An under-powered economy facing stiff headwinds

The most important takeaway from the Mid-year Economic Analysis of the government is something that has been common knowledge for a while now: that the economy is now powered by just two engines — public investment and private consumption — out of a possible four. The outliers are private investment and exports.

Even as the Centre is patting itself on the back for stepping on the public expenditure pedal at the right time there is a larger question looming: how long will it be able to sustain its expenditure programme in the face of challenges that are already visible on the horizon?

But first the good news. The noteworthy aspect to the increase in public expenditure is its quality. Unlike in the past, the governments — Centre and States — have focussed on capital expenditure which increased by about 0.5 per cent of GDP in the first half, three-fifths of which has come from the Centre. Interestingly, revenue expenditure has fallen by 0.3 per cent of GDP in the same period. States seem to have been prudent in increasing their capital spending from the higher resources that devolved on them after the report of the Fourteenth Finance Commission was accepted. Real gross fixed capital formation by the public sector grew 29 per cent in the first half of this fiscal.

Private consumption has basically anchored the GDP growth in the first half accounting for as much as 3.2 percentage points of the overall growth. But private investment has been rather weak contributing just 1 percentage point while exports have actually dragged down overall growth.

Looking ahead, the second half of this fiscal might actually get a boost as the Centre is unlikely to embark on expenditure reduction programmes as in previous years. This may provide the required ballast for growth to sail past the 7-per cent mark. The worry though is 2016-17 growth.

Given the stress on corporate balance sheets, uncertainty over global economic prospects (critical for exports) and the overall weak demand trends, it is clear that the Centre will once again have to play the rescue act with public spending. Yet, it may not be easy for Finance Minister Arun Jaitley to do an encore in 2016-17. There are strong headwinds that might force him to prune his ambitious expenditure programme.

Implementation of the 7{+t}{+h} Pay Commission’s recommendations will add a straight 0.65 per cent of GDP to government expenditure, according to the mid-year review. The boost of 1-1.5 percentage points to consumption from lower oil prices this fiscal might not repeat next year unless if oil continues to stay at or fall below the current levels of $40 a barrel through 2016, which is unlikely.

A dramatic revival in exports appears unlikely even given the optimism over better prospects for the US economy. Indirect tax revenues soared this fiscal thanks to an increase in excise duties on petrol and diesel and the Swachh Bharat cess. There may not be much room left for further increase in duties on fuels unless if oil prices dip to the $20 a barrel levels, which means that tax revenues might not be as strong.

The chances of keeping the public investment programme going and also meeting the tight fiscal deficit target of 3.5 per cent for 2016-17, thus, appear bleak indeed. There is, of course, the option of consigning the target to cold storage but that will bring forth its own set of problems. For its part, the Mid-year review hints that such a course might not be a bad idea. The 2016-17 Budget will have the answers.