After the breathless rally, let’s do a reality check on economy

The biggest discussion at this stage is about which party will get how much vote share and who will form the next government. However, irrespective of the party that comes to power, growth prospects seem to be very lackluster.

Most economists are revising downwards their GDP growth estimates for FY20 to below 7 per cent level compared with an earlier estimate of 7 per cent or above. The lower growth expectations are based on sustenance of weak rural demand, impact of relatively higher borrowing costs and weaker consumption growth, which has now percolated to staples too.

Growth has been propped up recently almost solely by government expenditure. Healthy cement and steel volumes based on a seemingly healthy investment cycle have been back on the government’s focus on affordable housing, roads and urban infrastructure.

There has been optimism of recovery in the investment cycle on the back an increase in capacity utilisation. In FY20, the fiscal space will be constrained to support capex given the tall ask from GST collections and focus on revenue expenditure. While the call for fiscal stimulus may intensify through lower GST rates, there is limited scope for the government to lose out on revenue, maintain expenditure and stick to the fiscal consolidation path.

The pause on fiscal consolidation has had its impact on interest rates. A slowdown in rural demand is unlikely to reverse immediately given the continued contraction in farmers’ profitability due to lower crop prices. Structural issues in the agriculture sector such as supply glut, lower cash usage and muted global prices are unlikely to change farmers’ fortunes in the near term. The impetus from the 7th Pay Commission implementation has also faded, which will continue to weigh on consumer durables.

The monetary policy transmission channel may remain weak as the fiscal overhang and liquidity challenges will likely continue. While CRR cuts could alleviate transmission problems, RBI is likely to continue to see it as a last resort. The liquidity issue continues to haunt private sector banks, which will probably make a stronger case for more focused liquidity injection.

While calls for aggressive rates cuts and fiscal stimulus will intensify, the medium-term impact of profligacy should not be ignored. The causes of the slowdown are more structural and policy measures should address agricultural slowdown, financial sector health, improving household savings rate and the government’s crowding out effect. The slowdown and benign inflation would open up space for a 25-50 bps rate cut, however it’s important that the same is transmitted.

Neutral liquidity stance has not helped ease rates in spite of rate cuts due to fiscal overhang. Arguing for a fiscal stimulus will only weaken the medium-term growth outlook.