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Chapter1
VolumeII
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Chapter 1Introduction
SectionA.AnalyticalreviewofrecentdevelopmentTheGoods&ServicesTax
ParadigmShifttoLowInflationWedgebetweenassetprice&realeconomyFarmLoanWavers- MacroEconomicImpact
Demonetization:LongTermBenefits&ShortTermCostSectionB.Outlook&policiesfor2017-18
SectionC:ReviewofDevelopmentin2016-17
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Outlook & Policies for 2017-18
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Outlook for Real Activity for 2017-18
Forsometimenow,Indiahasbeeninthethroesofwhat CarmenReinhartandKennethRogoffhavecalledbalancesheet“recessions”("weakerthanpotentialgrowth"ratherthan"recessions"isamoreappropriatecharacterizationforIndia).
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Outlook for Real Activity for 2017-18
Para1:Credit&InvestmentLegacy
GeneralScenario• Inmostcountries,boomsareaccompaniedbyrapidincreases increditgrowth,followedbydeleveraging(orcreditdecline) afterwhichcreditgrowthcannotnecessarilywillpickup.
• Chinahasfollowedadifferentpath:ithaschosentore-leveragewithavengeanceinordertostaveoffagrowthslowdown.
• Thisworksintheshortrun,althoughattheexpenseofdecreasingcapitalefficiencyandbuildingupfinancialsectorvulnerabilitiesthatcouldleadtodramaticgrowthslowdownsinthefuture.
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Outlook for Real Activity for 2017-18
IndianScenario• Indianboomofmid2000isnotfollowedbyseriousdeleveraging.• Slowdowninbankcreditisthesourceofconcern.• IfdeleveragingisnecessaryconditionforresuminggrowththanIndianeedsmoredebtresolutionandreduction—intheshortrun.
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Outlook for Real Activity for 2017-18
Para2:CurrentSituationofIndianEconomy
• A numberofindicators—GDP,coreGVA(GVAexcludingagricultureandGovernment),IIP,credit,investmentandcapacityutilization— pointtoadecelerationinrealactivity.
• RealGVAgrowthforQ42016-17was5.6percent.• Unlesspotentialoutputgrowthismuchlowerthanis
commonlyassumed(around7percentormore),outputgapsareexpectedtowiden.
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Outlook for Real Activity for 2017-18
Para3:ExpectationinVolumeIofEconomicSurvey
• VolumeIrangeforGDPgrowthofbetween6.75and7.5percentfactoringin–• Morebuoyantexports• Postdemonetizationcatchupinconsumption• Relaxationofmonetaryconditionswhichprevailedduring
demonetization.
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Outlook for Real Activity for 2017-18
Para4:Presentfactorsaffectingtheexpectations
• Deflationarybiasisexpectedineconomyreasonbeing-ü Realexchangerateappreciation.ü Farmloanwaiversü Increasedstresstobalancesheetinpower,
telecommunicationandagriculturalsector.ü TransitionalChangesimplementingtheGST
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Outlook for Real Activity for 2017-18
Para6- Effectoffarmloanwaiver
• ThedeflationaryimpactoffarmloanwaiverwilldependuponhowmanystatesimitatethesameactionasUP,Mahrashtra,MP&Karnataka.
• Deflationaryimpactisexpectedtobe0.35%duetothefarmloanwaiving.
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Outlook for Real Activity for 2017-18
Para7- MonetaryPolicyandit’seffect
• RealpolicyrateistighterthanwhatwasexpectedinVolumeI.
• ItisexpectedthatifcurrentmonetarypolicywillcontinuethenforecastedGDPwillshowadownsiderisk.
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Outlook for Real Activity for 2017-18
Para8- TBSandProspects• SincetheVolumeIGovernment&RBIhastakenvariousstepsto
resolvetheTBSproblem.• MarketConfidencehasboosted.• Deleveragingthecorporatebalancesheetswillbenecessarytorestore
investment&creditdemand.• Deleveragingofbankbalancesheetswillbeessentialtounblockthe
chokedchannelsofthesupplyofcredit.• However,thesubstantivegrowthimpactofthestepstakenwill
dependonthescope,effectiveness,andtimelinessof resolutionofstressedassets.
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Outlook for Real Activity for 2017-18
Para9- GSTEffectsThereisalsosomeupsidefromtheGST.Theremovalofcheckpostsandtheconsequenteasingoftransportconstraintscanprovidesomeshort-termfillip toeconomicactivity.
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Outlook for Real Activity for 2017-18
Para10- Conclusion• InVolumeIgrowthinGDPwasexpectedtobe7%
from6.75%.• Buttheprecedingdiscussionindicatesthatthe
balanceofrisksseemtohaveshiftedtothedownside.• Thebalanceofprobabilitieshaschangedaccordingly,
withoutcomesclosertotheupperendhavingmuchlessweightthanprevious.
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Outlook for Price & Inflation for 2017-18
Thesectionon‘ParadigmShifttoLowInflation’arguedthatIndiamightalreadybeinthethroesofastructuraldisinflationaryshift,drivenbymorepermanentdevelopmentsinboththeinternationaloilmarketanddomesticagriculture reflectedinunanticipatedinflationdevelopments.
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Para1– AnticipatedInflationaryTrend
Outlook for Price & Inflation for 2017-18Para2– Headline&CoreCPI
RBI’snewlyadoptedFlexibleInflationTargetingframework:HeadlineCPI- Measurestargetrateofinflationindicatingpriceofessentialconsumotion goodsandgoodshavinghighlyvolatileprices.Inflationinthesepriceshurtsthelowerincomegroup.CoreCPI- Representslongterninflationtrendofeconomy.Itignoresfoodproductsandallsuchproductofwhichpricesarevolatilelikeoil.
Thisisdonetoseparatepermanentandtemporaryinflationmovements.
Outlook for Price & Inflation for 2017-18Para3– DeterminersofInflationinNearTerm
• Capitalflowsandexchangerateswhicharedependentupontheoutlook&policiesofadvancedeconomiesspeciallyofUS.
• Recentexchangerateappreciation• Themonsoon• TheGSTimpacts• The7th PayCommissionAwards• LikelyFarmLoanWaivers• Theoutputgap
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Outlook for Price & Inflation for 2017-18OtherImportantIssues
• Foodpricesareexpectedtobeonhighersideandveryencouragingduetotheanticipatedbetterrainfallthanpreviousyears.
• TheGSTisexpected,onbalance,toreducepricesbecauseofthelowerincidenceoftaxationcomparedtothecombinedincidenceofcentralandstatetaxespreviously.
• The7thPayCommissionhousingawardisexpectedtoincreaseinflationonaveragebybetween0.4and1.2percentagepoints,dependingonwhetherjusttheCentreortheCentreandallthestatesimplementtheaward.
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Outlook for Price & Inflation for 2017-18OtherImportantIssues
• Farmloanwaiversaremorelikelytobedeflationarythaninflationaryandhenceimpartadownwardnotupwardbiastoprices.
• Outputgapsareimportantforinflationandtheearlierdiscussionpointstoaweakeningeconomyandwideningoutputgaps.
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PolicyInstances
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MonetaryPolicy
ThreemainfeatureshavecharacterizedtheMonetaryPolicysincereleaseofVolumeI:
1.RealInterestratesarecurrentlyhigh.2.UnusualvolatilityinG-SecRatesofBonds.(Chapter3)3.Glutofliquidityinbankshaspersistedforabout9months.(Chapter3)
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Ratesarealsosubstantiallyhigherthanincomparableemergingmarketcountries.
NominalNeutralRate&RepoRateNormalorneutralinterestratesarethosethatprevailwheninflationisclosetotargetandrealGDPclosetopotential.
Attargetedinflationrateof4%;neutralinterestratemustbebetween5.25-5.75%butthepresentrateis6%whichshowsadeflationof25-75Basispoints.
Currentinflation,at1.5percent,isrunningwellbelowthe4percenttarget,withthedomesticeconomylackingthedynamismtopushthisbacktowardthetarget.Example:CapacityutilizationinQ3of2016-17is72.7%.
Itissuggestthatthepolicyrateshouldactuallybebelow—not50-100basispointsorsoabove—theneutralrate.
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Conclusion:
• Thescopeformonetaryeasingisconsiderable,morethanthatsuggestedbycomparisonwithneutralinterestrates.
• Theearliertheeasing,complementedwithotherreformactionsespeciallytoaddresstheTBSchallenge,thequickertheeconomycanapproachitsfullpotential.
• RealRateswhichaffectthedecisionofconsumerandinvestorsareyearlyaveragenotwhatisatthecertainpointoftime.
• In2016-17theaverageinflationratewas1.8%,evenifin2017-18wereachthetargeted4%theaveragewillbe3%.
• Stillthepolicyinterestrateissubstantiallyhigherthantargetedinflationrate.
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LendingRate,BaseRate&PolicyRates(RepoRates):
Argumentagainsteasingreporate:Whyreporateshouldbereducedifbaseratedoesnotreduceaccordingly.Baseratedeclinesby80bp incomparisonwith175bp ofpolicyrates.
Answer:• Therearefinancialstability benefitsfromcuttingpolicyrates• Thereductioninthecostoffundswithoutacommensuratedeclineinlendingrateswillhelprestorebanks'profitability.
• LowerrateswillalsofacilitatetheTBSproblemresolutionprocess.• Thesereductionsinlendingratesbenefitallborrowers,includingsmallandmediumenterprises(SMEs).
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FiscalPolicy
Thefiscaloutlookforthisyearisuncertain.Downsiderisk otherthanthosediscussedinbudgetpreviouslyinclude:
• Reducedtaxrevenues fromslowernominalgrowththananticipated.• ReducedGSTcollectionsonaccountofthelowerGSTratescomparedwiththepre-
GSTtaxes,andtransitionalchallengesfromGSTimplementation.• Reducedspectrumreceiptsonaccountofthestructuraljolttotheviabilityof
incumbentfirms.• Higherexpenditures fromthe7thPayCommissionestimatedatRs.30,000crore.
A SlightupsidetrendmayalsobeseenbypositiveaspectofGSTimplementationandtaxcompliancepoliciesbythedemonetizationprocess.
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OtherPolicies• Agriculturalstresswillneedappropriatepolicyresponses.• Giventhat2017willalsobeayearofsurplusratherthanscarcity,andtotheextentthatfirminguppriceswillbeessentialtoboostagriculturalincomes.
• Situationofcobwebcyclemayariseifagricultureissuesnotseenproperly.
• Properremunerationpolicy,stableMSPandeasyaccesstoexportmarketwillprotectbothproducersandconsumersfromproduction&priceswings.
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CobwebCycle
• CobwebCycleisfeaturedbymarketinwhichsupplybyproducerdependsuponthepricesinthepreviousperiod.
• Itisthebasiccharacteristicofthemarketinwhichtimegapbetweenproductionandsellingislarge.
• Whattoproduceinnextyearisdependentonpreviousyears’experience.
• Forexample,ifpulses’pricesareparticularlyhighinagivenyear,morefarmerswillchoosetoplantpulsesthenextyeartotakeadvantageofthehighprice.Thisincreasedsupply,however,willleadtolowerprices.
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OtherPoliciesAlltheimpedimentsthatcomeinthewayofrealizingbetterpricesforfarmers—stocklimitsimposedundertheEssentialCommoditiesAct,exportrestrictions,impedimentstotheimplementationofe-NAM—needtoberemoved.
NationalAgricultureMarket(NAM)isapan-IndiaelectronictradingportalwhichnetworkstheexistingAPMC(AgricultureProduce&MarketCommittee)mandis tocreateaunifiednationalmarketforagriculturalcommodities.
Thetimeisalsoripetoconsiderwhetherdirectsupporttofarmerscanbeamoreeffectivewaytoboostfarmincomesovercurrentindirect,Ineffective,andinefficientformsofsupport.
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