The government is expected to show a big spend budget in 2017-18 when it presents the Union Budget to Parliament in February 2017. Big spend accompanied by tax rate cuts should help negate the effects of demonetization, which is expected to shave off 50bps of GDP growth. RBI has lowered the forecast for GDP growth from 7.6% to 7.1% even as it maintained policy rates status quo in its policy meet this month.
The government and the RBI will also take into account the global growth effects of Fed rate hikes, after the Fed raised rates by 25bps in its December meet and guided for more rate hikes in 2017. RBI will be hard pressed to cut rates in the face of Fed rate hikes and that leaves the government to provide a fiscal boost to the economy.
The government will have room to spend in the budget without disrupting its fiscal deficit target of 3.3% of GDP for fiscal year 2017-18. The demonetization is expected to add over Rs 2 trillion to government revenues both from voluntary disclosure and from demonetized notes not coming back into the system. The government will use this money for spending and that would help pump prime the economy in the next fiscal year.
Economic data has been mixed in the April-November 2016 period. Exports have started to improve with three months of consecutive growth. Exports have just about shown positive growth for the first eight months of this fiscal year. Imports too have rebounded in November 2016, growing by 13% with non oil imports growing by 11.7%. Positive outlook for the world economy driven by the US will help boost India’s trade.
Tax collections too have shown good growth with overall taxes growing by 21.2% driven by indirect taxes that grew by 26% while direct taxes grew by 15%.
Index of Industrial Production (IIP) grew by negative 1.9% in October 2016 and by negative 0.3% in April-October 2016 while manufacturing grew by negative 2.4% and 0.1% respectively. CPI inflation dropped to fourteen months lows of 3.63% in November 2016 and demonetization could have a stronger negative effect on inflation.
Bank credit dropped to 6.6% in November 2016 from 9.9% levels in October 2016 indication sharp drop in working capital requirements as demonetization drove down demand in the economy.
Interest rates have dropped sharply in the economy on the back of RBI rate cuts of 175bps over the last two years and high system liquidity brought about by demonetization, RBI OMO purchases of Rs 1.1 trillion and government spending. Low interest rates can help boost demand in the economy though demand could pick up only in the first quarter of next fiscal year, helped by waning effects of demonetization on tractions and by a positive budget.