Indian economy gets an implicit stimulus

After much criticism of the government over the deceleration of economic activities following demonetization and the rollout of GST (FY2018 Q1 growth slumped to 5.7%), the government has announced two major plans:

1. Recapitalization of state-owned banks: IRs2.11 trillion (IRs2 lakh 11 thousand crores) recapitalization package consisting of IRs1.35 trillion from sale of ‘recapitalization bonds’ and IRs76,000 crore from budgetary support and ‘market-raising’. Initially, the government had planned IRs20,000 crore bank recapitalization strategy for FY2018 and FY2019. This is a major step to ‘unfreeze’ the credit market where by banks are saddled with high non-performing assets (around IRs7.7 trillion) and major corporates high on debt already are not able to borrow with restructuring their loans. One question that looms large is that how is this not going to add to the fiscal deficit target of 3.2% of GDP for FY2018 (except for IRs18,000 already committed under Indradanush Recapitalization Scheme over the next two years)? Isn't recapitalization a form of net lending by the government (okay, you don't pay interest on it immediately after issuance but in subsequent years both interest and principal payments will need to be factored in)? CEA Arvind Subramanian says that recapitalization bonds do not impact fiscal deficit as per IMF accounting rules but will increase government liability/debt.

2. Approval of IRs6.92 trillion worth of highway projects: The plan is to construct 80,677 km of highways over the next five years. It aims to crate 14.2 crore man-days of jobs and would ensure substantial delegation of authority to enable accelerated implementation. This includes BharatMala projects (34,500 km of roads with an investment of IRs5.35 trillion) consisting of economic corridors, inter-corridor and feeder route, border roads and international connectivity, and coastal roads and port connectivity, among others.

One unanswered question is that will these implicit stimulus measures turn around the slumping economic activities, especially in FY2018? Both the reforms outlined above are medium-term measures and their effectiveness would depend on how fast and effectively they are implemented (coupled with administrative and operational reforms at PSBs and execution of capital projects).

Growth from above: Impact of trade disruptions was larger than impact of earthquakes

It is adapted from South Asia Economic Focus, Fall 2017. An earlier blog post on the same issue here (update figures here). 

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With two major earthquakes in April and May, and a severe disruption of trade with India from August onwards, the year 2015 was no doubt Nepal’s most turbulent since the end of its armed conflict. The two earthquakes killed about 9,000 people, injured at least twice as many, and destroyed uncountable houses and buildings. Later in the year, dissatisfaction among the Madhesi minority about their representation under the new federal arrangements triggered protests that culminated in the complete shutdown of international trade with India. Official statistics put GDP growth for FY2015 (which starts in October 2014) at 1.6 percent, and for FY2016 at 0.8 percent. This represents a drop of roughly 4 percentage points relative to previous years.

Based on monthly nightlight data, the economic impact of the 2015 shocks was smaller than official statistics suggest. The earthquakes affected most severely rural areas that were characterized by low nightlight intensity even in good times. The fact that these areas were mostly in the dark suggests that even if local impacts were large in relative terms, they may not have made a major difference at the aggregate level. The impact of the trade disruption, on the other hand, was massive. Based on the elasticity approach, from June to October 2015 the GDP growth rate of Nepal declined by 4 percentage points. But economic activity bounced back strongly in November, and over the full year the GDP growth rate might have declined by less than 2 percentage points.

The shocks had a more substantial impact at the local level. This can be seen by using the spatial approach to estimate GDP by district, and then comparing the performance of districts directly affected by the shocks to that of unaffected districts. However, instead of spatially distributing the official annual GDP, the methodology is applied to the monthly GDP estimated using the elasticity approach. This way of proceeding allows to assess local economic activity on a monthly basis.

In comparing growth rates at the district level, it is important to keep in mind that the locations most affected by the earthquakes, or most affected by the trade disruptions, could be systematically different from other locations. As a result, they could grow at a different pace even in normal times. To address this possible bias, a “differences-in-differences” approach can be used.

The first difference is between the annual growth rate of local GDP in the two months following the shock and the annual growth rate in the same two months of the previous year. The two months considered are April and May in the case of the earthquakes, and September and October for the trade disruptions. Growth rates are computed relative to the same two months one year earlier. This first difference can be called a growth shock, for brevity. The second difference is between the growth shocks experienced by affected and unaffected districts. The median growth shock across districts in each group is used for the comparison.

Based on this exercise, in April and May 2015 districts affected by the earthquakes experienced a decline in their local GDP by 1.8 percentage points, while unaffected districts grew slightly faster than before. And in September and October 2015, districts in the Terai region closer to India contracted by 9.0 percentage points, whereas the rest of the country saw GDP growth decline by a more modest 1.4 percentage points. These results confirm, once again, that the impact of the trade disruption was much more severe than that of the earthquakes.

Communist alliance in Nepal; RBI lowers growth forecast in India

Communist parties form alliance for upcoming polls

Two major leftist forces-CPN-UML and CPN (Maoist Centre), along with the Babu Ram Bhattarai-led Naya Shakti Party-Nepalformed a broad electoral alliance ahead of the upcoming provincial and federal elections. They also agreed to form an eight-member panel that would work for a formal merger of the three parties at the earliest.

Meanwhile, Nepali Congress, which was taken by surprise by the latest political development, is considering a democratic alliance including Terai-based parties.

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RBI keeps policy rate unchanged but lowers growth forecast

Anticipating upside risks to retail inflation, Reserve Bank of India (RBI)  kept interest rates unchanged at 6% on October 4. It sees upside risks to inflation coming from farm loan waivers, tates’ implementation of pay commission allowances, and price revisions following GST and rising international crude prices. The RBI expects inflation to rise from its current level and range between 4.2-4.6 per cent in the second half of FY2018 (ends March 2018). In August, the RBI slashed the repo rate by 25 basis points (bps). The central bank's medium-term target for CPI inflation is 4% (+/- 2%).

Gross value added (GVA) growth forecast is lowered to 6.7% from 7.3% owing to the adverse impact of GST implementation particularly on manufacturing activity; investment squeeze due to stressed balance sheets of banks and corporates; lower than expected kharif foodgrains output (deficient and uneven pattern of south-west monsoon);