months of the year. Government is hoping that the revenue coming from the spectrum auctions along with the recent softening witnessed in crude oil prices would help it to reach the fiscal deficit target for the year.

In the year 2014, India bounced back from the edge of a macroeconomic crisis character-ised by double digit inflation, a high and rising current account deficit (CAD), and a falling rupee. Towards the end of the year, the landscape vastly changed. Macro-economic stability returned, reforms were being undertaken, and above all, a new stable Government came into power. Although it is still too early to detect signs of robust recovery, emerging trends indicate that the growth deceleration has bottomed out. Looking ahead, 2015 would hold host of promises and challenges for the economy. Support from favourable external environ-ment will be crucial in this regard.

Chandrajit BanerjeeDirector General, CII

Page 4: Economy Matters - Nov-Dec 2014
Page 5: Economy Matters - Nov-Dec 2014

3 NOVEMBER-DECEMBER 2014

Page 6: Economy Matters - Nov-Dec 2014
Page 7: Economy Matters - Nov-Dec 2014

5

EXECUTIVE SUMMARY

NOVEMBER-DECEMBER 2014

Global TrendsJapan slipped into recession as the quarter-on-quarter growth figures took a dive into the negative territory in the April-June and July-September 2014 quarters. High public debt inheritance and low potential growth accreted to the larger-than-expected decline in domestic demand follow-ing the increase in the consumption tax. The only positive results were received on the inflation front as the country emerged out of a decade-and-a-half long deflation period. Similarly, the GDP growth figures in the Euro Area hovered in the negative region during the second and third quarters of 2014, mainly on account of weak investment and exports. Although this partly reflected temporary factors, the recov-ery has been slowed by the crisis legacies and low potential growth. The recovery uneven across member nations and unemployment and disinflation persists. The only respite was provided by the resilient financial markets. The global economy witnessed some steadiness as output rallied in the US. This recovery and advantageous financing conditions supported the growth in developing East Asia and Pacific, wherein, net exports were a pivotal contribution. However, rebuilding fiscal space and elevated debt service remain ma-

jor concerns in the region.

Domestic TrendsEconomy is passing through choppy waters currently. Differ-ent economic indicators released in December 2014 painted a rather mixed picture of the economy. On one hand, ba-rometer of industrial performance in the country, index of industrial production (IIP) came in at a dismal -4.2 per cent in October 2014 as compared to 2.8 per cent posted in Septem-ber 2014. However it improved to 3.8 per cent in November 2014. On the other, WPI based inflation dipped to 64-month low of 0 per cent in November 2014 from 1.8 per cent in Oc-tober 2014. CPI inflation too decelerated to 4.4 per cent in November 2014, far below the 11.2 per cent recorded in No-vember 2013. It however, accelerated in December 2014, as per the latest data print. On the external front, the balance of payments (BoP) data released for second quarter of the current fiscal (2QFY15 henceforth) showed some weaken-ing of the external sector fundamentals. India’s current ac-count deficit (CAD) increased to US$10.1 billion (2.1 per cent of GDP) in 2QFY15 from US$7.8 billion (1.7 per cent of GDP) in the preceding quarter and US$5.2 billion (1.2 per cent of GDP) in Q2 of 2013-14. The increase in CAD was primarily on account of higher trade deficit contributed by both a decel-eration in export growth and increase in imports.

Sector in Focus: Enabling ‘Make in In-dia’ Through Effective Tax ReformsIndia stands out as a country with immense potential and opportunity given the current global environment. It is once

again creating an interest and excitement in the global arena as hopes build for its reforms agenda to be carried forward. Industry expects tax reforms to be at a priority position in this agenda. Around the world, the discussions on tax policy have become centric to checking tax base erosion and en-hancing transparency in terms of exchange of information. India’s tax policy is no exception and is changing in response to the global developments. However, India needs to strike the right balance between checking tax avoidance and mak-ing the tax environment more facilitative compared to other jurisdictions competing for investments. The Government has already embarked on the journey to deliver a litigation-free and a certain tax environment. With the various action items on the OECD BEPS Action plan gathering momentum, it is also seen that the policy responses are varying across the globe. The Government should engage with the indus-try actively on all the BEPS Action items to develop a coor-dinated response. Implementation of Goods & Services Tex (GST) remains another important policy measure which the Government would seek to implement in the next fiscal. In this month’s Sector in Focus, we present excerpts from the recently released report titled “Enabling ‘Make in India’ Through Effective Tax Reforms”. It was released by CII and

Ernst & Young (E&Y) jointly in December 2014.

Focus of the Month: Indian Economy – Recent Trends and ChallengesIn July 2013, India was teetering on the edge of macroeco-nomic crisis with double digit inflation, a high and rising cur-rent account deficit (CAD), and a falling rupee as investor sentiment turned sour in the aftermath of the Fed’s taper decision to signal the end of its quantitative easing. Nearly 18 months on, the landscape has vastly changed. Macro-eco-nomic stability has returned, reforms are being undertaken, the external environment has moved in India’s favour, and above all, a new Government has come into power with a relatively unencumbered political mandate for decisive eco-nomic change, a mandate that markets have enthusiastically embraced. Although it is still too early to detect signs of robust recovery, emerging trends indicate that the growth deceleration has bottomed out, manifested in the relative improvement in growth in the latest 2 quarters. However, risks still remain on the horizon. Investment is yet to pick up significantly. But on the upside, inflation has come down dramatically, the monsoons failed to extract as much of a toll on growth as expected, and India received a large sup-ply side shock in the form of reduced commodity prices that amounted to about 1.5 per cent of GDP. According to the government estimates, 2014-15 could end with growth around 5.5 per cent. Looking ahead, 2015-16 would hold host of promises and challenges for the economy. Support from favourable external environment will be crucial in this re-gard.

Page 8: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 6

GLOBAL TRENDS

Trouble in Paradise: Japan and Euro Area

Even as the global economy inches towards steadi-ness, flagging growth continue to plague Japan and Euro Area. While Japan is growing, high pub-

lic debt inheritance and very low potential growth cre-ate major macroeconomic and fiscal challenges. The decline in domestic demand in the country, following the increase in the consumption tax, was larger than expected. Similarly, in the Euro Area, growth came to a halt in the second quarter, mainly on account of weak investment and exports. Although this partly reflects temporary factors, the recovery has been slowed by the crisis legacies and low potential growth. Uncertainty about the persistence of the growth slowdown in the region remains.

Resolve amid Gloom in Japan

In Japan, the pattern of growth in the first half of the year was affected by the April consumption tax hike, from a rate of 5 per cent to 8 per cent, which boosted activity in the first quarter at the expense of the second. Japan experienced a strong growth outturn to the tune of 1.1 per cent in the first quarter of 2014 compared to the first quarter in the previous year. This largely reflect-ed a stronger than expected rise in consumption ahead of the hike. This was, however, offset by a sharper than envisaged slowdown in the second and third quarters, wherein the growth figure stood at 0.8 per cent, year on year, as the consumption contracted in both the quar-ters. Another key factor behind the plunge in growth was a decline in business investment. Further, exports also showed signs of bottoming out after remaining dis-appointingly weak despite a sharply weaker yen. Resi-dential investment was another soft spot.

Page 9: Economy Matters - Nov-Dec 2014

7

GLOBAL TRENDS

NOVEMBER-DECEMBER 2014

While Japan slipped into recession as the quarter-on-quarter growth figures took a dive into the negative territory in the April-June and July-September periods, the government claims that it does not signal serious trouble. People shifted the timing of consumption goods purchase from the second quarter to the first in anticipation of the tax hike, so the true negative growth has been observed only for a quarter. Further, the nega-tive growth disappears upon exclusion of the change in inventory.

Even though the growth figures took an undesirable turn, positive results were received on the inflation front. Aggressive monetary policy easing, the first arrow of Abenomics helped lift inflation and inflation expecta-tions and the country emerged out of a decade-and-a-half long deflation period in 2014. Actual and expected inflation progressed toward the 2 per cent target dur-ing the year. Though, excluding the effects on the price level of the increase in the consumption tax rate in the second quarter of 2014, headline inflation ran below the Bank of Japan’s inflation target.

The policies have been an initial success, brightening household and corporate sentiment by boosting stock prices and weakening the Yen. Despite the two straight quarters of contraction, the size of Japan’s economy is still 1.4 per cent bigger than before Abe seized power in late 2012. Plummeting growth figures factored in the decision to delay a second tax hike to 10 per cent by 18 months until April 2017, easing concerns about the outlook for consumer spending, which makes up 60 per cent of GDP.

But the recession has also shown that Abe’s stimulus policies have not been enough to strengthen the under-lying economy even after two years in office, as com-panies remain hesitant of boosting wages and capital spending. The government’s announcement of devel-oping a deadline bound plan to achieve a fiscal surplus may lead to a credible plan to reach fiscal sustainability. Further, a strategy based on the third arrow of Abe-nomics, that of growth strategy, enacted in June 2014 offers 10 focus areas for economic reforms.

Euro Area Stuck in a Quagmire

The GDP growth figures in the Euro Area hovered in the negative region during the second and third quarters of 2014, contracting by 0.3 per cent and 1.2 per cent, re-spectively, related to comparable quarters of the previ-ous year. The recovery, thus, remains weak, uncertain and further, uneven across member nations. While Greece witnessed positive developments, contraction in growth persisted in Italy. Growth in Spain resumed, supported by external demand as well as higher domes-tic demand reflecting improved financial conditions and rising confidence. German manufacturing and services expanded at the slowest pace in 16 months, signaling that growth in Europe’s largest economy is poised to re-main sluggish. French manufacturing continued shrink-ing as demand fell, casting doubt on the solidity of the country’s economic rebound seen in the third quarter.

The unemployment rates far exceeded their equilibrium value in most countries, and Euro-Area-wide inflation remained too low, pointing to pervasive weakness in domestic demand and reflecting large output gaps for

Page 10: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 8

GLOBAL TRENDS

most Euro Area countries. The only positive news was seen from the financial markets, which remained gen-erally resilient even amidst a fragile recovery. Further

current account balances have improved, but with per-sistent surpluses in creditor economies.

On the monetary policy front, measures were taken by the European Central Bank to tackle low inflation, boost liquidity and address fragmentation, in the form of lower policy rates, the announcement of cheap term funding for banks and a program of private asset pur-chases. However, a downward drift in inflation expec-tations warrant further actions, including purchases of sovereign assets. Although, reducing fragmentation in stressed economies and ensuring that inflation rises back toward the price stability objective requires action beyond monetary policy. The review of banks’ asset quality that is currently underway is critical to reestab-lishing confidence in banks and improving intermedia-tion, according to the International Monetary Fund.

Looking beyond the demand constraints, structural measures are required to increase very low potential growth rates. On the fiscal policy front, the pace of fiscal consolidation slowed down and the overall fis-cal stance for 2015 is projected by the IMF to be only slightly contractionary, in order to sustain a balance be-

tween demand support and debt reduction. Germany, having completed its fiscal consolidation, is expected to finance much-needed public investment in infra-structure. Large negative growth surprises in Euro Area countries are not projected to trigger additional consol-idation efforts, which would be self-defeating.

The eighteen-nation economy is projected to witness a weak recovery, supported by a reduction in fiscal drag, accommodative monetary policy, and improving lend-ing conditions, with a sharp compression in spreads for stressed economies and record-low long-term interest rates in core countries. Further, inflation is projected to increase gradually to 0.9 per cent on an annual basis in 2015 and 1.2 per cent in 2016, as the recovery strength-ens and output gaps slowly decrease. While an unprec-edented stimulus by the European Central Bank is antic-ipated to take effect in coming months, weak growth in Germany and France and rising tensions in Ukraine are likely to threaten the Euro Area’s modest revival.

Page 11: Economy Matters - Nov-Dec 2014

9

GLOBAL TRENDS

NOVEMBER-DECEMBER 2014

Opportunities Ahead

Japan and the Euro Area stand at a crossroads, facing a difficult balance between energy security, environmen-tal concerns, and economic efficiency goals. Highly ac-commodative policy stances are anticipated in both the economies. Rebuilding policy space and implementing structural reforms for sustainable and stronger growth are likely to remain key policy priorities. Fiscal consolida-tion is a priority in Japan, where debt levels are relative-ly higher. Further, labor market reforms are desirable in

In Japan, the sharp economic contraction in the second quarter induced by the consumption tax increase is ex-pected to be short lived, with a moderate pace of re-covery returning thereafter. The country is projected to witness an average growth of about 0.8 per cent during 2015, according to the World Economic Outlook by IMF

both Japan and Euro Area. In particular, increasing the labor supply is of the essence, given unfavorable demo-graphic trends, but it is also important to reduce labor market duality, enhance risk capital provision to boost investment, and raise productivity through agricultural and services sector deregulation. The task of boosting growth is also critical in light of the challenges posed by high public debt and the need for sizable fiscal consoli-dation, for which a concrete medium-term plan beyond 2015 is urgently needed.

during October, 2014. Further, the IMF projected the growth in the Euro Area to average about 1.3 per cent in 2015. Prospects are uneven across countries. While Spain received an upward revision compared to an ear-lier outlook in April, the projections for Italy, Germany and France were revised downward.

Recent Developments

The global economy witnessed slight recovery with an expansion of activity in high-income economies, accord-ing to East Asia Pacific Economic Update by the World Bank during October 2014. In this article, we highlight the key findings of this update. As per the update, in the US, output rallied on the back of accommodative monetary policy, easing fiscal consolidation, and rising employment, investment growth, and confidence. The Euro Area, however, continued to be plagued by weak domestic demand and credit growth along with sub-dued investment prospects. In Japan, monetary policy accommodation and reform commitments provided on-going support. The global recovery and advantageous financing conditions supported the growth in develop-ing East Asia and Pacific. Capital flows to developing countries have been on an upward trend since March.

Growth picked up in China, on the back of investment stimulus, and in each of the ASEAN-5 countries, benefit-ted by rising exports and diminished unrest in Thailand. Among the region’s smaller economies, Cambodia and Myanmar performed well, while growth weakened in Mongolia and the Lao PDR.

Indonesia, Philippines and Vietnam witnessed a slow-down in investment due to falling commodity export prices, increases in the cost of capital and weak real estate sector, the update highligted. Private consump-tion remained resilient, supported by election-related spending in Indonesia, robust labor markets in Malay-sia and buoyant remittances in Philippines. Institutional weaknesses, in particular government effectiveness and regulatory environment, remain a significant underlying constraint on investment. Net exports emerged as a

East Asia and Pacific: Outlook and Opportunities

Page 12: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 10

GLOBAL TRENDS

pivotal factor in contribution to GDP growth across the region. In the Philippines, Malaysia and Vietnam, export growth accelerated, propelled by a cyclical turnaround in high-tech electrical and electronics manufactures. China continued to gain global market share, including in exports of office, data processing and telecommuni-cations equipment and electrical machinery. Indonesia and Thailand saw an import compression.

Abundant global liquidity renewed foreign portfolio in-vestment into the region, which revived in the second quarter, following the “taper tantrum” of May–Sep-tember 2013 and its “echo” in December 2013–January 2014. Indonesia and Vietnam saw particularly large capi-tal inflows. While the former benefitted from an appre-ciation of real exchange rate, the latter was supported by low wage costs, proximity to China’s supply chains and gains in macroeconomic stability. In contrast, Thai-land saw portfolio outflows, continuing last year’s neg-ative trend.

Efforts aimed at rebuilding fiscal space were not sus-tained. Stagnant commodity prices impaired revenue growth in Indonesia. Elevated subsidy costs, particular-ly for energy, constrained spending on priority areas in Indonesia, Malaysia and Thailand. Overall, fiscal deficits narrowed over time on the back of rising net exports. Mongolia and Indonesia remained important excep-tions due to a broader lack of macroeconomic adjust-ment to declining commodity export prices. Inflation, in general, remained within the target range, leading

many central banks including Indonesia, Vietnam and Thailand, to keep monetary policy on hold. However, in-flationary pressures have risen in the Philippines, Mon-golia and Malaysia, which tightened monetary policy in 2014.

Commodity prices remained broadly stable during 2014. Geopolitical concerns in Ukraine and Iraq triggered only modest and temporary increases in oil prices during the second quarter. Prices eased subsequently on favora-ble news about oil production in Iraq, Libya and the US, along with weak demand data for China and Europe.

Credit growth was dampened by monetary tightening in Indonesia in 2013, and in Malaysia and the Philippines in 2014. Credit growth was constrained by macro-pruden-tial measures directed at the housing market through-out Indonesia, Malaysia, the Philippines, and Thailand and additionally, by political and structural problems in Thailand and Vietnam. Mongolia was an exception with a highly expansionary monetary policy fueling rapid credit growth.

Growth Outlook

As per the update, global growth is expected to rise modestly to 2.6 per cent in 2014, and an average 3.3 per cent in 2015–17. Growth in the US is projected at about 2 per cent in 2014, rising to 3 per cent in 2015. In both the Euro Area and Japan, growth is projected at about 1 per cent in 2014, rising slowly thereafter.

Page 13: Economy Matters - Nov-Dec 2014

11

GLOBAL TRENDS

NOVEMBER-DECEMBER 2014

The update highlights that a boost in demand for ex-ports from developing East Asia and Pacific is antici-pated with the gradual strengthening of activity in high-income economies. This will sustain growth in the region, which is expected to moderate gradually from 7.2 per cent in 2013 to 6.9 per cent in 2014–15. In the region excluding China, growth will bottom out at 4.8 per cent in 2014, reflecting the slowdown in Indonesia and Thailand, before an expected recovery to 5.3 per cent in 2015–16. Developing East Asia and Pacific will re-main the fastest-growing developing region. In China, growth will gradually moderate to 7.4 per cent in 2014 and 7.1 per cent in 2016, reflecting intensified policy ef-forts to address financial vulnerabilities and structural constraints, and place the economy on a more sustaina-

Risk Scenario

A slower than expected recovery in the global demand, with a negative impact on regional exports and growth, presents major risk. The near-term outlook for high-income economies is subject to downside risks particu-larly in the Euro Area and Japan. Cambodia, Malaysia,

ble growth path. Measures to contain local government debt, curb shadow banking and tackle excess capacity, high energy demand, and high pollution will reduce in-vestment and manufacturing output.

The capacity to benefit from the global recovery will vary significantly across countries, reflecting structural constraints to investment and export competitiveness, and weak export prices for commodity producers. Cam-bodia, Malaysia, Vietnam are well positioned to increase their exports, reflecting their deepening integration into global and regional value chains. But in Indonesia, export performance will remain fragile, as its commodi-ty export prices continue stagnating and infrastructural bottlenecks hamper efforts at diversification.

Vietnam, and Thailand appear greatly exposed, given their greater openness. Monetary policy is expected to diverge across high-income economies, with a tighten-ing in the UK and the US in the first half of 2015, and continued accommodation in the Euro Area and Japan. Overall, global financial conditions are anticipated to tighten. The normalization process is expected to be

Page 14: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 12

GLOBAL TRENDS

complex, since monetary policy in high income econo-mies has remained expansionary over an extended period of time. The unwinding of large central bank interventions could be accompanied by abrupt market reactions, increased volatility and overshooting of inter-est rates. The divergence in monetary policy raises the risk of disorderly exchange rate and interest rate move-ments.

In many countries, debt service ratios are now at his-torically elevated levels, owing to the sharp accumula-tion of debt since the global financial crisis. In particular, the risk of debt service problems may be significant for households and corporates, although not governments, should interest rates rise. Abrupt changes in market ex-pectations could also lead to a sharper-than-expected reduction in capital inflows, exposing some countries to considerable pressures.

The risks posed by potential commodity price increases appear relatively small at this time, barring a sharp slow-down in China. Nevertheless, the impact of any such increases would vary sharply across countries. Energy price increases would have a relatively strong negative impact on Cambodia, Lao PDR, and Thailand (petroleum importers), and a relatively strong positive impact on Indonesia and Mongolia (coal exporters). Increases in food prices would most benefit Vietnam, Lao PDR, and Thailand (significant exporters of rice and other food-stuffs).

The Way Forward

While the global environment remains uncertain, there are opportunities to enact critical reforms. The short-term priority in several countries is to address the vul-nerabilities created by loose financial conditions and fiscal stimulus. In Indonesia, Malaysia, the Philippines, and Thailand, measures to boost revenues and reduce poorly targeted subsidies will create space for produc-tivity-enhancing investments and reestablish fiscal buff-ers. Among smaller economies, Lao PDR and Mongolia need to reduce the fiscal deficit and tighten monetary policy to ensure debt sustainability and macroeconomic stability. Vietnam needs to broaden its revenue base and strengthen its banking system. In China, the au-thorities need to strike a balance between containing the growing risks from rising leverage and meeting the indicative growth targets.

Over the longer term, the focus in most countries must be on implementing the structural reforms needed to enhance their export competitiveness. Such reforms will position them to benefit from the global recovery, as well as from China’s continued move up the value chain to less labor-intensive exports. Key reform areas include infrastructure investment, logistics, and the lib-eralization of services and FDI, including in the context of regional integration.

Other Key Global Developments During the Month• Russia’s central bank raised its key interest rates by 6.5 percentage points to 17 per cent from 10.5 per cent in

order to halt its currency (Rouble’s) freefall on December 16, 2014. The move was the largest single increase since 1998, when Russian rates soared past 100 per cent and the government defaulted on debt. Russian cur-rency Ruble is down by nearly 70 per cent against the US Dollar on a year-to-date (YTD) basis, having lost over 20 per cent over in November 2014 alone. A number of factors such as fall in oil prices, waning investor confi-dence and high inflation have been weighing on the Ruble. The sudden sell-off last week has brought to light Russia’s weak macroeconomic fundamentals. Russia is facing economic headwinds, brought about by geopo-litical tensions and sanctions imposed by the West. The economy has slowed significantly this year to slightly below 1 per cent growth. Going ahead, consumption spending is likely to remain depressed as weak wage growth, high inflation and Ruble (RUB) depreciation continue to erode purchasing power. The outlook for private investment also appears bleak amid poor investor sentiment. Meanwhile, inflation remains elevated. While the currency has stabilised for now, there are certain risks that could trigger worsening of the scenario. First, there remains the risk of further sanctions from the West, as tensions between Russia and West seem to be far from over. Then, there could be a feedback effect of falling domestic asset prices, possible funding stress and a withdrawal of credit lines. Therefore, the domestic banking system has become the most impor-tant place to watch for signs of mounting stress.

Page 15: Economy Matters - Nov-Dec 2014

13

GLOBAL TRENDS

NOVEMBER-DECEMBER 2014

• The US Federal Reserve took the second step towards normalizing its monetary policy stance by altering the forward guidance from “keeping the interest rate low for considerable time” to “patient in beginning the policy normalization. The first step was the end of the asset purchase program in October earlier this year. The Fed also released its macro-economic projections for the next few years. The growth projection has been revised to 2.4 per cent from 2.1 per cent released previously in 2014 while maintaining the long term growth forecast at 2.2-2.3 per cent. Unemployment rate projections were slightly lowered during the next few years. However, the Fed looked more dovish on inflation. In light of the recent fall in commodity prices, Fed projec-tions reflects inflation averaging 1.4 per cent and 1.6 per cent respectively in 2014 and 2015 as against 1.7 per cent and 2.0 per cent reported previously.

• The Swiss National Bank (SNB), in an unscheduled statement released on December 18, 2014 put in place negative interest rate of -0.25 per cent on sight deposits (cash balances) held at SNB. The benchmark 3-month Swiss Franc (CHF) Libor target range was expanded to (-)0.75-0.25 per cent from 0.0-0.25 per cent. The new guidelines will apply to all accounts held by commercial banks while excluding those held by the Government. The negative interest rate will be charged only on that portion of the account balance that exceeds a certain threshold (set atleast at CHF 10 million). The main reason behind introducing negative interest rates was that there has been an increasing appreciation pressure on the Swiss Franc on the back of rising safe haven de-mand, fuelled by global concerns. The move to implement negative interest rates comes in light of preventing the Franc from strengthening further. By imposing a tax on sight deposits, SNB probably intends to discour-age foreign exchange inflows.

• The Japanese government on December 27, 2014 approved an emergency economic stimulus package worth about 3.5 trillion yen (about US$29.06 billion) to drive regional economies hit by higher prices due to sales tax hike and the Yen’s fast retreat. The stimulus package is aimed at providing subsidies designed to offset rising fuel costs and help local governments carry out necessary measures to invigorate their communities at their discretion. Under the package, 9.96 billion dollars will be used to support consumers and companies, about 4.98 billion dollars for revitalization of local communities and some 14.11 billion dollars for disaster prevention and reconstruction. An extra budget for the fiscal 2014, intended to fund the package, is slated for cabinet approval on January 9, 2015 and the government will try to finance the supplementary budget from the fiscal 2013 budget and tax revenue in the current fiscal year.

• A survey of Chinese manufacturers has found that their activity contracted in December 2014 in a new sign that the world’s second-largest economy is slowing despite government efforts to shore up growth. HSBC ‘s monthly purchasing managers’ index (PMI) fell to 49.6 on a 100-point scale on which numbers below 50 show activity contracting. It was down from November’s break-even 50 reading and the first contraction since May. Beijing is trying to steer the economy to slower, more sustainable growth based on domestic consumption instead of exports and investment. But after growth fell to a five-year low of 7.3 percent in the third quarter of 2014, Chinese Central Bank cut interest rates unexpectedly in November 2014 in an apparent effort to stop the decline.

• US real gross domestic product (GDP) grew 5.0 per cent at an annual rate in the third quarter of 2014—the strongest single quarter since 2003—according to the third estimate from the Bureau of Economic Analysis. On annual y-o-y basis, GDP growth was revised to 2.7 per cent from 2.3 per cent forecasted previously. While quarterly growth reports are volatile, and some of the growth in Q3 reflected transitory factors, the recent robust growth data indicate a solid underlying trend of recovery. Indeed, the strong growth recorded in each of the last two quarters suggests that the economy has bounced back strongly from the first-quarter decline in GDP, which largely reflected transitory factors like unusually severe winter weather and a sharp slowdown in inventory investment. Consumer spending, business investment, and net exports all remained positive in this quarter.

Page 16: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 14

DOMESTIC TRENDS

Industry Hopes for a Pro-Growth Budget: CII President

Q1: The Narendra Modi government has been in power for six months now. Do you think it has lived up to its expectations?

I think so, definitely. For the first time, a government has come to power on the theme of growth, develop-ment and governance. Modi has come to power with the experience of running the state of Gujarat success-fully. Now he is trying to do it in the centre. We do feel the government hit the ground running and we agree with this philosophy that you don’t have to wait for the budget to make changes. So many changes have been brought about outside the budget, whether diesel price decontrol, lot of FDI (foreign direct investment) issues, labour-related issues. So, we are very happy the way the

government has moved to get the economy kick-start-ed and I can tell you this is the industry view.

Q2: If the sentiment is so positive, why have things have not moved on the ground? Why have investments not picked up? Why did we see industrial growth con-tract at its worst in three years in October?

For a country like India, you can’t bring changes over-night. Like, say, the infrastructure projects that were pending, now when you start giving them a push, the approval processes which earlier took years, now I believe projects are actually at the stage of taking off through the approvals of various ministries. It takes time, it can’t happen overnight. And then there are so many issues which are state-related. So, both the cen-tre and states have to work in tandem. But one or two things that can be done more now which will help dra-matically in terms of kick-starting the economy is creat-ing the demand-side growth. And that’s where interest rates plays a very major role. As a representative of the industry, I can say with both inflation and fiscal deficit under control, we would appreciate if RBI (Reserve Bank of India) goes ahead and cuts interest rates by at least one percentage point. That impacts the common man, the EMIs (equated monthly instalments) come down, and consumption picks up.

Page 17: Economy Matters - Nov-Dec 2014

15

DOMESTIC TRENDS

NOVEMBER-DECEMBER 2014

Q3: But do you think a 1 percentage point cut in inter-est rates is a panacea that will kick-start the economy?

No; it’s a combination of factors. But inflation is under 5 per cent, fiscal deficit is within the planned 4.1 per cent of GDP (gross domestic product). So, these are within the parameters of what was identified as the required level for boosting the economy. One of the ways that it can be done is through a cut in interest rates.

Q4: On the land acquisition Act, the government has made it clear that its effort will be only to ease some of the restrictions in acquiring land, but the high com-pensation packages will not be tinkered with. Are you happy with that kind of a stand?

Absolutely. Let’s be practical. The government in the past came out with a particular set of parameters to evaluate the values. In a democracy, it is not easy to change values like that. The important point is time. The earlier process laid down a time frame of 56 months to acquire the land. Now, in five years, the whole project changes. So, the current government’s approach to bring it down to two years—and as I understand they are also looking at exemptions in certain areas for ac-quiring it faster—I think it is the right way to go.

Q5: The next budget will be presented in February. Many analysts say this will be the most crucial budget for this government as there are no state elections imminent. What are the expectations of the industry from this budget? Are you looking at some tax incen-tives to boost manufacturing?

CII has given quite a few proposals on how to simplify and ease tax processes. We believe it is very important to bring in transparency, more ease in implementation

of taxes and taxes should be used for boosting invest-ments. Unfortunately, we get caught in the issue of big-bang reforms. I don’t know what big bang means. So, I am not looking for any big-bang approach in the budget. What I want to see is whether the budget is in the same direction that the government is setting even now—that is, for increasing economic growth and cre-ating jobs. These are the two key elements which are re-quired for the country. And they have the programmes of ease of doing business and many other parameters, they have the plan of goods and services tax, I think some of these things can make a difference in terms of the pace of economic growth growing much faster. We are not looking at exemptions. We have asked for some of the remaining inverted duty structure to be removed in this budget.

Q6: India has signed a number of free-trade agree-ments (FTAs). Have they benefited the industry? India is also negotiating a mega-regional agreement in THE Regional Competitive Economic Partnership. Are you in its favour?

FTAs are a given in the world today. We have to work within that. In some of the areas where there is a differ-ence in the taxation system between the two countries involved, if there are anomalies, they should be looked at and studied so that it is a fair play. But we are in fa-vour of larger regional agreements because that will create larger common markets and that will ultimately help. Indian companies also need to move harder to take advantage of the FTAs and collaborate and work with countries around. We feel with our economy pick-ing up, with more ease of doing business, with GST (goods and services tax) affecting transaction costs, we will be as competitive as anyone else.

This Interview appeared in Mint dated 15th December 2014. The online version can be accessed from the following link: http://www.livemint.com/Industry/bKHUh8Y3GqabtNXP4512HJ/We-are-not-looking-for-any.html

Page 18: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 16

DOMESTIC TRENDS

Signalling improvement in growth momentum, index of industrial production (IIP) moved to the positive terri-tory in November 2014. It posted growth to the tune of 3.8 per cent in November 2014 as compared to -4.2 per cent posted in October 2014. The significant weakness in October reading was primarily on account of lesser number of working days amid festival season. Broadly, the disaggregated data suggests improvement, though there remain pockets of concern. Negative output in

The eight core industries grew by 6.7 per cent in No-vember 2014 after rising to 6.3 per cent in October 2014. The main drivers of growth include coal, cement and electricity, which recorded double-digit growth. Output of the coal industry grew by 14.5 per cent in November 2014 while that of the electricity sector grew by 10.2 per cent. Cement production grew by 11.3 per cent, this be-ing its highest growth in the last four months. Output of the steel sector grew at a slower pace of 1.3 per cent

consumer goods still remains a matter of worry. On a cumulative basis, industrial output grew by 2.2 per cent in the first eight months (April-November) of the cur-rent fiscal as compared to 0.1 per cent in the same pe-riod last year. The sequential momentum as indicated by the movement in the seasonally-adjusted month-on-month series too showed that industrial output growth improved in November 2014 (from -6.7 per cent in Octo-ber 2014 to 6.1 per cent in November 2014).

in November 2014. Output of refinery products grew by 8.1 per cent during the month. This is its highest level in the last 20 months. Output of the crude oil, natural gas and fertiliser industry was seen falling in November 2014. Output of the fertiliser sector fell by 2.8 per cent. This is the sixth consecutive month of a decline in pro-duction. Output of the natural gas sector declined by 2.9 per cent while that of the crude oil sector fell by 0.1 per cent.

November IIP Signals Improving Growth Momentum

Page 19: Economy Matters - Nov-Dec 2014

17

DOMESTIC TRENDS

NOVEMBER-DECEMBER 2014

On the sectoral front, output of the manufacturing sector, grew by 3.0 per cent in November 2014 as com-pared to contraction to the tune of 7.4 per cent in the previous month. In terms of industries, sixteen (16) out of the twenty two (22) industry groups (as per 2- digit NIC-2004) in the manufacturing sector showed positive growth during the month of November 2014 as com-pared to the corresponding month of the previous year. The industry group ‘Wearing apparel; dressing and dye-ing of fur’ showed the highest positive growth of 19.8 per cent, followed by 17.5 per cent in ‘Motor vehicles, trailers & semi-trailers’ and 12.8% in ‘Fabricated metal products, except machinery & equipment’. On the oth-er hand, the industry group ‘Radio, TV and communica-tion equipment & apparatus’ showed the highest nega-tive growth of (-) 60.0 per cent, followed by (-) 26.3 per cent in ‘Office, accounting & computing machinery’ and (-) 17.4 per cent in ‘Tobacco products’.

Electricity output rose decelerated marginally to 10.0

per cent in November 2014 as compared to 13.3 per cent in October 2014. Mining output too grew at a slower pace of 3.4 per cent in the reporting month as com-pared to 4.9 per cent in the previous month. Going for-ward, we expect the electricity production growth to slow down further due to shortfall in coal supply. In ad-dition, the Supreme Court ruling on cancellation of coal blocks allocations to 214 mines could see mining sector growth decelerating further in the months to come.

From the use-based perspective, during the month, consumer goods’ output continued to contract, fall-ing by 2.2 per cent in November 2014, most of it led by the consumer durables sector where output fell 14.5 per cent, while consumer non-durables output grew by 6.0 per cent. Acute rainfall deficiency during the initial phase of the monsoon season (about 30 per cent av-erage during June to August) has likely to have dented farm incomes and hence demand for consumer dura-bles. Capital goods sector output grew by 6.5 per cent after contracting in the previous month.

Outlook Industry is buoyed by the improvement in IIP recorded in November 2014. We hope that going forward, the incipi-ent signs of revival would transform into a firm recovery especially as there is some progress in investment inten-tions and business confidence is on the ascendant. To steer the economy towards an accelerated growth path, demand creation has to be a priority. In this regard, the manufacturing sector must be given a major impetus.

Page 20: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 18

DOMESTIC TRENDS

WPI based inflation dipped to 64-month low of 0 per cent in November 2014 from 1.8 per cent in October 2014, mainly due to inflation for primary articles and fuel products slipping to sub-zero level during the month. Inflation reading in November 2014 was the lowest since (-) 0.3 per cent in July 2009. WPI inflation has been in rapid decline over the past few months, in-fluenced significantly by the fall in oil prices, of course, but also reinforced by trends in food prices. Of the 676 commodities, the inflation rate for about 233 commodi-ties, which carry 33 per cent weight in the WPI, rose in November 2014 compared with the October 2014 infla-tion rate. About 303 commodities, holding 55 per cent weight in the WPI, witnessed a decline in the inflation rate in November 2014. However, inflation for 140 com-

Primary inflation declined to 1.0 per cent in November 2014 from 1.4 per cent in October 2014. Part of the mod-eration was driven by a high base of last year. Primary food inflation too eased to 0.6 per cent from 2.7 per cent in the previous month. Notably, food inflation has come down sharply in the last couple of months, thanks to proactive steps taken by the government such as release of food grain stocks, low increase in minimum support prices etc. Amongst food articles, inflation for vegetables, fruits, milk, food grains, spices, oilseeds, sugarcane etc, eased, contributing to the overall de-cline in inflation in November 2014. Primary non-food

modities, carrying 12 per cent weight in WPI, remained unchanged in November 2014. WPI inflation during this fiscal has been downward bound. While it did rise in May 2014 to 6.2 per cent, it has since been slowing down.

CPI inflation too decelerated to 4.4 per cent in Novem-ber 2014, far below the 11.2 per cent recorded in No-vember 2013. While the dramatic decline in crude oil prices clearly played a role, both directly and indirectly, through its impact on input costs, the real story was that of food prices. However, CPI edged up to 5.0 per cent in December 2014. Core CPI inflation dropped fur-ther to 5.2 per cent in December 2014 from 5.8 per cent in November 2014. This is the lowest core inflation re-corded since the beginning of the new CPI series.

inflation continued to remain in the red for the second consecutive month as it slipped further to -3.7 per cent in November 2014 from -1.4 per cent in the previous month. Amongst non-food articles, inflation in minerals was the main driving force behind the moderation.

Fuel inflation too contracted sharply by 4.9 per cent in November 2014, as compared to 0.4 per cent in the previous month. Fuel prices came off sharply tracking a fall in global Brent crude prices, which is now trading at a two-year low. Inflation in petrol declined further to 10.0 per cent from -7.0 per cent in October 2014. In an

Inflation Remains on Track

Page 21: Economy Matters - Nov-Dec 2014

19

DOMESTIC TRENDS

NOVEMBER-DECEMBER 2014

interesting development, in October 2014, government de-regulated the price of diesel and announced a new price for domestically-produced natural gas. The price of diesel, like petrol, would now stand linked to the mar-ket without any government intervention, with retail rates reflecting price changes in the global market. The immediate impact on diesel will be a reduction in prices by Rs 3.37 a litre.

Manufacturing inflation eased further to 2.0 per cent in

November 2014 as compared to 2.4 per cent in the pre-vious month. Encouragingly, non-food manufacturing or core inflation, which is widely regarded as the proxy for demand-side pressures in the economy, continued its downward trajectory as it moderated to 2.2 per cent during the month as compared to 2.5 per cent in Octo-ber 2014. In the coming months, we expect core WPI to hover around 3.0-3.5 per cent, RBI’s comfort level for this inflation measure. Manufacturing food inflation too decelerated during the month.

Outlook CII welcomes the steep fall in headline inflation, which has dropped to zero per cent in November 2014 owing to a broad-based decline in all sub-indices, which is significantly better than market expectations. What is also note-worthy is that both food and fuel prices entered the negative terrain during the month. This data comes close on the heels of a drop in retail inflation to a low of 4.38 per cent in November, thereby reaffirming the moderation of the inflation print which in turn would have a beneficial impact on inflationary expectations. Going forward, the continuing slowdown in global commodity prices as well as the government’s resolve to rein in the fiscal deficit would prevent prices from moving upwards. This should induce the RBI to rethink its cautious monetary stance and urgently move towards a growth propelling monetary policy. The RBI should not wait till the next monetary policy announcement and reduce interest rate substantially, as industrial production is in the red and investment and consumption demand are yet to show visible signs of a pick-up.

Page 22: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 20

DOMESTIC TRENDS

The Balance of Payments (BoP) data released for sec-ond quarter of the current fiscal (2QFY15 henceforth) showed some weakening of the external sector funda-mentals. India’s current account deficit (CAD) increased to US$10.1 billion (2.1 per cent of GDP) in 2QFY15 from US$7.8 billion (1.7 per cent of GDP) in the preceding quarter and US$5.2 billion (1.2 per cent of GDP) in Q2 of 2013-14. The increase in CAD was primarily on account of higher trade deficit contributed by both a deceleration in export growth and increase in imports. On BoP basis, merchandise export growth decelerated to 4.9 per cent

The optimism surrounding India and the benign global financial market condition helped garner significant amount of capital flows into the economy. India re-ceived foreign investment of US$17.8 billion in 2QFY15 as against US$1.5 billion in same quarter last year, of which portfolio inflows were US$9.8 billion and FDI in-

in 2QFY15 from 11.9 per cent in 2QFY14. On BoP basis, merchandise imports increased by 8.1 per cent in the second quarter as against a decline of 4.8 per cent in Q2 of 2013-14, largely due to a sharp rise in gold imports. The recently announced removal of restrictions on gold imports led to the increase in the import bill during the quarter. In the invisibles component, services exports grew by 3.4 per cent, while transfers were relatively flat at 1.5 per cent growth. Meanwhile, net outflows on the primary income increased slightly to US$6.9 billion in 2QFY15 as against US$6.3 billion in the same quarter last year.

flows US$8.0 billion. The reliance on portfolio flows to fund the current account deficit has reduced consider-ably. Benign CAD and strong capital inflows resulted in net accretion of US$6.9 billion to India’s foreign ex-change reserves during 2QFY15, as against a drawdown of US$10.4 billion in 2QFY14.

Current Account Deficit Increases in 2QFY15

Page 23: Economy Matters - Nov-Dec 2014

21

DOMESTIC TRENDS

NOVEMBER-DECEMBER 2014

Other Important Developments During the Month

• Government passes ordinance to ease land acquisition: The Union Cabinet, chaired by the Prime Minister Shri Narendra Modi, approved certain amendments in the Right to Fair Compensation and Transparency in Land Ac-quisition, Rehabilitation and Resettlement Act, 2013 by introducing an ordinance on December 29th, 2014. The Act came into effect from 01.01.2014 but it has been reported that many difficulties were being faced in its im-plementation. In order to remove them, certain amendments have been made in the Act to further strengthen the provisions to protect the interests of the ‘affected families’. In addition, procedural difficulties in the acqui-sition of lands required for important national projects required to be mitigated. States, Ministries and stake-holders had been reporting many difficulties in the implementation of this Act. Several suggestions came up in interactions with State Revenue Ministers and key implementing Ministries. Proposed amendments meet the twin objectives of farmer welfare; along with expeditiously meeting the strategic and developmental needs of the country.

The existing Act vide Section 105 (read with Schedule IV) has kept 13 most frequently used Acts for Land Acqui-sition for the Central Government Projects out of the purview. These acts are applicable for national highways, metro rail, atomic energy projects, electricity related other projects etc. Thus a large percentage of famers and affected families were denied the compensation and R&R measures prescribed under the Act. The present amendments bring all those exempted 13 Acts under the purview of this Act for the purpose of compensation as well as rehabilitation and resettlement. Therefore, the amendment benefits the farmers and the affected families.

The second important aspect of the amendment is to make developmental and security related works much faster without compromising on the benefits/compensation to be given to the farmers. In the process of pro-longed procedure for land acquisition, neither the farmer is able to get benefit nor is the project completed in time for the benefit of society at large. Therefore the present changes allow a fast track process for defence and defence production, rural infrastructure including electrification, housing for poor including affordable housing, industrial corridors and infrastructure projects including projects taken up under Public Private Part-nership mode where ownership of the land continues to be vested with the government. These projects are essential for bringing in better economic opportunities for the people living in these areas and would also help in improving quality of life.

CII Reaction: CII has always advocated the need for a simple and transparent Land acquisition framework, which is also commercially affordable for industry. CII whole heartedly welcomes the fact that the government has incorporated our suggestion to exempt projects in certain important sectors like defence, rural electrifica-tion, rural housing and industrial corridors from the mandatory 80 per cent consent from affected families. Further, exemption of these projects from social impact assessment is also a welcome and crucial initiative. Industry has also suggested that PPP projects should be exempted from mandatory consent requirement as the land ownership in such cases rests with the Government.

• Economy to grow by 5.5 per cent in FY14 according to the Mid-Year Economic Review: Economy is expected to grow by 5.5 per cent in the current fiscal as compared to 4.7 per cent recorded in the previous year on the back of improving macro-economic situation as per the Finance Ministry’s Mid-Year economic review 2014-15 document which was tabled in the Parliament on December 19, 2014. This in agreement with our forecast of growth in the range of 5.5-6.0 per cent during the current year. Encouragingly, in the medium-term, the review, expects the trend rate of growth of about 7-8 per cent. CII is buoyed by the fact that the review makes a men-tion of introducing of GST at the earliest, which in our view will prop up the GDP by 1.5-2.0 percentage points and help in achieving the medium-term growth projection.

Page 24: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 22

DOMESTIC TRENDS

The improvement in growth and the consequent turnaround in investor sentiment have been spurred by slew of critical policy decisions taken by the incumbent government after being voted to power with a resounding mandate in July this year. However, the review document duly points out that the risks have not abated fully. Investment is yet to pick up significantly, revenue collections remain subdued, and external environment re-mains volatile. Notably, the review also reiterates CII stand that current interest rate stance, if continued, is tight compared to the recent history and is hurting growth prospects. There are ample reasons to believe that the current downward momentum in inflation is likely to sustain in view of the sharp moderation in commodity prices, depressed demand conditions, deceleration in rural wage growth etc. Consequently, it is the opportune time for RBI to reverse its monetary policy stance earlier-than-expected.

Highlighting the threat from fiscal excesses, the review mentions the challenges especially related to weak rev-enue growth, which will increase difficulties of achieving the fiscal deficit target of 4.1 per cent of GDP for the year. However, we are happy to note that the despite the difficult odds, government remains committed to meeting the fiscal deficit targets for the year. On the external front, for the year as a whole, review expects cur-rent account deficit to remain close to 2 per cent of GDP. In sum, in order to revive demand, the review states that it is critical that the pace of new investment is speeded up various sectors of the economy, especially in infrastructure. We are hopeful that stalled projects measuring Rs 18 lakh crore (about 13 per cent of GDP) will rapidly start receiving clearances with the active intervention of the Project Monitoring Group under the proac-tive leadership of the Prime Minister. Additionally, impetus should also be given to reviving public investments as a complement to private investment, going forward.

• Constitutional Amendment Bill for GST introduced in Lok Sabha: The Union Cabinet approved on 17th De-cember, 2014 the proposal for introduction of a Bill in the Parliament for amending the Constitution of India to facilitate the introduction of Goods and Services Tax (GST) in the country. The Union Finance Minister Shri Arun Jaitley introduced the said Bill in the Lok Sabha on December 19, 2014. The proposed amendments in the Constitution will confer powers both to the Parliament and State legislatures to make laws for levying GST on the supply of goods and services in the same transaction. GST will simplify and harmonise the indirect tax regime in the country. GST will broaden the tax base, and result in better tax compliance due to a robust IT infrastructure. Due to the seamless transfer of input tax credit from one state to another in the chain of value addition, there is an in-built mechanism in the design of GST that would incentivize tax compliance by traders. It is thus, expected that introduction of GST will foster a common and seamless Indian market and contribute significantly to the growth of the economy.

• Over 50 per cent Farmers in Debt: As per NSSO report titled, Situation Assessment Survey of Agricultural Households in India based on a countrywide survey of nearly 35,000 households by NSSO (70th round) for which data was collected on the agricultural year spanning July 2012 to June 2013, showed that nearly 52 per cent of agricultural households in India are indebted and levels of debt are as high as 93 per cent in Andhra Pradesh and 89 per cent in Telangana. On sources of credit, the survey revealed high levels of dependence on non-institutional channels. Nearly 40 percent of all loans came from informal sources with 26 per cent ad-vanced by moneylenders.

Further, the survey showed that rural India had an estimated 90.2 million agricultural households— about 57.8 per cent of the total estimated rural households in the country. An agricultural household was defined in the survey as a household receiving value of produce of more than Rs.3,000 from agriculture with at least one member self-employed in farming. Average monthly income per agricultural household during the agricultural year July 2012- June 2013 was estimated at Rs.6,426. Net receipt from farm business (cultivation and farming of animals) accounted for 60 per cent of the average monthly income per agricultural household, the survey

Page 25: Economy Matters - Nov-Dec 2014

23

DOMESTIC TRENDS

NOVEMBER-DECEMBER 2014

noted. Income from wages and salary accounted for nearly 32 per cent of the average monthly income. About 44 per cent of the estimated agricultural households in the country had an employment guarantee scheme or MGNREGA job card. However, only 38 per cent in the lowest land class (less than 0.01 ha) had job cards. “The reported lower rate of possession of MGNREGA job cards in lowest size class is noteworthy in the context of higher dependency of these households on wage/salaried employment,” the survey noted.

Worryingly, the survey revealed low levels of awareness among households of government procurement op-erations—at minimum support prices (MSP)—and even lower level of sale of these crops to procurement agencies. Except for sugarcane, less than half of the households, which were aware about MSP, sold off their crop to agencies. Most farm households were unaware of crop insurance schemes, the survey said. Addition-ally, farmers continued to remain far removed from new technologies and guidance from state run research institutes, the survey data shows. Over 59 per cent of the farm households received no assistance from either government or private extension services.

• Industrial Employment Declines in 2012-13 as per ASI: Data from the Annual Survey of Industries (ASI) for the year 2012-13, released on 29th December 2014, revealed that the number of employees in industrial activities actually declined by 3.5 per cent in 2012-13 to 12.8 million from 13.3 million in 2011-12. While employment de-clined, wages grew at a muted pace. Wages to workers grew at the rate of 11.1 per cent in 2012-13 compared to 16.6 per cent in the previous year. The survey, which comes with a lag of two years, showed profits of firms sur-veyed declined by 4.7 per cent to Rs 4.3 lakh crore from Rs 4.5 lakh crore in 2011-12. ASI is more comprehensive than the index of industrial production (IIP), as it encompasses small and medium industries as well, covering all units that employ at least 10 workers and use power or 20 workers but do not use power.

• RBI released its Financial Stability Report on December 29, 2014. The key highlights were as follows: (1) On the domestic front, macroeconomic risks have abated in recent months on the back of improvement in growth outlook and external sector conditions, fall in inflation and political stability. (2) However, growth in banking business and activity in primary capital markets remain subdued due to poor investor sentiment. (3) Stress tests suggest that the asset quality of banks may improve in the near future under expected positive develop-ments in the macroeconomic conditions. However, under unfavourable macroeconomic developments, the asset quality may worsen from current levels.

• Fiscal Deficit inches closer to 100 per cent of budgeted estimates: India’s gross fiscal deficit (GFD) reached 98.9 per cent of the annual budget estimates in November 2014. The deficit during April-November 2014 amounted to Rs 5.3 trillion. At the same time last year, the deficit had amounted to 93.9 per cent of the budgeted target for 2013-14. Government expenditure rose by 5.2 per cent to Rs 10.2 trillion during April-November 2014, as compared to its year-ago level. While, net tax revenue collections of the government rose by a mere 4.3 per cent to just about Rs 4 trillion during April-November 2014. The government did not make much progress on the disinvestment front by November 2014. Its disinvestment receipts amounted a meagre Rs.2.2 billion during April-November 2014, as against an annual target of Rs 634.3 billion..

• Government establishes NITI Aayog (National Institution for Transforming India) to replace Planning Com-mission: In accordance with a key announcement made by Prime Minister Narendra Modi on Independence Day, the Union Government on January 1, 2014 established NITI Aayog (National Institution for Transforming India), as replacement for the Planning Commission. Dr. Arvind Panagariya has been appointed as the Vice-Chairman of NITI Aayog. This comes after extensive consultation across the spectrum of stakeholders, includ-ing state governments, domain experts and relevant institutions. NITI Aayog will seek to provide a critical directional and strategic input into the development process.

Page 26: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 24

SECTOR IN FOCUS

Enabling ‘Make in India’ Through Effective Tax Reforms

India stands out as a country with immense potential and opportunity given the current global environ-ment. It is once again creating an interest and ex-

citement in the global arena as hopes build for its re-forms agenda to be carried forward. Industry expects tax reforms to be at a priority position in this agenda. Around the world, the discussions on tax policy have become centric to checking tax base erosion and en-hancing transparency in terms of exchange of informa-tion. India’s tax policy is no exception and is changing in response to the global developments. However, In-dia needs to strike the right balance between checking tax avoidance and making the tax environment more facilitative compared to other jurisdictions competing for investments. More than low rates of tax or tax in-centives, the investors look for a responsive tax admin-istration that provides certainty and consistency in tax treatment.

The Government has already embarked on the journey to deliver a litigation-free and a certain tax environ-ment. It has taken positive steps to correct some of the

policy and administrative decisions taken by the tax de-partment in the last couple of years which resulted in immense uncertainty and angst among the taxpayers. The Budget 2014 also announced measures to improve the existing disputes minimisation and resolution mech-anisms.

The focus now needs to be on an effective implementa-tion of these measures and building trust between the tax administrators and taxpayers. A facilitative tax en-vironment is crucial to creating a more positive image for India as an investment destination and to make the Prime Minister’s mission for ‘Make in India’ a success.

With the various action items on the OECD BEPS Action plan gathering momentum, it is also seen that the policy responses are varying across the globe. The Govern-ment should engage with the industry actively on all the BEPS Action items to develop a coordinated response. The risk of unilateral policy, legislative or enforcement response could compound the pre-existing backlog of tax litigation and further damage the investment cli-mate.

At present, the most awaited tax reform in India is the Goods and Services Tax. While the Centre and the States are still engaged in discussions on the design of the tax

Page 27: Economy Matters - Nov-Dec 2014

25

SECTOR IN FOCUS

NOVEMBER-DECEMBER 2014

system, the industry hopes for an early consensus for a comprehensive GST that will put the economy on the high growth trajectory.

In this article, we present excerpts from the recently re-leased report titled “Enabling ‘Make in India’ Through Effective Tax Reforms”. It was released by CII and Ernst & Young (E&Y) jointly in December 2014. It discusses the above mentioned issues in great detail.

(A). GST: How Can We Make “Good” Better?

The Goods and Services Tax (GST) is a significant step in indirect tax reforms, eagerly awaited by the industry. The initiatives being taken by the Centre to forge a con-sensus with the States on various issues surrounding the Constitutional amendment, required for implemen-tation of the GST, are commendable. The industry hopes that the discussions with the States will culminate into a good and progressive tax system for the country.

All the issues currently under debate, including the amendments to the Constitution, the design of GST, the GST rate and the rules for implementation of the GST are very significant and need a thorough debate and consideration before they are finalised and implement-ed. Without a good design and structure, the GST will not be the “positive sum game” for stakeholders as it was envisaged to be. Furthermore, it will not be able to achieve its fundamental objectives, such as simplifica-tion of the tax system, improvement in tax compliance, enhancement in industrial productivity and competi-tiveness and a 1.5–2.0 per cent increase in the economic growth of the country. To the contrary, a partial or a “compromised” GST will bring more pain for the indus-try and will not be in the best interests of the country. Let’s discuss some important issues coming under the realm of implementation of GST.

A1. Treatment of Petroleum and Alcohol under GST

The States continue to oppose the inclusion of petro-leum products (petroleum crude, high speed diesel, motor spirit, natural gas and aviation turbine fuel) and alcohol for human consumption in the GST purview.

The proposal to exempt any product is against the inter-ests of the industry and the economy. The suppliers of exempted goods and services are not eligible to claim a

credit for the tax on inputs. Non-recovery of input taxes results in substantial tax cascading, adding to the cost of production and distribution. Moreover, the burden of blocked input taxes falls entirely on domestic manu-facturers — foreign manufacturers acquire their inputs abroad, free from Indian taxes. The substantial burden of cascading taxes increases the cost of doing business, discourages investment in the sector, and creates a bias in favour of imports. This will be contrary to the basic objective of GST of minimizing tax cascading.

Petroleum Sector

The petroleum sector includes oil exploration and pro-duction, refining, transportation and pipelines, distribu-tion and marketing. At all these stages, substantial in-puts of goods and services are acquired, for instance, survey and exploration of mineral oil or gas service, cargo handling service, transportation of goods by road service etc. All such inputs will be taxable under the GST, but the tax paid would be non-recoverable if the petroleum products are excluded from GST. According to estimates, the quantum of blocked input credit for the petroleum sector could be as high as INR 300 billion per annum, depending on the quantum of investment in the sector in a given year. Keeping the petroleum sector out of the GST regime is likely to raise many con-sequential issues for the industry and the government. New layers of complexities will also arise, followed by increased litigation, relating to apportionment of cred-its for inputs used in common for taxable and excluded items.

Differential treatment of petroleum and other prod-ucts may render the IGST model for taxation of inter-state sales unworkable or inordinately complex in this sector. The taxation of inter-state supplies of services provided to the excluded sector would also involve sig-nificant complexities to determine the place of supply. For instance, services such as advertising acquired by petroleum companies have no unique place of supply or consumption. It will be a challenge to decide which State would collect tax on them.

The decision to exclude the petroleum sector from GST is apparently based on the concern that its inclusion will lead to revenue losses for States. The revenue objec-tive of the States, however, could be readily achieved through a supplementary excise or sales tax on petro-leum products, as is the practice in many international

Page 28: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 26

SECTOR IN FOCUS

jurisdictions. Even now, with the exception of a few States such as Assam and Tamil Nadu, almost all States levy VAT on petroleum. The VAT applied by these States is at an increased rate, which is akin to a supplementary rate over and above the standard rate.

Therefore, the fear of the States about revenue loss is really unfounded. The revenue would be determined by the level of tax rates and not by the structure of the GST. The supplementary tax can be levied by the Cen-tre as well as the States and allow them full flexibility to raise additional revenues from petroleum products, while freeing up the petroleum sector from the distort-ing effects of tax cascading through denial of credits for the GST on products and distribution inputs of the sec-tor.

Alcohol

Like any other industry the alcohol industry, if excluded from GST, will face similar challenges and problems as mentioned above.

Under the current Constitution, the power to levy ex-cise on alcohol is exclusively with the States. Cenvat does not apply to the production/manufacture of alco-hol. Therefore, no credit is allowed for the Cenvat and the Service Tax paid on inputs used in the production and distribution of alcohol. At the State level, the alco-hol industry is subject to sales tax or VAT (as well as ex-cise and other levies), but generally no credit is given for taxes paid by the industry on its inputs. Therefore, there is significant amount of tax cascading resulting in increased costs for the industry. The alcohol sector faces additional complexities due to the significant di-versity and variation in the taxes across States.

The exclusion of alcohol from GST will perpetuate these complexities, and pose serious collateral problems for other allied sectors too. The hotels, restaurants and other outlets serving alcohol, which sell both GST and non-GST items will be the worst affected in terms of administrative complexities. Administrative issues will also arise for both the industry and the government in terms of assessment and compliance, which will add to the compliance costs and disputes.

On the other hand, the inclusion of alcohol sector in the ambit of GST is likely to give more revenues to State governments as they will continue to have the power to levy supplementary excises and other levies over and

above the GST on alcohol. The jurisdictional control of the States over this sector will not be undermined in any way.

If GST applies to alcohol, it will significantly reduce tax evasion and give more revenues to States due to im-proved enforcement and compliance. Since the Centre will also be involved in the administration of GST there will be an opportunity for the States to have an auto-matic mechanism to cross-verify the sales declared for the GST with those declared for the income tax. The improved intelligence and monitoring under the GST would minimize any leakages and positively impact gov-ernment revenues. Seamless coordination between Cen-tre and State administrations will provide audit trail and plug revenue leakages.

States continue to have concerns about the loss of fiscal autonomy if alcohol were included in the GST. Under the current Constitution, the States have exclusive powers to legislate in respect of matters relating to the “pro-duction, manufacture, possession, transport, purchase and sale of intoxicating liquors”. They also have the ex-clusive power to levy excise duties on the manufacture/production of alcoholic liquors for human consumption and countervailing duties at the same or reduced rates on similar goods manufactured or produced elsewhere in India.

If alcohol is included under GST, the States will retain the exclusive power to levy excise duties. Therefore, to pro-tect their revenues, the States could levy supplementary excises and other levies over and above the GST on the alcohol products. This is also the practice in most inter-national jurisdictions where the alcohol industry is cov-ered under the GST at par with other sectors and sup-plementary duties are imposed to raise revenues or to discourage consumption of alcohol.

Revenue Neutral Rate (RNR)

An ideal GST should have a single GST rate, kept at a rea-sonable level to make it socially and politically accept-able, minimise classification disputes and to facilitate voluntary compliance. However, if at all the government has to apply tax at two rates, the following guidelines should be kept in mind:

n Goods of the same nature (e.g., all food items) should be kept in the same rate basket to avoid clas-sification disputes.

Page 29: Economy Matters - Nov-Dec 2014

27

SECTOR IN FOCUS

NOVEMBER-DECEMBER 2014

n Competing goods should also be kept in the same rate basket to avoid any classification disputes.

n Essential goods should attract the lower of the two rates.

n All goods sold by a general store should attract the same rate so that traders, particularly small traders, are not burdened with the compliance complexi-ties.

n Services should attract the lower of the two rates.

GST Council

The role of the GST Council for a dual GST, as proposed to be introduced, cannot be over-emphasised. It will be a forum where the Centre and the States can discuss and jointly decide upon critical parameters such as GST rates, exemptions, thresholds and other key param-eters such as the place of supply rules. A forum of this nature will be fundamental to achieving harmonisation, essential for GST implementation.

The role of the GST Council has been contentious and the Centre and the States have had divergent views on the issue of the degree of harmonization and the States’ fiscal autonomy. The States have expressed concerns about the supremacy of the Council over the legislature, if its decisions were to be binding on the States. Therefore, according to the Constitution (A) Bill, the Council’s powers have been made only recommen-datory though they will be guided by the need for a har-monised structure of GST.

While it is expected that the GST Council’s recommen-dations will be respected and abided by the Centre and the States, for structural features of the GST such as the determination of place of supply, the recommendations of the Council should be binding on all States. This will be essential to ensure that there is no double taxation of any supply of goods or services or cascading impact of any taxes.

A2. Place of Supply Rules

Determination of the place of supply will be fundamen-tal to determining the State where tax is to be paid and therefore, deciding on the application of SGST or IGST. We understand that the Government of India has al-ready prepared the Draft Place of Supply Rules. Before finalising the Rules, the industry must be provided an

opportunity to work closely with the government in fur-ther developing these Rules after considering the intri-cacies of the businesses.

The rules should not be simply an adaptation of those that apply at the Centre level. Under the rules pre-scribed by the Centre, place of supply or point of taxa-tion is generally defined to be the place where the re-cipient or customer is located. Where the place of buyer and seller is the same, SGST could apply. Where the buyer and the seller are located at different places, IGST would apply. The main difficulty with these rules is that while at the national level the place of buyer/supplier is readily identifiable, this will not be the case at the State or sub-national level. Many suppliers have a pan-India presence and operate from many States. Similarly, many recipients/customers have a pan-India presence.

In such cases, neither the place of supplier nor the place of buyer is unique. Ad-hoc or arbitrary rules are needed in such cases to define their location, which in turn im-pacts whether they are subject to SGST or IGST and if it is SGST, in which state it would apply.

The following aspects must be considered while finalis-ing the Place of Supply Rules:

n The Rules should follow the consumption–destina-tion principle, i.e., the supply of goods or services should be taxed in the State where it is consumed.

n The destination must be unique among the States. Place of supply should not impact in any way input tax credit entitlement of the supplier or the recipi-ent.

n As far as possible, the rules should apply uniform-ly to goods and services. Where they differ, clear guidelines must be provided for treatment of com-posite supplies consisting of both goods and ser-vices.

n Where the State tax rates differ, the Rules should minimise any incentives to divert supplies to low rate jurisdictions.

n Matters relating to the place of supply may be con-sidered by the GST Council. However, as observed in the previous section, the Constitution (A) Bill re-quires the Council’s powers to be only recommen-datory.

Page 30: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 28

SECTOR IN FOCUS

(B). Global Tax Trends: How is India Responding?

B1. Tax Base Erosion

BEPS: OECD/G20 Project: Overview and Cur-rent Status

The 2008 financial crisis had put Government budgets under strain and MNEs were criticised for failing to pay their “fair share of tax”. In June 2012, the G20 released a statement calling for “the need to prevent base ero-sion and profit shifting (BEPS)”. The OECD responded to this call by releasing an initial report on BEPS in Feb-ruary 2013. The initial report contained studies and data available regarding perceived magnitude of BEPS and provided an overview of global developments, which affected corporate tax matters. The report primarily echoed the view that BEPS concerns were aggravated because current international tax standards failed to keep pace with changes in global practices, particularly

in the area of intangibles and the development of e-Commerce/digital economy.

The initial report was followed up by a comprehensive 15 Action Plan report released in July 2013. The Action Plan report recommended consensus-based changes needed to address risk of double non-taxation or cases of no or low taxation arising primarily due to artificial separation of activities from the jurisdiction in which the value was created.

Three Pillars of BEPS

13 out of 15 actions are classified under three pillars viz. coherence, substance and transparency. Action Plan 1 (Digital Economy) is an industry-specific report likely to be affected by other actions, while Action Plan 15 fo-cuses on swiftly implementing the results of the Action Plan by way of a multilateral instrument. The following table provides a broad overview of various action plans, which form part of the 3 pillars:

Action plans under the ”coherence” pillar aim to ensure that there is consistency and fairness in tax treatment across jurisdictions to check cases of double non-tax-ation arising from differing or preferential tax treat-ments under domestic laws of various countries or due to differing treaty rules.

Action plans under the ”substance” pillar aim to en-sure that income is offered for taxation in the jurisdic-tion in which value creation functions take place. These emphasize transfer pricing apart from checking treaty abuse (including treaty shopping). Action plans coming under the “transparency” pillar encourage exchange of information and aim to provide certainty and predict-ability to taxpayers through a dispute-resolution mech-anism.

Actions So Far

The OECD has differing time lines stretched over 2014 and 2015 under each of the above Action Plans. The re-sults of these actions are expected to provide countries the tools they need to ensure that profits are taxed where economic activities generating profits are per-formed and where value is created. With respect to 7 out of 15 actions, the reports (aggregating to more than 700 pages) came to be made public in mid-September 2014. Among them are key recommendations for CbCR and a proposal for a new multilateral instrument de-signed to provide an innovative approach to achieve automatic amendment to treaties across the globe to ensure that recommendations emerging from different action plans are implemented swiftly.

Page 31: Economy Matters - Nov-Dec 2014

29

SECTOR IN FOCUS

NOVEMBER-DECEMBER 2014

B2. India’s Response to BEPS

In response to the BEPS questionnaire dated 8 August 2014 issued by the UN, India has also highlighted that like any other developing economy, BEPS is a concern for India in view of the fact that Indian economy is also reliant on corporate tax from MNEs. India has identi-fied certain major BEPS challenges such as — excessive payments towards finance and service charges to over-seas affiliates; inappropriate (mispricing) of business functions actually conducted in India; ability of a digi-tal economy player to have significant virtual presence without paying any source country tax; ability of MNEs to artificially avoid PE trigger and engage in treaty shop-ping. As part of its response, India highlighted signifi-cance of effective EOI among jurisdictions.

While India continues to express strong commitment on the BEPS initiative, the response states that India strongly believes that BEPS issues must be addressed in a manner that result in breaking down all such struc-tures or practices that promote or protect base erosion and profit shifting. For example, if the problem is a leak-ing bucket then steps must be taken to swiftly plug that leak or replace the bucket instead of debating how to calibrate the speed of inflow of water into the leaking bucket.

B3. Global Trends

While OECD actions are likely to be finalised by end of 2015, significant unilateral actions are seen in various countries, which touch upon many of the aspects iden-tified in BEPS action plans. To illustrate:

• Many countries have strengthened SAARs to deal with targeted/ identified anti-avoidance measures apart from introducing GAAR (e.g. Finland, France and Norway).

• Certain countries have taken positions to tax inter-net activities even in the absence of a fixed place of business (such as, Taiwan and Vietnam) — [e.g., proposed introduction of a special tax in the UK to primarily target technology companies having eco-nomic activity in the UK].

• With a view to counter hybrid mismatch, significant action has been seen in the form of comprehensive anti-hybrid rules (in the UK, Denmark and South Af-rica), taxing dividends where they are deducted by the payer (in Germany, Hungary and Poland), limit-ing the deductibility of an expense where the recipi-ent is subject to no or low tax (in Austria, France, Mexico).

• A few countries currently have disclosure rules tar-geted at aggressive tax planning (e.g., the UK, Can-ada, Ireland, Israel, South Africa and the US). The scope of these rules is defined either by reference to features of the transaction (in Ireland, South Af-rica, Israel) or by the commercial arrangement with the advisor/promoter (in Canada) or by both (in the UK, the US).

B4. India Trends

Globally, India was one of the early proponents of BEPS concerns. The following legislative provisions or ap-proach illustrate this:

• Though no specific domestic tax provisions con-cerning digital economy are present, definition of royalty/fees for technical services under the domes-tic law is perceived to be wide enough to capture many technology/digital economy transactions. As part of its response to BEPS Action Plan on Digital Economy, India has reiterated that, in the e-com-merce era, the current PE concept based on physi-cal presence may lead to serious disequilibrium in sharing of tax between country of source and coun-try of residence.

• India’s tax treaties are characterised by a reduced threshold for PE definition, inclusion of a provision on service PE, etc.

• While Indian tax authorities do, in general, follow the OECD TP Guidelines, the following aspects con-cerning TP may merit attention:

1. Definition of the term “intangible property” for TP purposes is wide enough to include human capital-related IP such as trained and organized workforce and employment agree-ments.

Page 32: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 30

SECTOR IN FOCUS

2. The Indian TP administration does not agree with the position that risk can be controlled re-motely by the parent company and that Indian entities engaged in core functions, such as car-rying out R&D activities or providing services can be risk mitigated entities.

3. According to India, apart from location sav-ings, profit from location-specific advantages (referred to as “location rent”) such as skilled manpower, access to market, large customer base, superior information and distribution network should also be allocated between as-sociated enterprises.

B5. What India Needs to do/Conclud-ing Thoughts?

The importance of equity, certainty and fairness are es-sential attributes for an effective and efficient tax sys-tem and they should be given due consideration in the making, administration and enforcement of tax laws. Unfortunately though, in recent years, a perception has been formed that India is not a very friendly place to do business. What startled people the most was retrospec-tive amendment in 2012 to virtually negate SC judge-ment in the Vodafone case. There is an urgent need to change this image and the current Government appears to be committed to act towards this to usher in nonad-versarial tax regime.

India has set up a Tax Administration Reform Commis-sion (TARC) comprising senior government officials and private sector tax professionals under the chairmanship

of Dr. Parthasarathi Shome, with an objective of bring-ing in credibility among tax payers and streamlining in-come tax procedures. The first report of the TARC that was made available to the public in June 2014 expresses an overwhelming need for fundamental reform in tax administration and contains various recommendations to achieve desired tax reforms. The report contains re-freshingly significant recommendations for a “compre-hensive” transformation of tax administration founded on accountability and recognition of the taxpayer as a “customer”. The recently released guidelines direct field officers to implement a series of taxpayer-friendly measures. These guidelines consolidate some earlier in-structions and are aimed to boost efforts in achieving the objective of furthering a nonadversarial and cus-tomer-friendly tax regime.

Moreover, in terms of TP assessment, Indian audits are perceived to be aggressive and have made various ad-justments, which were seen to be inconsistent with the basic tenets of taxation. Introduction of APA and prag-matic response to the applicants will go a long way in controlling proliferation of tax litigation in the field of TP.

While there may be no objection to plugging the weak-ness created by e-commerce trading and while tax eva-sion and artifice can be dealt with sternly, discretion should be exercised in so implementing the law that there is no disincentive to invest in India. The growth of business brings many other economic advantages to the country. It becomes important to sustain the cli-mate of confidence, clean environment and equitable approach in matters of tax administration.

Page 33: Economy Matters - Nov-Dec 2014

31

FOCUS OF THE MONTH

Indian Economy – Recent Trends and Challenges

NOVEMBER-DECEMBER 2014

In July 2013, India was teetering on the edge of mac-roeconomic crisis with double digit inflation, a high and rising current account deficit (CAD), and a falling

rupee as investor sentiment turned sour in the after-math of the Fed’s taper decision to signal the end of its quantitative easing. Nearly 18 months on, the landscape has vastly changed. Macro-economic stability has re-turned, reforms are being undertaken, the external en-vironment has moved in India’s favour, and above all, a new Government has come into power with a relatively unencumbered political mandate for decisive economic change, a mandate that markets have enthusiastically embraced. Although it is still too early to detect signs of robust recovery, emerging trends indicate that the growth deceleration has bottomed out, manifested in

the relative improvement in growth in the latest 2 quar-ters. However, risks still remain on the horizon. Invest-ment is yet to pick up significantly. But on the upside, inflation has come down dramatically, the monsoons failed to extract as much of a toll on growth as ex-pected, and India received a large supply side shock in the form of reduced commodity prices that amounted to about 1.5 per cent of GDP. According to the govern-ment estimates, 2014-15 could end with growth around 5.5 per cent. Looking ahead, 2015-16 would hold host of promises and challenges for the economy. Support from favourable external environment will be crucial in this regard.

In this month’s Focus of the Month, we look at the year gone by and list out the challenges which await us in 2015. In this regard, we cover the recent trends emanat-ing out of investment and fiscal data, important events which shaped up 2014 and what the industry is expect-ing from the forthcoming Union Budget 2015-16

Page 34: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 32

FOCUS OF THE MONTH

The industry would be keenly looking at the Un-ion Budget 2015-16 with hope that the govern-ment would do the needful to delineate a new

economic vision for the country. There are mounting expectations that the Budget would chart out a bold reforms plan which would take the economy to the tra-jectory of 7-8 per cent growth in the near future. Recent actions and bold measures by the finance minister has lent credence to this expectation.

In the prevailing scenario, maintaining fiscal prudence is crucial to rejuvenating growth drivers. Reviving in-vestment demand, which is a major growth propel-ler, should be among the top priorities of the Budget. Gross fixed capital formation in the private sector as a percent of GDP has been decelerating from almost 25 per cent in 2007-08 to around 23 per cent in 2012-13. CII recommends that projects are awarded to the private sector after securing the key sovereign clearances for PPPs with proper interventions to ease norms in land, labour and environment. As many approvals derive from states, a coordinated approach of both centre and states is essential. It is necessary to clear the backlog of projects for new investment plans to fructify.

Significant investments for building new capacities can come from cash rich public sector companies. Their role becomes important especially at a time of subdued private sector investment. The public sector could con-template funding the initial construction cost for cre-

ating infrastructure assets, and once the projects are completed and start generating cash flows, these can be given out to the private sector for operation and maintenance on a revenue sharing basis. This would also help “crowd in” private investments.

There is need to rev up investments in the real estate sector. The real estate investment trusts (REITs) and InvIts have yet to take off because of unviable tax struc-ture. Dividend distribution tax exemption needs to be extended to REITs. Moreover, long term capital gains should be exempted for sponsors of REITs.

The government is putting a lot of emphasis on reviving the manufacturing sector. With its share of around 15 per cent to GDP, its contribution is extremely small com-pared to its potential. Countries like China, South Korea and Taiwan have done better in terms of manufacturing share of GDP. The renewed attention to manufactur-ing through the ‘Make in India’ initiative has been long overdue. CII is certain that this call to action would start yielding results, sooner than later.

The Budget would be closely watched for its taxa-tion measures. The introduction of the Constitutional Amendment Bill on GST in the Lok Sabha marks the process of ushering in the most crucial tax reform in the country. GST would spur manufacturing activity by creating a seamless market and eliminating tax cascad-ing. Industry is delighted to learn that GST would be introduced by April 2016.

Industry Will Keenly Look at the Budget for Re-vival and Growth

Page 35: Economy Matters - Nov-Dec 2014

33

FOCUS OF THE MONTH

NOVEMBER-DECEMBER 2014

Similarly, issues such as restricting MAT to 10 per cent, providing MAT and DDT relief to units and developers of SEZs; making investment allowance eligible for deduc-tion while calculating MAT are other fiscal measures to boost manufacturing.

A large part of investor sentiments are determined by the ease of doing business. The World Bank ranks us at 142 out of 189 countries. Keeping taxation simple, con-

sistent and predictable as well as reducing the scope of tax litigation deserve priority consideration of the gov-ernment for attracting investment. We also hope that GAAR would be deferred by another two years to refur-bish the business climate.

The Union Budget 2015-16 is riding on the crest of huge expectations.

This article appeared in Financial Express dated 31st December 2014. The online version can be accessed from the follow-ing link: http://www.financialexpress.com/article/companies/industry-will-keenly-look-at-the-budget-for-revival-and-growth/24950/

Page 36: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 34

FOCUS OF THE MONTH

Amidst an unpredictable global environment, opportunities to enact critical reforms have emerged even though challenges persist. In

India, recent policy measures and the strategic direc-tion defined by the new government, especially its am-bitious ‘Make in India’ campaign, hold the promise of revitalizing growth in the medium and long-term. The post-election recovery of confidence in India also pro-vides an opportunity to embark on much-needed struc-tural reforms. At a time when various indicators are be-ing keenly securitized to trace some signs of economic recovery, positive news comes from the figures on new investment proposals for the second quarter (2QFY15). New investment proposals peaked to a record high fig-ure of Rs 257 thousand crores during the second quarter of 2013-14, the highest in last thirteen quarters, growing by an astonishing 129 per cent as compared to the sec-ond quarter previous year. This brought a much needed respite from measly proposals worth Rs 86 thousand crores in the first quarter this year, when they had con-tracted by as much as 51 per cent on a year-on-year ba-

sis. This corroborates the findings of the recent World Economic Outlook update, which projected a pickup in investment accounting for a rise in growth in India to 5.6 per cent in 2014 and further to 6.4 per cent in 2015.

Combined with positive signals emerging from other in-dicators such as improving export prospects, narrowing current account deficit, reduction in exchange rate vol-atility and downward trend in inflation, the jump in the value of new investment proposals in 2QFY15 lends sup-port to the beginning of improvement in business senti-ments. There is, however, a case for cautious optimism, as recovery remains fragile and lopsided. To strengthen the recovery momentum and spread its coverage to wider sectors, policy interventions – fiscal, monetary and others - would continue to play critical role for several quarters to come. Further, infrastructure bot-tlenecks in India are not just a medium-term worry but have been flagged as a constraint even on near-term growth by the World Bank in its October 2014 update.

CII Analysis

New Investment Proposals Witness Electrifying Growth

Page 37: Economy Matters - Nov-Dec 2014

35

FOCUS OF THE MONTH

NOVEMBER-DECEMBER 2014

The mammoth increase in the new investment propos-als in the 2QFY15 was brought about by a steep rise in in-vestment in the electricity sector, which accounted for 44 per cent of the total investment proposals for all in-dustries during the July-September quarter of 2014. The proposals nearly quadrupled compared to the sector average for past nine quarters and new investment pro-posals during the quarter in the electricity generation activity stood at Rs 112 thousand crores. Contribution by both private and government owners stood at the high-est level since 2012-13, with the government spending in the sector being as high as Rs 82 thousand crores.

While electricity was one of the two sectors which saw highest investment proposals since 2012-13, the other sector which too saw an increase in proposals was non-financial services sector, wherein the investment pro-posals stood at Rs 88 thousand crores in the 2QFY15. A breakdown of the constituents of this sector reveals that new investment proposals in hotels & tourism as well as wholesale & retail trading services have been buoyant this year. Fresh proposals in transport services saw a jump by three times over the average for past nine quarters, on the back of steep rise in proposals in road transport, shipping and logistics services, which compensated for dismal performances by railways and air transport. Tele-communication services witnessed a desirable high, rising by eight times over the aver-age since 2012-13 in 2QFY15. Growth of proposals in IT remained stagnant during the quarter. Proposals in storage & distribution services also rose steeply. Apart from transport services, remaining components failed to garner considerable support from the private own-ers. Similarly, the government too largely invested only in transport services in the non-financial service sector.

Manufacturing sector failed to reap in the buoyant at-mosphere. The investments, though higher than the previous quarter, stood only at Rs 39 thousand crores in 2QFY15 falling short of the average since first quarter of 2012-13. A component analysis reveals that fresh pro-posals in food & agro-based products and textiles re-

mained near stagnant in 2QFY15. Chemicals & chemical products saw a steep decline in investment proposals, driven by decline in the pharma, plastic and petroleum industries during the said quarter. Consumer goods saw a mild uptrend, rising by three times over the average since first quarter of 2012-13, on the back of domestic appliances and cosmetics industry. Construction ma-terials as well as metal & metal products industry also held back. Machinery, especially industrial machinery & engines, saw an increase in the investment proposals during the quarter.

The situation presented a huge conundrum because even though metals, chemicals, construction mate-rial, food products figured in the top ten avenues for investment by the private and government owners, the overall investment levels fell short of desirable lev-els. A possible reason was confusion and delays on the part of government. In view of the fact that growth in manufacturing production has remained muted for the last many years even as the sector is desired to grow in the range of 10-12 per cent per annum, there is need for strengthening of uptrend by way of introducing various policy measures such as softer monetary policy, fast tracking clearances of held up projects and encouraging new investments by central government, state govern-ment and, local bodies.

The construction & real estate sector sought invest-ment proposals to the tune of Rs 14 thousand crores in 2QFY15, which were driven by both the private and gov-ernment owners. The growth in this sector was a result of doubling of both housing construction and commer-cial complexes over their last nine quarter average since 2012-13. Among other sectors, irrigation sector saw a steep jump in investment proposals which stood at Rs 3 thousand crores, highest in the past nine quarters in 2QFY15. Investment proposals in the mining sector saw a contraction in 2QFY15 driven by huge contraction in crude oil & natural gas sector, even as it figured in the top ten avenues of private and government owners.

Page 38: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 36

FOCUS OF THE MONTH

Both the government and private sectors rallied to in-vest in the July-September quarter of 2014. The share of government ownership in total proposals stood at a staggering Rs 145 thousand crores outdoing the pri-vately owned investment proposal by a slight margin as the latter stood at Rs 111 thousand crores. While the central government proposals saw a steady growth to Rs 77 thousand crores, the contribution by state govern-ment, standing at Rs 68 thousand crores, was the high-est by the latter since 2012-13. Most of this investment was channeled into electricity sector, transport services and chemical products. The private sector went on an investing spree pledging proposals to the tune of Rs 105 thousand crores in 2QFY15, reversing the deceleration seen in the last fiscal year. Foreign private sectoral con-tribution too came back on track in the second quarter

after a decline in the first quarter of the current fiscal. Most of this investment was channeled into metals, chemicals, electricity and construction industries.

There is a conscious effort by the new government at the center to revive India’s capex cycle. Although the emphasis is more on faster implementation of large in-dustrial and infrastructure projects, there is also a push towards setting up of new capacities in various seg-ments like power, education, health services and tour-ism. Given the necessity of large investments to take the economy out of the current quagmire, new invest-ment by private sector will be equally critical for eco-nomic revival. It is here that concerted policy efforts are required to push the interest of private sector in making new investments, even as the government continues to accelerate its own investment pace.

Page 39: Economy Matters - Nov-Dec 2014

37

FOCUS OF THE MONTH

NOVEMBER-DECEMBER 2014

A state-wise analysis reveals that major investing states continue to perform poorly. The shares of Gujarat and Karnataka in new investment proposals moderated to a disappointing 7 per cent and 4 per cent respectively in 2QFY15, nearly half of their long- run averages. The investment proposals in Gujarat have been laying low for five quarters in a row now, while those in Karnataka has not seen a major stimulus for last nine quarters. Maharashtra witnessed a marginal rise in share during the current fiscal year as investment rose in the sec-ond quarter. Fresh proposals in Odisha and Rajasthan returned to steady levels after measly investment in previous quarter, though their average share fell due to poor performance in the first quarter. Tamil Nadu sought the highest investment proposals during the second quarter, worth Rs 37 thousand crores, doubling its average share during the year from its long-run aver-age. Further, this ended the bad streak that the state had been facing since 2012-13. The trend was similar for Telangana and Andhra Pradesh, which saw investment proposals to the tune of Rs 36 thousand crores and Rs

34 thousand crores respectively in the reporting quar-ter, each of them ending their dry spells since 2012-13 and securing double-digit shares this year. States like Jharkhand and Uttar Pradesh witnessed minor stimu-lus, while West Bengal witnessed a slump in new invest-ment proposals.

The trend since 2013-14 shows that states like Gujarat and Karnataka were the top choices for private inves-tors, however, they rank low in the government priori-ties. Odisha and Andhra Pradesh are other such exam-ples. While these four states garner a collective share of 52 per cent of total private investment, they comprise of only 19 per cent of total government proposals. Ma-harashtra remains the only exception sourcing invest-ment from both private and government owners. In general the channeling of funds by private owners was highly skewed with as much as 62 per cent of propos-als being invested in the above five states. The govern-ment-owned proposals were largely equitable, even as Tamil Nadu, Kerala and Telangana emerged as top desti-nations, apart from Maharashtra.

Page 40: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 38

FOCUS OF THE MONTH

Conclusion The post-election recovery of confidence in India along with the ambitious “Make in India” campaign has reso-nated with record high investment proposals during the second quarter of 2013-14. Most of the investment was proposed in the electricity sector followed by non-financial services. Manufacturing sector continued to hold back as the major investing states performed poorly. There is need for strengthening of uptrend by way of introducing various policy measures such as softer monetary policy and fast tracking clearances of held up projects. Infra-structure bottlenecks in India are not just a medium-term worry but have been flagged as a constraint even on near-term growth. Highly encouraging news came from the conscious efforts of government in reviving the Indian capex cycle as it trumped the private owners in proposing fresh investment plans. As India gears to enact crucial reforms in face of uncertainties in the global environment, concerted efforts by both government and private own-ers and pickup in investment in major states form the way forward.

Page 41: Economy Matters - Nov-Dec 2014

39

FOCUS OF THE MONTH

NOVEMBER-DECEMBER 2014

1. CPI inflation gets into mainstream

The single largest impact of the Urjit Patel Committee recommendations was the adoption of CPI inflation as the nominal anchor for monetary policy in January 2014. A key concomitant development was the announce-ment of ‘glide path targets’ of 8 per cent by January 2015 and 6 per cent by January 2016 along with the eventual target of 4 per cent (with a band of 2 per cent on either side). With this landmark move, WPI inflation lost its erstwhile supreme status and India finally aligns itself with other countries on the global inflation map.

2. The beginning of monetary policy normalization in the US

The Federal Reserve started its tapering exercise from January 2014 onwards with “measured” reduction in the pace of asset purchases and eventually concluded its tapering program in November 2014. This marked the beginning of the US monetary policy normalization process, which had acquired an ultra loose characteris-tic since early 2009. Since global financial markets went through a tumultuous bout of adjustment during the ‘taper tantrum’ episode, the impact of actual taper was relatively mute.

3. As US exits, Japan and Euro zone join the QE table

The year 2014 saw a divergence in central bank be-havior. While US kick started the process of monetary policy normalization, the Bank of Japan (BoJ) in sharp

contrast upped the ante on quantitative easing (QE) along with some incremental focus on qualitative eas-ing (involving equity linked instruments). Similarly, the European Central Bank (ECB) also displayed inclination towards incremental balance sheet expansion by initiat-ing purchases of covered bonds and asset backed se-curities (ABS). There is a growing expectation that the ECB will now follow suit by extending its purchases to government bonds in early 2015.

Meanwhile in emerging markets, the monetary policy remained mixed. While Brazil, Argentina, Russia, Tur-key, and India hiked rates during the course of 2014, China seems to be moving towards an easing bias. To be sure, growth-inflation divergence continued to influ-ence monetary policy behavior in a world characterized by multi-speed recovery.

4. Dollar strength

With divergence in monetary policy reaction functions, the US dollar rose like a Phoenix and is poised towards the first yearly double digit gains since 2005. The US dol-lar has recorded close to 13 per cent strength in 2014 so far, with the DXY Index breaching the 90 levels for the first time in a decade.

5. The long awaited return of political stability

While the NDA was expected to win the general elec-tions held during Apr-May 2014, the margin of victory was unanticipated with the BJP along with its pre-poll

Review of the Year 2014

Below is a brief snapshot of the important events (not necessarily in chronological order) that had shaped Indian economy/markets in 2014

Page 42: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 40

FOCUS OF THE MONTH

allies garnering 332 seats (out of 543); a majority not seen since Congress party’s win of 404 seats, almost three decades ago in 1984. Truly a defining moment in India’s political journey – in fact, ‘Elections 2014’ has be-come the top trending search on Google India in 2014 so far!

6. Government Policy: Strong intent; small steps

In the 7-months of its tenure, the new government has maintained a clear focus on administrative and govern-ance reforms. While the pace of reforms has belied ex-pectations of sweeping changes held by some sections of the economy, the decisions taken so far appear to be creating the groundwork for clearing supply bottle-necks. Incremental success on changing labour laws, deregulation of diesel prices, efficient management of the food economy, passage of Coal Mines Bill along with measures to improve the ease of doing business are tangible outcomes. These were accompanied by longer term agendas of ‘Make in India’, ‘Digital India’, and ‘Skill India’.

Despite strong intent, policy momentum met with few hurdles due to lack of NDA majority in Rajya Sabha. Dur-ing the Winter Session, while the Lok Sabha passed as many as 17 bills by working overtime, the Rajya Sabha managed to pass only 12 bills – as such the government decided to move forward through the ordinance route in some of the areas like insurance, land acquisition, etc.

7. RBI back to building reserves

With focus on the CPI based real effective exchange rate (REER), the RBI has been building reserves this year. Between Jan-Oct 2014, the Central Bank purchased US$24.7 billion in spot and US$42.8 billion through for-wards. The strategy of building reserves helped in con-taining INR volatility during the course of 2014 while at the same time improving RBI’s firepower to fight a con-tagion. As of last update, RBI’s holding of foreign cur-rency assets stood at US$295.7 billion, the highest level since July 2008.

8. The year when commodities went bust

The combination of growth concerns (especially in Chi-na and Euro zone) and strong dollar led to a capitulation in commodity prices with the CRB Index falling by close to 17 per cent in 2014 so far – this would be the steepest fall in the CRB Index since 2008. Bulk of the decline in commodities was led by oil prices which fell by a whop-ping 50 per cent in 2014 on the back of geopolitical dy-namics (unwillingness by OPEC to calibrate production) and supply glut (especially coming from US shale, Libya, etc.).

9. Ruble in rubble

Sliding oil price found its first high profile victim – the Ruble (RUB). To be sure, the currency was under pres-sure right from the beginning of 2014 when Ukraine re-lated geopolitical uncertainty resulted in close to 7 per cent depreciation in Q1 2014. The currency stabilized somewhat in Q2 with support from oil prices. However, with oil price falling by 50 per cent in H2 2014 so far, RUB depreciated by 73 per cent, with Brent falling be-low US$60 pb levels exacerbating the loss of confidence in RUB. However, prompt action by the Russian policy-makers in mid-December 2014 along with some stability in oil prices has provided some comfort to RUB off late. While there is no fire as of now, the smoke continues to linger – keep a firm watch on RUB in 2015!

10. The year of inflation decline

Last, but not the least, 2014 will be known as the year of inflation decline in India. The impact of past monetary tightening, ongoing gradual fiscal consolidation, admin-istrative steps to curtail food price pressures, correc-tion in commodity prices, and a broadly stable currency helped to lower inflationary pressures considerably. In 2014, average CPI inflation dropped to 7.4 per cent (a 7-year low) and average WPI inflation dropped to 4.3 per cent (a 5-year low). Moreover, both inflation met-rics are now running below their decadal averages of 8.0 per cent and 6.6 per cent respectively.

Page 43: Economy Matters - Nov-Dec 2014

41

FOCUS OF THE MONTH

NOVEMBER-DECEMBER 2014

With the change in the government at the Centre (in particular with a clear mandate), the year 2014-15 was expected to be a bet-

ter year for the macro economy with the improvements expected in most of the macroeconomic conditions such as growth, inflation, investments, and fiscal situ-ation. The new government in its Union Budget in July 2015 has reiterated its keenness in bringing back the economy to a recovery path by retaining the Budget deficit targets (while commenting that it is too tight a target) set in the vote on account Budget. According to the Budget, the fiscal deficit target is set at 4.1 per cent for the year 2014-15. This was expected to be achieved through a combination of higher revenues, lower ex-penditures (especially oil subsidy) as well as higher disinvestment proceeds. However, the main assump-tion behind these targets is the assumption of 13.4 per cent nominal GDP growth. With more than half of the year is gone and the information is available for atleast first half of the year, here an attempt has been made to understand the fiscal situation and at the same time comment on the risks that is associated in achieving the fiscal deficit targets for the whole year.

Central Government Finances in April-September, 2014-15

As per the FRBM rules notified in 2013, the fiscal deficit target is set at 4.1 per cent for 2014-15. Medium term fis-

cal policy (MTFP) statement of 2013-14 have further set targets of 3.6 per cent and 3.0 per cent to be attained by 2015-16 and 2016-17 respectively. According to MTFP, Gross tax revenue which is a part of revenue receipts is aimed at 10.6 per cent of GDP and outstanding liabili-ties as percent of GDP is aimed at 45.4 per cent to be achieved by 2014-15. As per the quarterly data provided by the Controller of General Accounts, the following fis-cal scenarios are observed in the expenditure and rev-enue side of the Central Government in the first half of 2014-15:

Expenditure

Total expenditure for the whole of 2014-15 was project-ed at 13.9 per cent of GDP. In the first half of financial year 2014-15, the total expenditure is around 48 per cent of the whole year budgeted expenditure. Compared to the same period in 2013-14, which was 48.58 per cent, the current year expenditure (as a ratio to GDP) is slight-ly lower. The same as percentage of GDP has also gone down to 29.45 per cent in 2014-15 (April-September) compared to 30.43 per cent in the same period in 2013-14. Such trends are also found in both revenue and capi-tal expenditure. However, in terms of growth, capital expenditure (in particular under plan expenditure) ap-pears to show slightly higher growth compared to rev-enue expenditure, which itself is a positive sign.

Fiscal Situation in India

Page 44: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 42

FOCUS OF THE MONTH

Receipts

On the receipts side, the trends in the first half of 2014-15 are very discouraging. As a percentage of GDP, the net tax revenues have declined by half a percentage point in 2014-15 compared to 2013-15. Such trend is re-flected in all the tax revenue indicators. However, non-tax revenues have seen slightly higher ratio largely due to transfer of higher government share in the RBI prof-its. But the receipts from disinvestment proceeds (non-debt capital receipts) show some disappointing trends with a decline from 0.27 per cent in 2013-14 to 0.18 per cent in 2014-15. With the new and stable government in the Centre, there was some optimism regarding gener-ating higher disinvestment proceeds, which is also indi-cated in the Budget. However, until now the trends in disinvestments indicate that the targets could fall short with a large margin. In our view, this would be the big-gest risk in achieving the overall fiscal deficit target of 4.1 per cent in the current year.

The recent trends in both expenditure and receipts from first quarter of 2012-13 to second quarter of 2014-15 are presented in the graph below. The trends clearly indicate that in the current year, both expenditures as well as receipts have seen a decline. However, the fis-cal deficit, which is the net of expenditure and receipts suggest that the drop in receipts (as a ratio to GDP) is sharper than the drop in expenditures and hence higher fiscal deficits compared to the budgeted figure. As not-ed in table-2, the fiscal deficit for the first half of 2014-15 has already covered 83 per cent of the annual target. The recent data for April-November period suggest that fiscal deficit has already reached 99 per cent of the full year budgeted figures. By this period the revenue defi-cit has reached 108.6 per cent of the full year target. Such trends make it a challenge for the government in containing the full year fiscal deficit at 4.1 per cent. This is more so when the nominal GDP is revised downwards from 13.4 per cent to 10. 6 per cent in the Mid-term re-view. What led these fiscal indicators off track in the current year despite having stable government? What needs to be addressed to attain the targets?

Page 45: Economy Matters - Nov-Dec 2014

43

FOCUS OF THE MONTH

NOVEMBER-DECEMBER 2014

Revenue Deficit vs Fiscal Deficit

In the first half of 2013-14, the fiscal situation was not very different compared to 2014-15, although the sever-ity is marginally higher in the current year. With some ef-fort on the expenditure, by squeezing the plan expendi-ture as well as the cut in expenditure on social sector, defence, and subsidy, the Government could achieve lower fiscal deficit of 4.6 per cent than the budgeted figure of 4.8 per cent. However, this time around the options appear to be limited and the large adjustment may have to be borne by the public capital expenditure. What could be the right strategy on the fiscal policy more so when the macro policy is aimed at reviving

growth? This is biggest policy dilemma at the moment. In our view, the decision needs to be based on the size of multipliers that each public expenditure generates. Our own study on fiscal multipliers suggests that public capital expenditure is twice that of revenue expendi-ture. In such a situation, maintaining fiscal deficit tar-gets through reduction in capital expenditure is growth-retarding. In other words, the right strategy would be to undertake an expenditure switching strategy by reduc-ing the revenue expenditure, if possible, through reduc-tion in wasteful subsidies (which is currently over 2 per cent of GDP) and create space for increasing the public capital expenditures. On the other hand, if it is political-ly infeasible to reduce the revenue expenditures, then

Page 46: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 44

FOCUS OF THE MONTH

the compromise needs to be on the fiscal deficit target rather than reducing the capital expenditure. In such situation, one may end up with slightly higher fiscal defi-cit at the same time maintain the capital expenditures that will help in crowding-in private investments, and, hence, enhance growth. In other words, in our view, the policy target should be more on the revenue deficit and less on fiscal deficit.

Going forward, in the rest of 2014-15, the outlook on the fiscal situation seems slightly better. Sharp fall in the international oil prices is expected to reduce the oil sub-sidy bill sharply. Although the revenues from oil com-

panies (both through tax and profits) might decline, the net impact would improve the fiscal situation. On the other hand, if the government takes up the disinvest-ment of PSUs as planned and if the spectrum sale takes place, then the non-tax revenues could get a boost and could narrow the fiscal deficit sharply. However, the fall in tax revenue could still be a concern and achieving a fiscal deficit target of 4.1 per cent of GDP more challeng-ing. While there are views to cut the public capital ex-penditure, which is largely non-committal compared to revenue expenditure, in our view retaining the capital expenditure target even at the cost of slightly higher fis-cal deficit than targeted could help in reviving growth.

(The views expressed here are personal)

Page 47: Economy Matters - Nov-Dec 2014

45

ECONOMY MONITOR

NOVEMBER-DECEMBER 2014

Page 48: Economy Matters - Nov-Dec 2014

ECONOMY MATTERS 46

ECONOMY MONITOR

Page 49: Economy Matters - Nov-Dec 2014

47

CORPORATE SECTOR INDICATORS

NOVEMBER-DECEMBER 2014

Page 50: Economy Matters - Nov-Dec 2014
Page 51: Economy Matters - Nov-Dec 2014
Page 52: Economy Matters - Nov-Dec 2014