Economy Matters, January 2014

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The world's second largest economy, China, is slowly recovering. Even more importantly, the latest forecasts by the World Bank suggest that high-income economies appear to be finally turning the corner. We cover this in the section on Global Trends in this month’s issue of Economy Matters. In the section on Domestic Trends, we discuss the trends emanating out of the recent releases on GDP, IIP, Inflation, trade, and monetary policy. The Sectoral spotlight for this issue is on Manufacturing, which remains an important sector for realizing the higher growth potential of the economy. The section on Taxation dwells on BEPS and carries an interview with Mr. Akhilesh Ranjan, Joint Secretary, Ministry of Finance, Government of India on some critical international taxation issues. In the Special Article, we provide a snapshot of Central Government’s fiscal health along with a detailed Q&A of Mr. R. Seshasayee, Past President & Chairman Economic Policy Council, CII, on the subject. The section on Special Feature carries an article titled “The Tradeoffs for Policy Makers in India Today”, by Dr. Pronab Sen, Chairman, National Statistical Commission, Government of India.
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  • 1. ECONOMY MATTERS Volume 19 January 2014 Rev e No. 01 nue Expe ndit ure Fiscal Situation Cover Story Inside This Issue China GDP Slows Down Review of IIP, Inflation & Trade data Interview with Mr Akhilesh Ranjan, Ministry of Finance Interview with Mr R Seshasayee, Past President, CII Corporate Performance for 3QFY14 Special Feature: Policy Trade-offs by Dr Probab Sen
  • 2. FOREWORD The world's second largest economy, China is slowly recovering, though the pace of recovery has been rather lackadaisical. GDP for 2013 came in at 7.7 per cent- the lowest print in 14 years. In 2013, China tried to maintain strong growth while rebalancing its economy, by moving away from an investment-led growth model to one driven by domestic consumption. Firm recovery in China is very critical for the global economic prospects. The policy makers in China would need to adopt unconventional policy measures to stabilise GDP on higher growth trajectory in 2014, which the country has seen in the last many years. The rebalancing of economic growth in favor of domestic consumption will be crucial in order to achieve this. On the domestic front, the IIP numbers for the month of November 2013 were disappointing and reaffirmed our belief that signs of turn-around are sporadic and at best nascent. On a positive note, WPI inflation moderated to 5-month low in December 2013, driven by deceleration in food prices. RBI meanwhile, chose to hike interest rates again in its third quarter monetary policy review held on 28th January 2014. CII is disappointed with RBI's move as it is important for monetary policy to support growth at this crucial juncture especially when WPI inflation has shown signs of moderation. Low interest rates are the precursor for any meaningful recovery in both investment and consumption demand. Fiscal deficit has already widened to 95 per cent of the budgeted levels in the first nine months of the fiscal, thus raising red flags in the economy. Sluggish revenue growth due to weak GDP growth has been the main driver behind the widening deficit. Unfortunately, the options available in front of the government are clearly limited, given the fact that general elections are due soon. Any compression in plan expenditure in order to meet the fiscal target can be detrimental to growth. Consequently, CII has been advocating several unconventional sources of revenue for the government like utilizing the cash-pile of PSUs, monetising the surplus land lying with them, clearing up the funds held up in disputes and litigations etc time and again in its various dialogues with the government. Chandrajit Banerjee Director-General, CII 1 JANUARY 2014
  • 3. CONTENT Inside This Issue Executive Summary .................................................03 Global Trends 04 Fiscal Situation Cover Story China GDP Slows Down to 14-year Low but Crosses Official Target Domestic Trends 08 With the fiscal deficit having reached 95 per cent of the budgeted estimates for the entire year in the first nine (AprilDecember) months already, the Finance Minister’s call of not breaching the red-line of fiscal target of 4.8 per cent this year looks increasingly difficult. In the Special Article, we provide an analysis of the fiscal situation so far and its impact on the overall growth prospects. GDP, IIP, Inflation, Trade, Balance of Payments, Monetary Policy Taxation Interview with Mr. Akhilesh Ranjan, MoF 16 BEPS Action Plan on TP Mr Ameya Kunte ,Taxsutra.com Corporate Performance 20 Profitability Improves Sharply for Services, while for Manufacturing Remains Subdued in Q3 Sector in Focus 23 Manufacturing Special Article 30 Fiscal Situation Reining in the Fiscal Deficit Mr R Seshasayee , Past President, CII Subsidy Bill Bidisha Ganguly, Principal Economist, CII Special Feature 36 The Tradeoffs for Policy Makers Dr. Pronab Sen, Chairman, NSC Economy Monitor ................................................... 38 ECONOMY MATTERS 2
  • 4. EXECUTIVE SUMMARY two quarters is encouraging, especially, since it comes at the back of a lackluster showing in the preceding several quarters. Global Trends China's economy, the world's second-largest, has shown signs of stabilising, as 2013's growth rate matched that for 2012. Gross domestic product (GDP) grew at an annual rate of 7.7 per cent in the October-toDecember period, down from 7.8 per cent in the previous quarter. With this, the full year GDP growth came in at 7.7 per cent, higher than the government's target rate of 7.5 per cent for the year. Coming to the global economies, the latest forecasts for the world economy released by the World Bank recently suggests that after several years of extreme weakness, high-income economies appear to be finally turning the corner, contributing to a projected acceleration in global growth from 2.4 per cent in 2013 to 3.2 per cent this year. Sector in Focus: Manufacturing Manufacturing sector has played a robust role in driving the GDP growth in the 2005-11 period, when it was growing at around 9 per cent CAGR. However, since then, industry has posted an overall slump, with manufacturing GDP growth at around 3 per cent in 201112 and at around 1 per cent in 2012-13. This is in sharp contrast to the over 10 per cent average annual growth that the sector needs in order to reach its aspiration of 25 per cent share in national GDP by 2022, as envisaged by the National Manufacturing Policy. However, multiple opportunities exist even in this environment; new avenues are still opening up. The depreciation of the currency in 2013 has lent optimism to Indian manufacturers as regards exports. A good monsoon has raised hopes of strong rural demand. Overall, industry is more confident of achieving a higher growth going forward as compared to previous years. Domestic Trends Industrial sector output contracted for the second consecutive month in November 2013, despite a supportive base effect. Industrial output declined to 2.1 per cent in November 2013, worsening from the -1.6 per cent print seen in the previous month. In a positive sign, WPI based inflation moderated to 5-month low of 6.2 per cent in December 2013 as compared to 7.5 per cent in the previous month on the back of cooling of primary food inflation and subdued manufacturing inflation. However, in an unanticipated move, Reserve Bank of India (RBI) in its third quarter monetary policy review held on 28th January 2014 chose to hike the repo rate by 25 bps to 8.00 per cent, citing stickiness in core CPI. Special Article With the fiscal deficit having reached 95 per cent of the budgeted estimates for the entire year in the first nine (April-December 2913) months already, the Finance Minister's firm call of not breaching the red-line of fiscal target of 4.8 per cent this year looks increasingly difficult. A challenging domestic and external economic environment has kept the revenue growth low, while expenditures have so far not shown any signs of abatement. Given that the general elections are due soon, the options available to the government to restrict the fiscal deficit within the budgeted levels of 4.8 per cent are clearly limited. The urgent task, therefore, is to prune expenditure while trying to boost government revenues, especially tax revenues. The axe is bound to fall on plan expenditure and that in turn will have a negative impact on the growth momentum. Under this scenario, it is best for the government to opt for getting revenue from unconventional sources. CII has suggested several innovative measures to prop up the government's revenue stream. Corporate Performance The analysis of the results of the firms in India, which have declared their results so far for the third quarter (Q3) of current financial year, suggests an improvement in their financial result at the aggregate level. It may recalled that the firms had recorded an improvement in their sales growth in the second quarter as well after disappointing previous few quarters as per the RBI analysis of 2,708 listed nongovernment non-financial (NGNF) companies. This improvement in corporate performance for the last 3 JANUARY 2014
  • 5. GLOBAL TRENDS China GDP Slows Down to 14-year Low but Crosses Official Target was the lowest GDP print in 14 years. Consumer price inflation rose by 2.6 per cent in 2013, with the maximum increase coming from food articles. In 2013, China tried to maintain strong growth while rebalancing its economy, by moving away from an investment-led growth model to one driven by domestic consumption. Firm recovery in China is very critical for the global economic prospects. The policy makers in China would need to adopt unconventional policy measures to stabilise GDP on higher growth trajectory in 2014, which the country has seen in the last many years. The rebalancing of economic growth in favor of domestic consumption will be crucial in order to achieve this. C hina's economy, the world's second-largest, has shown signs of stabilising, as 2013's growth rate matched that for 2012. Gross domestic product (GDP) grew at an annual rate of 7.7 per cent in the October-toDecember period, down from 7.8 per cent in the previous quarter. With this, the full year GDP growth came in at 7.7 per cent, higher than the government's target rate of 7.5 per cent for the year. To be sure, this Moderate GDP Growth in 2013 y-o-y% 8.2 8.1 8 7.9 7.8 7.8 7.7 7.7 7.6 7.6 7.5 7.4 7.4 7.2 7 1Q12 2Q12 3Q12 4Q12 Source: National Bureau of Statistics ECONOMY MATTERS 4 1Q13 2Q13 3Q13 4Q13
  • 6. GLOBAL TRENDS In 2013, Chinese policymakers took various steps to open up new avenues of growth. China announced dramatic new social and economic policies contemplating much greater reliance on market forces than it has in the past and inviting private-sector participation and foreign competition in industries, previously controlled by the central government. It also relaxed its one-child policy, opening the country and its people to vast new opportunities. In 2013, the total value added of the industrial enterprises above designated size was up by 9.7 per cent at comparable prices. Specifically, the year-on-year growth of the first quarter was 9.5 per cent, 9.1 per cent for the second quarter, 10.1 per cent for the third quarter and 10.0 per cent for the fourth quarter. Coming to the demand-side, investment in fixed assets (excluding rural households), a measure of government spending on infrastructure, grew by 19.6 per cent in 2013. Retail sales, a key indicator of consumer spending, gained 13.6 per cent on year-on-year basis in December 2013 and rose 13.1 per cent in 2013. Additionally, in order to boost trade, a free trade zone was launched in Shanghai recently. However, challenges are galore for the economy as it steps into 2014. One of the several concerns for the economy currently is the growth of shadow banking - lending by non-banking companies - in the country. Shadow banking makes credit less transparent and poses a major risk to China's economic growth. China is thought to be drafting rules calling for greater supervision and monitoring of the shadow banks. Banks have been told to publish data on 12 key indicators, including offbalance-sheet assets, to enhance their transparency. The total value of imports and exports in 2013 came at US$4,160.3 billion, which translates into an annual increase of 7.6 per cent. Out of this, the total value of exports stood at US$2,210.0 billion, up by 7.9 per cent on y-o-y basis; while the total value of imports was at US$ 1,950.3 billion, registering a y-o-y increase of 7.3 per cent in 2013. Consequently, the trade balance stood at US$259.75 billion for 2013. World Bank Upbeat about 2014 Global Growth The latest forecasts for the world economy released by the World Bank recently suggest that after several years of extreme weakness, high-income economies appear to be finally turning the corner, contributing to a projected acceleration in global growth from 2.4 per cent in 2013 to 3.2 per cent this year, 3.4 per cent in 2015, and 3.5 per cent in 2016, as the drag on growth from fiscal consolidation and policy uncertainty eases and private sector recoveries gain firmer footing. Highincome countries growth is projected to strengthen from only 1.3 per cent in 2013 to 2.2 per cent this year and 2.4 per cent in each of 2015 and 2016. This strengthening of output among high-income countries marks a significant shift from recent years when developing countries alone pulled the global economy forward. United States ticked up in response to expectations of the gradual withdrawal of quantitative easing. Other major headwinds included declining commodity prices for commodity exporters. Overall, growth in developing countries is projected to pick up modestly from 4.8 per cent in 2013 to 5.3 per cent this year, 5.5 per cent in 2015, and 5.7 per cent in 2016. However, it is pertinent to note that the developing-country GDP growth will be about 2.2 percentage points weaker than it was during the precrisis boom period. The developing countries will not cover the entire lost ground because growth in those years was unsustainably high, partly because of the global credit bubble. As per the report, India will see the strongest economic recovery among the major developing economies between 2013 and 2016. Its rate of expansion will go up by 2.3 percentage points, from 4.8 per cent in 2013 to 7.1 per cent in 2016. Interestingly, World Bank projections suggest that the gap between economic growth rates of India and China could narrow sharply by 2016. Chinese economic growth will remain at current levels while Indian growth will accelerate. There will be only a 0.4 percentage point gap in 2016 compared with the 3.1 percentage points gap in 2014. The latest edition of the Global Economic Prospects report published by the multilateral lender further adds that the activity and sentiment in developing countries have turned up since mid-2013, bolstered by strengthening high-income demand and a policyinduced rebound in China. These positive developments were partly offset by tighter financial conditions and reduced capital flows as long-term interest rates in the 5 JANUARY 2014
  • 7. GLOBAL TRENDS World Bank's GDP Growth Forecast (y-o-y %) 8.0 7.7 6.5 6.2 3.2 3.0 2.8 2.8 1.1 0.9 Jun'13 Jan'14 Jun'13 World Jan'14 Jun'13 US Jan'14 Jun'13 Euro Area Jan'14 Jun'13 China Jan'14 India Source: Global Economic Prospects, January 2014- World Bank US Unemployment Rate Falls to 6.7 Per cent The unemployment rate in US declined from 7.0 per cent to 6.7 per cent in December 2013, the lowest since October 2008, as more people dropped out of the labor force. The labor force participation rate, which gauges the proportion of the working-age population in the labor force, slipped to 62.8 percent, down 0.8 percent from a year ago, and the lowest since February 1978. However, the U.S. economy added only 74K jobs in December, the smallest increase since January 2011. The unseasonably severe winter weather last month probably played a part in the disappointing December jobs number. November was revised to 241,000 from 203,000, while October's gain was unchanged at 200,000. Of the 74K jobs created in December, 55K were in retail, above its average of 32K in 2013. Health care was down 6K, a huge drop from its 2013 average of adding 17K jobs. Manufacturing added 9K jobs and construction jobs were down by 16K US Unemployment Rate Falls Sharply Thousand of Jobs 332 350 8 300 238 250 199 200 148 176 241 175 172 200 7 142 150 89 100 74 6 Source: US Bureau of Labour Statistics 6 Dec/13 Nov/13 Oct/13 Sep/13 Unemployment Rate (RHS) US NFP ECONOMY MATTERS Aug/13 Jul/13 Jun/13 May/13 Apr/13 Mar/13 Feb/13 Jan/13 50
  • 8. GLOBAL TRENDS Other Global Developments During the Month The US v Federal Reserve in its meeting held on January 29th, 2014, reduced its asset purchase program further from US$75 billion/month in the month of January to US$ 65 billion month in February. Fed would trim its purchases of long-term Treasury bonds to US$35 billion/month (from US$40 billion) and mortgage-backed securities (MBS) to US$30 billion/month (from US$35 billion). This was Ben Bernanke's last policy meeting as the Fed Chairman. Jenet Yellen takes over as new Fed Chairperson from the next policy. The Consumer price Index (CPI) in the UK grew 2.0 per cent on y-o-y basis in December 2013, falling to its target v level for the first time since November 2009. The inflation has eased dramatically in the last quarter of 2013, averaging 2.1 per cent, in Q4, sharply lower from 2.7 per cent in September 2013. The largest negative contribution came from 'food and non-alcoholic beverages', wherein inflation eased from 2.8 per cent in November to 1.9 per cent last month, marking its lowest level since February 2010. On the other hand, the contribution of 'transport' items - especially petrol and diesel - increased in December 2013. U.K. unemployment fell to 7.1 per cent in the three months through November from 7.4 per cent in the quarter v through October 2013. The data will add pressure on BOE Governor Mark Carney to reassess his guidance policy, under which the Monetary Policy Committee has said it will consider raising interest rates once joblessness has fallen to 7 per cent. In an v update to its World Economic Outlook report, IMF predicted the global economy would grow 3.7 per cent this year, 0.1 percentage point higher than its October 2013 projection. It said it sees growth of 3.9 per cent in 2015. IMF highlighted the basic reason behind the stronger global recovery as the brakes to recovery being progressively being loosened. As per the Fund, United States is likely to be one of the bright spots, after a budget deal in Congress reduced some of the government spending cuts that had weighed on domestic demand. 7 JANUARY 2014
  • 9. DOMESTIC TRENDS GDP, IIP, Inflation, Trade, Balance of Payments, Monetary Policy underpinned by robust performance by exports sector. Industry growth picked up to 2.4 per cent in Q2FY14 from a mere 0.2 per cent in the previous quarter. The revival in industry was led by an improvement in the construction and utilities sector. Manufacturing growth remained weak at 1.0 per cent, albeit it moved into the positive territory from the previous quarter. On the aggregate demand-side, though high interest rates in the economy continue to impact private final consumption expenditure growth, a vibrant rural economy helped to negate some of the ill-effect, thus pushing its growth to 2.2 per cent from 1.6 per cent in the previous quarter. Growth in gross fixed capital formation or investment moved into the positive territory in second quarter, clocking a growth of 2.6 per cent as compared to decline to the tune of 1.2 per cent in the previous quarter. G DP data released on 29th November, 2013 showed that growth increased to 4.8 per cent in the second quarter of the current fiscal (Q2FY14 henceforth) as compared to 4.4 per cent in the quarter before, mainly led by healthy performance by the agriculture sector and mild upturn in industry. With this the first-half growth stands at 4.6 per cent as compared to 5.3 per cent in the same period last year. From the demand-side, GDP picked up to its highest value since March 2012, Real GDP increases in 2QFY14 GDP at factor cost GDP at market prices 5.6 4.8 4.7 4.8 4.4 4.1 3.0 2.4 3QFY13 4QFY13 1QFY14 Source: CSO ECONOMY MATTERS 8 2QFY14
  • 10. DOMESTIC TRENDS The CSO released the revised estimates for 2011-12 and 2012-2013 and final estimates for 2010-11. According to the revised estimates, the economy had grown by 4.5 per cent in 2012-13, compared with the earlier estimate of 5 per cent. Similarly, the growth for 2010-11 was revised downwards to 8.9 per cent
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