Indian government estimates GDP to grow at 5% in FY2020

India’s National Statistics Office has released first advance estimates of national income for FY2020. The estimates are based on benchmark-indicator method with data up to seven to eight months. GVA growth at basic prices is expected to grow at 4.9%, much lower than 6.6% in FY2019 and an average of 7.3% in the last five years. GDP at market prices (GVA plus net taxes on products including import duties) is expected to grow at 5%. It is much lower than 7% target set by the government. Eventually, when the actual estimate for FY2020 is released after a year or so, even 5% advance estimate may look a bit optimistic.

The provision GDP growth estimate for FY2019 is 6.8% and the average in the last five years was 7.5%. The sharp downward revision of annual estimate is in line with the slowdown seen in the quarterly estimates (up to Q2 FY2020) released last month. FY2020 GDP growth estimate of 5% is the lowest since FY2009, when it grew by 3.1%. Here is the IMF's latest Article IV assessment.

It looks like a broad-based slowdown. Almost all sectors are expected to slowdown in FY2020. Agricultural output is estimated to grow at 2.8%, which marks three consecutive years of slowdown. Industrial output is also expected to slowdown further to 2.5%. It marks four consecutive years of deceleration of industrial output. Similarly, services output is expected to growth at 6.9%, which marks five consecutive years of deceleration of services output. 

Within industrial sector, mining & quarrying output is expected to grow at 1.5%, marginally higher than 1.2% in the previous year. However, manufacturing output growth is expected to slump to 2%, much lower than 6.9% in the previous year. Electricity, gas and water supply activities are expected to growth by 5.4%. Construction activities are expected to grow at 3.2%, much lower than 8.7% in the previous years. It reflects the slowdown in private consumption as well as investment, especially on capital and core industrial goods.

Services output is expected to grow at 6.9%, the lowest growth rate since FY2009. Within services sector, trading, hotels & restaurants, transportation and communication activities are expected continue decelerating. Similarly, financial, real estate and professional activities are also expected to grow at a slower pace than in the previous year. But then public administration, defense and other services are expected to grow at 9.1%, higher than 8.6% in the previous year. 

On the expenditure side, while both consumption and investment are expected to decelerate net exports are expected to recover. Government consumption is expected to grow at a rate slightly higher than in the previous year, reflecting the front-loading of government spending in the first two quarters of FY2020. However, private consumption is expected to grow at 5.8% only, the lowest since FY2013. Gross capital formation (generally investment) is expected to grow at 1.5%, much lower than 4.3% in FY2019 and 12.9% in FY2018. Within GCF, fix capital investment is expected to nosedive. GFCF is expected to grow at 1% only, a sharp dive from 10% growth in the previous year. Similarly, change in stocks is also expected to slowdown. Meanwhile, a larger slowdown in imports compared to slowdown in exports meant that net export growth is positive. 

Nominal GDP growth is estimated to be 7.5%, much lower than 12% target set in the FY2020 budget speech.

IFC allowed to issue local currency bonds in Nepal, spending cut to lower deficit in India, and more

IFC given permission to issue local currency bonds

From The Kathmandu Post: The International Finance Corporation has received permission from the government to issue Nepali currency bonds in international markets but will have to reinvest the capital collected back in Nepal for at least three years. The private sector lending arm of the World Bank Group got approval from the Cabinet to issue Nepali currency bonds worth $20 million outside Nepal in November last year. This is the first time an international agency has been granted approval to issue Nepali currency bonds in international markets.

Some conditions:

1. The IFC cannot return the invested money before three years.

2. It will have to deposit the capital within three months from the date the bonds are issued.

3. The amount should be invested in the productive sector, such as industry, infrastructure and tourism, among others

The IFC will hedge the foreign exchange risks through the private sector window of the International Development Association, also an arm of the World Bank Group. The IFC has yet to state the interest rate at which the bonds will be issued. But the central bank has suggested that the Finance Ministry decide the interest on investment through microfinance institutions at not more than 8 percent.

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Govt plans to cut spending to curb fiscal deficit

From livemint: India's government is likely to cut spending for the current fiscal year by as much as 2 trillion Indian rupees as it faces one of the biggest tax shortfalls in recent years, three government sources said.

The government has spent about 65% of the total expenditure target of 27.86 trillion rupees till November but reduced the pace of spending in October and November, according to government data. A 2 trillion-rupee reduction would be about a 7% cut in total spending planned for the year. In October and November, government spending increased by 1.6 trillion rupees, nearly half the 3.1 trillion it spent in September. The fiscal year starts April 1 and ends March 31. Lack of demand and weak corporate earnings growth in the economy led to lagging tax collections this year. Analysts said growth will be hurt.

The government is likely to keep the fiscal deficit under 3.8% of gross domestic product, sources said, while letting it slip from its earlier set target of 3.3% for the year.

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Globalization in transition: The future of trade and value chains

From McKinsey.com: Although output and trade continue to increase in absolute terms, trade intensity (that is, the share of output that is traded) is declining within almost every goods-producing value chain. Flows of services and data now play a much bigger role in tying the global economy together. Not only is trade in services growing faster than trade in goods, but services are creating value far beyond what national accounts measure. Using alternative measures, we find that

• Services already constitute more value in global trade than goods.
• All global value chains are becoming more knowledge-intensive. 
• Low-skill labor is becoming less important as factor of production. 
• Contrary to popular perception, only about 18 percent of global goods trade is now driven by labor-cost arbitrage.

Three factors explain these changes: 

• Growing demand in China and the rest of the developing world, which enables these countries to consume more of what they produce
• Growth of more comprehensive domestic supply chains in those countries, which has reduced their reliance on imports of intermediate goods
• The impact of new technologies

IMF's assessment of Indian economy

Here are the highlights from the IMF’s latest Article IV report on Indian economy, including macroeconomic assessments, which are based on data available through 16 October 2019. For national accounts estimate till second quarter of FY2020, see this blog post.

Macroeconomic development

• GDP growth: The deceleration of consumption and investment and weaknesses in the non-bank financial sector along with corporate and environmental regulatory uncertainty have contributed to the slowdown. 
• Inflation: Weak demand as well as low food prices thanks to favorable monsoon rainfall moderated inflation to a low level.
• External sector: External vulnerabilities eased due to lower oil prices and renewed portfolio inflows. The Indian rupee depreciated both in REER and NEER terms. Gross reserves can cover 7 months of imports. 

Macro-financial risks from banking sector have decreased, thanks to enhanced monitoring of NBFCs. Capital position of public sector banks and asset quality have improved due to capital injection by government and the implementation of insolvency and bankruptcy code (IBC).

Central government largely adhered to its headline fiscal deficit objective despite revenue shortfalls. Headline general government fiscal deficit narrowed thanks to decline in fiscal deficits of the states. The high public sector borrowing requirements implies that general government debt is also high at about 69% of GDP. Since India’s debt, denominated in domestic currency, is largely held by residents with relatively long maturity period, debt build up is generally sustainable. That said, current fiscal deficit target is ambitious due to overly optimistic revenue targets and reduction of corporate income tax rates. 

Outlook

Macroeconomic outlook is subdued and uncertain. FY2020 growth is projected at 6.1% on account of strong investment and private sector consumption. The lagged effect of monetary policy loosening in the previous periods and recent measures to facilitate monetary policy transmission will also support economic activities. 

• Growth is projected to rise to its medium-term potential of 7.3% over the medium term. It is conditional on continued commitment to inflation targeting, gradual macro-financial and structural reforms and implementation of reforms initiated earlier. 
• Inflation is projected to be around 3.4% on account of subdued demand offsetting base effects of low food prices. 
• Current account deficit is projected to remain around 2% of GDP. Higher capital inflows would mean balance of payments surplus. India’s external position is broadly consistent with fundamentals and desirable policy settings. 

Risks

Risks are titled to the downside. 

• Tax revenue shortfalls, delays in structural reforms, and subdued credit growth due to risk aversion among banks are the major domestic risks. 
• High oil prices, a sharp rise in risk premia in global financial markets, and rising protectionism globally are the main external risks. 

Recommendations

Medium-term fiscal consolidation, subsidy-spending rationalization and tax-base enhancing measures are needed to reduced debt and to avoid crowding out of private investment. 

To counter the cyclical weakness of the economy, monetary policy should be eased until a recovery takes hold. Fiscal stimulus should be avoided given the fiscal space at risk. Exchange rate flexibility should be maintained. External debt is about 19% of GDP and debt is projected to remain sustainable thanks to favorable growth-interest rate differential and that public debt is primarily denominated in domestic currency and held by residents.

Credible fiscal consolidation path is needed to reduced debt, free up financial resources for private investment, and reduce the interest bill. Additional measures to boost revenues could be expansion of property taxation, increase in coal cess, and equal tax treatment of agricultural and non-agricultural income. 

Enhance governance of PSBs and efficiency of their credit allocation. Inflation targeting is contributing to macroeconomic stability, anchoring inflation expectations, and improving economic well-being of low-income households. Forward guidance accompanied by market development can be an effective instrument in shaping market expectations. 

Indian economy continues to slow down

Indian economy continues to slowdown. The latest estimate of economic activities by the government shows that GVA growth was 4.3% in the second quarter (July-September 2019) of fiscal year 2019-20. GDP growth at producers’ prices was 4.5%, the lowest in the last 25 quarters (quarterly GDP grew by 4.3% in Q4 FY2013). In terms of GVA growth (basic prices), this is the lowest quarterly growth rate since the availability of quarterly data (2011-12 constant price series).

Growth in all sector slowed down compared to Q2 FY2019. Agricultural output is estimated to increase by 2.1%, much lower than 4.9% in Q2 FY2019 but slightly higher than in the first quarter. However, industrial output slumped the most. It is estimated to grow by just 0.5% in Q2 FY2020, far lower than 6.7% in the corresponding quarter in last fiscal. Similarly, services sector is estimated to grow by 6.8%, which is also lower than the previous quarters. 

Within industry sector, manufacturing output actually contracted. It is expected to grow at a negative 1% compared to 6.9% in Q2 FY2019. Mining and quarrying output is expected to grow by 0.1%, which is better than negative 2.2% growth in Q2 FY2019, but lower than 2.7% in Q1 FY2020. Construction is continuing to slowdown too with growth of just 3.3%, also lower than the growth rates in the corresponding quarter in previous fiscal years. Electricity, gas and water supply activities are also slowing down. 

Within services, all activities are nosediving expect for public administration and defense related services. 

If we look at expenditure side of GDP data (which is basically GVA plus taxes minus subsidies), then we will see a drastic fall in gross capital formation (basically investment). It consists of gross fixed capital formation, change in stock and valuables. Gross capital formation growth is expected to be just 0.5%, the lowest in the last 22 quarters. GFC contracted (negative growth of 4.9% in Q4 FY2014). There is an improvement in net exports because exports growth remained stable but imports growth decreased slightly. Private consumption growth is almost stable but public consumption growth is picking up, albeit slowly. Essentially, the 4.5% GDP growth (producers’ prices) attributable to slight pickup in consumption but a drastic slowdown in investment. 

So, whats happening? Consumption demand is still weak, domestic credit is tight (partly contributed by the mess in non banking financial institutions) and investment in construction & infrastructure is slacking, weak external demand is slowing down exports and manufacturing, and consumer as well as investor sentiment is not that great. Core industrial output is slumping. It appears the structural reforms such as GST, bankruptcy law and slashing of corporate taxes are not yielding results in the short term (and they are not expected to do so). What is needed right now is fiscal policy that stabilizes the economy and brings it up to the growth sustained in the past. This requires more and faster government spending in sectors that can give high return (infrastructure investment) or some kind of fiscal transfers in rural sector (agricultural households) or significant efficiency enhancement of public capital investment. This might help stimulate demand in the short-term. However, this risks increasing fiscal deficit. There is a trade off, and managing is both good economics and art of managing consumer and investor expectations. 

Undershooting the macroeconomic targets

It was published in The Kathmandu Post, 21 October 2019. Related detailed blog post here.

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Undershooting the targets

For the last fiscal year, 2018-19, the government had targeted a gross domestic product (GDP) growth of 8 percent. During that time, it promised that Nepal would experience double-digit growth within a few years. The government claims that the economy is in far better shape than when it inherited it from the previous government, because of policies and effectiveness of government operations. By vowing to overhaul public spending capacity, investment regulations, and governance, it has set an even higher growth target (8.5 percent) for 2019-20.

The latest data released by the government and the central bank show that economic performance is actually far behind the stated targets. The government failed to achieve most of the macroeconomic goals set during the beginning of the fiscal year. It indicates underperformance relative to its unrealistic targets.

Worse than expected

The economy is expected to grow at 6.8 percent at basic prices (7.1 percent at market prices) in 2018-19, lower than the government’s target. The government is claiming that since this is the third consecutive year of growth being over 6 percent, the Nepali economy is in a solid footing with strong economic and institutional fundamentals. Unfortunately, the reality is a bit different. In a way, the last three growth episodes are idiosyncratic. In 2016-17, the growth rebound was essentially a base effect because of the rock bottom economic activity in the previous two years due to the 2015 earthquake and India’s trade blockade. In 2017-18, it was due to temporary fiscal stimulus related to post-earthquake reconstruction and elections that drastically increased demand for goods and services. In 2018-19, it was good agricultural harvest underpinned by a favourable monsoon, post-earthquake reconstruction related fiscal stimulus, and tourism and real estate activities. Surprisingly, industrial output has contracted (especially manufacturing activities), and foreign direct investment has declined. This is in contrast to the Oli-led administration’s grand promises, of building the right policy environment and promoting political stability, at investment and infrastructure summits.

Consistently lower actual GDP growth than what was projected during budget speeches indicates that the government is not keeping its promises at the policy and operational levels. Consider the case of poor budget execution. While presenting the 2018-19 budget, the finance minister argued that the government would be spending over 90 percent of the capital budget and avoid expenditure bunching in the last quarter of the fiscal year. In reality, actual capital spending was just three-fourths of budgeted capital spending and over 40 percent of it was either spent or settled in the last month. It shows that budget execution undershot the target, and there was no change in spending pattern, raising concerns over the quality of spending. Moreover, actual capital spending is projected to be 6.9 percent of GDP, which is actually lower than in 2017-18. This is also reflected in the expenditure side of GDP data, as a deceleration of public gross fixed capital investment (think of the setback in completing large infrastructure projects such as Melamchi and Upper Tamakoshi).

Revenue performance was also below the target. A revenue growth target of about 30 percent—a feat achieved just once in the last decade—was too ambitious in the first place. The finance minister had asserted that the government would achieve it (to finance increasing recurrent expenditure) by plugging in leakages, broadening the tax net and implementing administrative reforms. Unfortunately, the lower than expected GDP growth rate and a slowdown in imports, which is the source of over 45 percent of tax revenue, meant that revenue growth fell below 20 percent. Expenditure under-performance but less than expected revenue mobilisation means that fiscal deficit will remain at a high level.

On the monetary front, inflation averaged 4.6 percent, much lower than the targeted 6.5 percent but higher than 4.2 percent in 2017-18. Higher fuel prices, depreciation of the currency and strong consumer demand propped up the prices of goods and services. Meanwhile, the money supply in the economy and credit to the private sector were not only lower than in 2017-18, but they were also below the central bank’s target. Liquidity shortage, caused primarily due to aggressive credit growth relative to deposit growth, persisted and interests rose to even higher levels. This increased the cost of financing for the private sector. In fact, the interbank rate (the rate at which banks and financial institutions lend to each other) is at its highest level since the last financial crisis in the fiscal year 2011-12. The stock market is more volatile than ever.

On the external front, a lower rate of import growth compared to export growth and steady remittance inflows despite a decline in the number of outmigrants resulted in a narrower current account deficit. However, the balance of payments slipped into the negative territory, the first time in the last nine years. The decrease in net foreign direct investment partly contributed to this. Consequently, foreign exchange reserves were just enough to cover 7.8 months of import of goods and services, down from 9.4 months in 2017-18.

Change is required

The government has again set ambitious targets for 2019-20 without notable changes to its operational strategy and policy facilitation. The latest consensus GDP growth forecast is between 6 percent and 6.5 percent, much lower than the 8.5 percent target set by the government. Despite the unfavourable monsoon, strong services sector output (contributed by steady remittance inflows and high tourist arrivals ahead of Visit Nepal 2020) together with ongoing post-earthquake reconstruction will support growth of around 6 percent. Achieving growth rate higher than 6.5 percent will require the government to address structural issues related to land acquisition, environmental clearances, investment-friendly regulations, productivity-enhancing infrastructure, human resources and the efficacy of the usually lethargic bureaucracy. It is a race against time for the powerful government with a two-thirds majority in Parliament to address these structural bottlenecks.

Given the way the government is implementing the budget, it is unlikely that there will be a drastic change in capital spending absorption capacity and revenue mobilisation, leading to a wider fiscal deficit and a higher level of public debt. Furthermore, investors are not entirely convinced by the government’s band-aid approach to solving structural issues plaguing private investment. Most of the commercial deals in infrastructure these days are settled at the government-to-government level, bypassing the usual competitive procurement among private companies. Liquidity issues are far from being resolved, and interest rate volatility will continue. The external sector is also projected to deteriorate next year.

Against this backdrop, the likelihood of the government missing its own targets again is quite high. The existing way of formulating the budget and its execution, coordination with the various tiers of government, tinkering policies to resolve structural issues instead of overhauling decades-old laws and policies, and slow pace of bureaucracy (be it due to politicisation or sheer inability) are not going to result in a vibrant economy that can sustain a near double-digit growth rate.

Tariff war and policy uncertainty leading to synchronized global slowdown

In its latest World Economic Outlook (October 2019), the IMF argues that the global economy is in a synchronized slowdown, thanks to rising trade barriers and increasing geopolitical tensions. It has downgraded global growth for 2019 to 3%, the slowest pace since the global financial crisis a decade ago. Specifically,

• US-China trade tension will reduce the level of global GDP by 0.8% by 2020
• Growth is affected by idiosyncratic country-specific factors in emerging market economies. Growth in Argentina, Iran, Turkey, Venezuela, Saudi Arabia, India, Russia, Brazil, Mexico, China, etc are expected to slowdown
• Growth weakened in China because of regulatory efforts needed to rein in debt and macroeconomic consequences of increased trade tensions
• Growth slowed down in India because of corporate and environmental regulatory uncertainty in addition to the concerns regarding the soundness of nonbank financial sector. 
• Growth is also affected by structural factors such as low productivity growth and aging demographics in advanced economies

So, what is causing the weak growth? 

• Sharp deterioration of manufacturing activity 
• Global trade affected by higher tariffs
• Prolonged trade policy uncertainty affecting investment and demand for capital goods

What is supporting growth?

• Services sector is keeping labor markets afloat and wage growth and consumption spending healthy in advanced economies. This may not last long due to weaknesses in the US and Euro area.
• Monetary policy is supporting growth by easing policies amidst the absence of inflationary pressures and weakening economic activity. 

What are the risks to growth?

• Heightened trade and geopolitical tensions including Brexit-related risks
• These could lead to shift in risk sentiment, financial disruptions, and a reversal of capital flows to emerging market economies 
• Low inflation is constraining monetary policy and its effectiveness

What is needed to rejuvenate growth, especially to boost confidence and reinvigorate investment, manufacturing, and trade?

• Undo the trade barriers, rein in geopolitical tensions, and reduce domestic policy uncertainty. Tariffs should not be used to target bilateral trade balances. Cooperation to resolve roots of dissatisfaction is needed (resolve deadlock over WTO dispute settlement mechanism; modernize WTO rules to encompass e-commerce, subsidies and technology transfer, etc)
• Monetary policy needs to be coupled with fiscal support where fiscal space is available. If borrowing costs are low, then countries should borrow more to invest in social and infrastructure capital 
• If monetary policy is supporting growth, then macroprudential regulation should be the norm to prevent mispricing of risk and excessive buildup of financial vulnerabilities
• Sustainable growth requires structural reforms to boost productivity, improve resilience, and lower inequality. These reforms are more effective when good governance is already in place (applies to emerging market and developing economies)

Although global growth will inch up to 3.4% in 2020 it is still a downward revision from the April 2019 projection. This is supported by growth rebound in emerging market and developing economies. The ‘recovery’ is not broad-based and remains vulnerable because of the expected slowdown in major economies like the US, Japan, and China.

South Asian outlook

• Nepal is clocking in the highest GDP growth in FY2019. In FY2020 Bhutanese economy is expected to grow at 7.2%, followed by Indian economy 7.0% and Nepali economy 6.3%.
• Nepal is projected to have the highest inflation rate, 6.1%, in FY2020.
• Maldives is expected to have the highest current account deficit, 15.7% of GDP, in FY2020, followed by Nepal (10% of GDP)

GDP growth
Economy	FY2019	FY2020
Bhutan	5.5	7.2
India	6.1	7.0
Nepal	7.1	6.3
Maldives	6.5	6.0
Bangladesh	5.9	6.0
Sri Lanka	2.7	3.5
Inflation
Economy	FY2019	FY2020
Nepal	4.5	6.1
Bangladesh	5.5	5.5
Sri Lanka	4.1	4.5
Bhutan	3.6	4.2
India	3.4	4.1
Maldives	1.5	2.3
Current account balance (% of GDP)
Economy	FY2019	FY2020
Maldives	-20.4	-15.7
Nepal	-8.3	-10.0
Bhutan	-12.5	-9.6
Sri Lanka	-2.6	-2.8
India	-2.0	-2.3
Bangladesh	-2.0	-2.1

New cross-border transmission line, 762 MW Tamor reservoir project, projected GDP growth of 6.4%

Nepal, India agree to build New Butwal-Gorakhpur transmission line with equal equity investment

From The Kathmandu Post: Nepal and India have agreed to fund a second high-capacity cross-border transmission line connecting Butwal to Gorakhpur in India through a commercial entity with both countries pledging equal equity in funding of the project. The agreement on Tuesday followed a two-day, Seventh Joint Steering Committee and Joint Working Group meeting on Nepal-India Cooperation in the Power Sector in the southern Indian city of Bengaluru. The meeting concluded with agreements on implementation and financing modality of the 135 kilometre-long, 400 kV transmission line and formalisation of an energy banking mechanism between the two South Asian neighbours.

“The sides have agreed to build the transmission line with 20 percent of equity investment and 80 percent debt,” said Energy Minister Barsha Man Pun. It was decided that a company would be formed under the modality within three months and to have a project implementation agreement, within six months.The decision came a month after the Nepali and Indian energy ministers expressed optimism over both sides coming to terms on the development modality of the proposed 400 kV New Butwal-Gorakhpur transmission line project.

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HIDCL, Power China to build 762MW Tamor hydel

From The Himalayan Times: The government has awarded the 762-megawatt Tamor reservoir hydropower project to a Nepali and Chinese joint venture firm. Hydroelectricity Investment and Development Company Ltd (HIDCL) of Nepal and state-owned Power China Corporation will construct the project on government-to-government (G2G) basis. Construction of the Tamor project is expected to start from next fiscal and be completed by 2025.

During Chinese President Xi Jinping’s two-day state visit to Nepal, the Investment Board Nepal (IBN) and Ministry of Energy, Water Resources and Irrigation (MoEWRI) awarded the contract to HIDCL-Power China to build the project under the public-private-partnership (PPP) model. Minister for Energy, Water Resources and Irrigation, Barsha Man Pun, informed that the government has also signed an agreement with Power China to build the 156-megawatt Madi multipurpose hydropower project which is located in Rolpa district. As per an initial study, the project cost is around $39 million.

Earlier, HIDCL and Power China had jointly submitted a project development proposal at the IBN to build both the projects with a share structure of 46:54 per cent for the Tamor project, with the Nepali firm investing 46 per cent and Power China investing 54 per cent of the project cost. Similarly, in Madi multipurpose hydropower project, HIDCL will manage 26 per cent and Power China will manage 74 per cent of the total investment.

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World Bank projects Nepal’s GDP growth rate to average at 6.5%

From myRepublica: The World Bank has projected the growth of Nepal’s gross domestic product (GDP) to average at 6.5% over the current fiscal year – FY2019/20 and the next fiscal year – FY2020/21.The medium-term outlook is supported by government consumption and investment, according to the bank. Reasoning strong services and construction activity due to rising tourist arrivals and higher public spending, the international financial institution made the growth projection for Nepal. 

According to the report, growth on the supply side will be driven by services, underpinned by steady remittance inflows and high tourist arrivals whereas investment and government consumption are expected to be the main drivers of growth on the demand side. The tourist arrivals will be supported by the Visit Nepal 2020 campaign, the completion of the second international airport and the construction of big hotels in the country.