Three important medium-term questions about the economy

GDP numbers for the first quarter of 2021-22 will be released on August 31. In its latest resolution, the Monetary Policy Committee of the Reserve Bank of India projected 21.4% growth in the quarter. This will not make up for the 24.4% contraction in the same period last year. Other forecasters, such as State Bank of India’s chief economist have projected lower growth rates . The only reason these numbers have not set alarm bells ringing is because the June quarter saw a big disruption due to the second wave of Covid-19 infections.

There is a view, especially within the government, about the inevitability of economic activity gathering momentum going forward. The biggest proof of this is the government’s roll-out of National Monetisation Pipeline (NMP) for the next four years (from 2021-22 to 2024-25) this week. NMP is basically an exercise in leasing public assets to private players at a pre-determined price. The government expects to raise ₹6 lakh crore from this exercise over the period.

Any such exercise only makes sense if the government can convince bidders that the economy will do well in the future. It is for this reason that the estimated proceeds have been qualified in the press release announcing the NMP. “The monetisation value that is expected to be realised by the public asset owner through the asset monetisation process, may either be in form of upfront accruals or by way of private sector investment. The potential value assessed under NMP is only an indicative high-level estimate based on thumb rules”, the release said.

But what is the real state of the macro economy?

The question of finance

The press release issued on the roll-out of NMP has left the modalities of the implementation very broad based. “The assets and transactions identified under NMP are expected to be rolled out through a range of instruments. These include direct contractual instruments such as public private partnership concessions and capital market instruments such as Infrastructure Investment Trusts (InvIT) among others.”

One question that emerges is the method of financing such a monetisation programme. It is reasonable to assume that domestic capital will be a significant player in this exercise and private debt will be an important instrument. The sum involved is bound to have a significant impact on the debt market for infrastructure.

RBI data available in the Centre for Monitoring Indian Economy (CMIE) database shows that the total outstanding credit to infrastructure sector was ₹10.9 lakh crore at the end of 2020-21. So, the expected NMP proceeds are almost 60% of total outstanding credit to infrastructure. This highlights the credit market churn which NMP will unleash, even more so, when it is read along with an ambitious target for private investment under the National Infrastructure Pipeline (NIP). These numbers also underline the risk to the financial system any exuberance in valuation of the assets being monetised can bring, via future bad loans.

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How important are capital market driven wealth effect tailwinds for formal sector engine of the economy?

Anybody who invested a significant sum when the stock markets crashed in March 2020 would have almost doubled it today. The ongoing stock market rally is bound to have generated a significant amount of positive wealth effect in the economy, especially among the classes and institutions which matter when it comes to big ticket investments. A look at the PE multiple – the ratio of price of a share and earnings per share – of the benchmark BSE Sensex shows that the stock market is more overvalued than it was before the pandemic. The persistence of a loose monetary environment has also encouraged another route to making stock market windfalls, where both institutional and high net worth individual players have exploited low interest rates to borrow money and invest in IPOs just to make listing day gains.

The problem with such capital gains avenues is that they are not self-sustaining. As expectations of monetary tightening, both in India and abroad, increase, capital flight to advanced countries and profit booking endeavours might lead to a significant correction. Any such development is bound to create a significant negative wealth effect. While financial market exposure is not as high in India as it was in the US during the 2008 crisis, any significant correction will have a not insignificant effect on business sentiment. And corporate profits did not suffer significantly during the pandemic, ruling out the possibility of a large rebound as things improve. This reduces the likelihood of significant tailwinds to capital markets.

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Will inflation put a squeeze on future growth?

Since December 2019 the Consumer Price Index has grown above RBI’s target of 4% every quarter. In the minutes of the latest MPC meeting, members warned against the practice of treating the upper band of 6% as the inflation target instead of the actual monetary target. RBI continues to maintain that the current phase of high inflation should be seen as transient and supply-side driven and monetary policy should do all it can do boost aggregate demand. Such an approach amounts to kicking the proverbial can of ”what will happen to already high inflation when aggregate demand picks up” down the road.

The government has ruled out the possibility of providing any significant relief in petroleum prices. This is a direct fallout of the precarious fiscal situation. This will create a cascading effect on inflation. As the 2024 elections near, the government will have to consider bigger hikes in Minimum Support Prices, which have grown at a lower rate than retail inflation. Many experts expect a spike in services inflation, once vaccinations cross a critical threshold and demand picks up. Persisting high inflation can adversely affect growth via two routes. It can spook foreign capital , leading to exchange rate depreciation, adversely affecting India’s trade balance in energy (every barrel of oil will cost more in rupee terms). There is also the danger of high prices putting a squeeze on un-indexed earnings of informal sector workers, which will weaken aggregate demand.

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All the three questions discussed above can be combined in a simple, yet profound question: has the pandemic and the slowdown which preceded it damaged India’s potential growth rate?