Statistically, Asia’s third-largest economy is outpacing China with above 7 per cent annual growth. But Prime Minister Narendra Modi’s economic advisers are complaining of a sharp slowdown that threatens their budget calculations.
In February, Finance Minister Arun Jaitley will present the budget for the fiscal year starting April 1. A senior official said the minister has been advised to increase its fiscal deficit target to 3.7 or 3.9 per cent of gross domestic product (GDP) from 3.5 per cent.
There is also a proposal to delay, by one year, a goal of lowering the fiscal deficit to 3 percent in 2017/2018, the official said.
“The economy is still suffering from slack demand,” said the finance ministry official. “It needs a conducive fiscal and monetary policy.”
But Shaktikanta Das, the ministry’s economic affairs secretary, said the government has yet to decide on relaxing the deficit targets.
Running a higher deficit could antagonise the Reserve Bank of India (RBI), which is counting on Jaitley’s pledge of tight fiscal policy to keep inflation to 5 per cent by March 2017.
“A miss on the fiscal targets will narrow scope for additional rate cuts,” said economists at DBS in Singapore.
Differences on what the government should do – spend to stimulate and risk high inflation, or cut the fiscal deficit to contain it – stem from a sharp divergence between nominal and real, or inflation-adjusted, growth, as well as in the direction of wholesale and retail prices.
GDP data “is underestimating nominal growth and overestimating real growth,” said N.R. Bhanumurthy, a professor at the government-funded National Institute of Public Finance and Policy.
Falling wholesale prices
He and other economists blame an over-representation of the wholesale price index in the GDP “deflator” for the anomaly.
The government uses the deflator to strip out price changes to make quarters comparable. Wholesale prices have a bigger weight in the deflator than retail ones.
Recently, wholesale prices have fallen, due to crashing commodity prices, showing a deflationary trend – hence some officials are pitching for stimulus.
But since September, retail inflation has picked up, hitting 5.41 per cent in November. This has rekindled inflation worries, and argues for reducing the fiscal deficit.
In July-September, the deflator fell an annual 1.3 per cent, sparking a debate on whether India’s economy was plunging into deflation. Retail inflation, which the RBI tracks to set interest rates, averaged about 4 percent in that period.
Bhanumurthy says ideally India should use producer prices for calculating the deflator. But as it has yet to build an index for them, he suggests using only retail prices, in the interim, to translate nominal economic growth figures into real ones.
Since India in January 2015 changed how it measures economic activity, policymakers have struggled to square robust headline growth figures with grim ground reality.
Differing rates of growth
Real annual GDP accelerated in July-September to 7.4 per cent from 7 per cent. But growth of nominal GDP, which Jaitley relies on to drive tax revenue, slowed sharply to 6 per cent from 8.8 per cent in April-June, suggesting tepid demand.
It was the first time in recent quarters nominal growth lagged the real figure.
“We know the economy is recovering,” the finance ministry official said. “But no one is sure about the recovery’s pace and strength.”
A loose fiscal stance taken during the 2008 global financial crisis led to prolonged double-digit inflation, paving the way for ouster of the previous government.
The RBI is already bracing for the inflationary fallout of a salary hike for millions of government employees next fiscal year.
“The mess is being created in Delhi, but the RBI will have to absorb the shock,” said Bhanumurthy.