Economic Survey
A
flagship annual document of the Ministry of Finance, Government of India,Economic Survey 2014–15 reviews
the developments in the Indian economy over the previous 12 months, summarizes
the performance on major development programmes, and highlights the policy
initiatives of the government and the prospects of the economy in the short to
medium term. This document is presented to both houses of Parliament during the
Budget Session.
With
detailed statistical data covering all aspects of the economy—macro as well as
sectoral—the report provides an overview of the following issues:
- Economic Outlook, Prospects, and Policy Challenges
- Fiscal Framework
- 'Wiping Every Tear From Every Eye' : The JAM Number Trinity Solution
- The Investment Climate: Stalled Projects, Debt Overhang and The Equity Puzzle
- Credit, Structure and Double Financial Repression: A Diagnosis of the Banking Sector
- Putting Public Investment on Track: The Rail Route to Higher Growth
- What to Make in India? Manufacturing or Services?
- A National Market for Agricultural Commodities - Some Issues and Way Forward
- From Carbon Subsidy to Carbon Tax: India’s Green Actions
- The Fourteenth Finance Commission (FFC) - Implications for Fiscal Federalism in India?
- State of the economy and Public Finance
- Monetary management and financial intermediation
- External sector and Service sector
- Prices, agriculture and food management
- Industrial, corporate and infrastructure performance
- Climate change and sustainabke development
- Social infrastructure, employment and human development
This document would be useful for policymakers, economists,
policy analysts, business practitioners, government agencies, students,
researchers, the media, and all those interested in the development in the
Indian economy.
The industry contributes about 7% of India'sGDP, employs millions, and is a major source of its foreign exchange earnings. The gems and jewellery industry, in 2013, created ₹251,000 crore (US$37 billion) in economicoutput on value added basis. It is growing sector of Indian economy.
1. MACROECONOMIC REVIEW
1.1 In July 2013, India was teetering on the edge of macroeconomic crisis with double digit
inflation, a high and rising current account deficit (CAD), and a falling rupee as investor sentiment
turned sour in the aftermath of the Fed's taper decision to signal the end of its quantitative easing.
India was grouped with Brazil, Indonesia, Turkey, and South Africa to constitute the Fragile (Famous)
Five amongst the emerging market countries (EMs).
1.2 Nearly 18 months on, the landscape has vastly changed. Macro-economic stability has
returned, reforms are being undertaken, the external environment has moved in India's favour,and above all, a new Government has come into power with a relatively unencumbered political mandate for decisive economic change, a mandate that markets have enthusiastically embraced.
The Indian stock market has increased in value by 33 percent since March (in dollar terms),amongst the highest in the EMs, benefitting from surging foreign capital inflows. India now represents one of the sparks in the world economy and the only major country not to suffer a growth downgrade by the IMF. From Fragile Five to Near-Solitary Spark of the global economy is the Indian narrative of the last year.
1.3 Figure 1.1 captures the change on the macroeconomic front. For the same Fragile Five,a macroeconomic vulnerability index (MVI) has been constructed which adds together a country's inflation rate, current account deficit, and fiscal deficit (all obtained from the latest World Economic Outlook of the IMF). The index is thus comparable across countries and across time. Heading into 2013, India was at the top of the pack on vulnerability with an index value of 22.4, comprising
10.2 percent inflation rate, a budget deficit of 7.5 percent and a current account deficit of 4.7 percent of GDP well above that in the other countries. Turkey in 2013 surpassed India because of high current account deficit (of nearly 8 percent). Since then, India's fortunes have improved dramatically and India demonstrated the greatest improvement in the MVI while the others maintained the status quo or showed only a marginal improvement. The chart, nonetheless, under-states the Indian improvement because the WEO has probably over-estimated India's inflation outturn for 2014. India still needs to be watchful in terms of its macro-economic fundamentals. The value of the index currently is well above 15 (recognizing that a value below 12-say 4 percent inflation, 2 percent CAD, and 6 percent fiscal deficit-is perhaps safer macroeconomic territory).
MID-YEAR ECONOMIC ANALYSIS
Figure 1.1: Macroeconomic Vulnerability Index
(Sum of inflation, current account deficit and fiscal deficit)
1.4 India's vulnerability to the Fed's "taper tantrum" owed also to investor perceptions about the underlying growth momentum. After several years of near 9 percent average growth, India's growth decelerated for about 12 quarters, declining below 5 percent in the last 2 quarters of
FY2014 (Figure 1.2).
Figure 1.2 : Quarterly Growth Rate of Real GDP
1.5 Although it is still too early to detect signs of robust recovery, emerging trends indicate that the growth deceleration has bottomed out, manifested in the relative improvement in growth in the latest 2 quarters
1.6 The macroeconomic improvement and the consequent turnaround in investor sentiment were spurred by the Government's policy actions. A non-exhaustive list of the major reforms includes:
Deregulating diesel prices, paving the way for new investments in this sector;
Raising gas prices from US$ 4.2 per million British thermal unit to US$ 6.17 (a 33 percent increase), and linking pricing, transparently and automatically, to international prices so as to provide incentives for greater gas supply and thereby relieving the power sector bottlenecks;
Increasing FDI cap in defense to 49 percent, and targeting 100 percent FDI in investment;
Replacing the cooking gas subsidy by direct transfers on a national scale;
Instituting the Expenditure Management Commission that will lay out a plan for rationalizing expenditures;
Reforming the coal sector via auctions and greater private sector entry;
Instituting a major program for financial inclusion--the Pradhan Mantri Jan Dhan Yojana - -under which over 9 crore new accounts have been opened till December 11, 2014;
Continuing the push to extending coverage under the Aadhaar program, targeting enrollment for 1 billion Indians;
Eliminating the quantitative restrictions on gold;
Expediting environmental clearances;
Facilitating Presidential Assent for labour reforms in Rajasthan, setting an example for further reform initiatives by the States; and consolidating and making transparent a number of labour laws; and
Implementing a program of disinvestments 1.7 On the inflation front, the key actions were the interest rate increases (of 75 basis points) by the RBI since August 2013, and the broader signalling of anti-inflation policy and framework in the form of the Urjit Patel Committee Report -- all of which contributed to policy credibility. This was significantly helped by this Government’s actions including the continuation of fiscal consolidation, release of food stocks, and crucially by the moderation of minimum support price (MSP) increases,from near double digits previously to 3-3.5 percent, in the case of rice and cereals.
1.8 On the current account, the increase in tariffs and imposition of restrictions on gold last year (since liberalized in two stages in May and then in November 2014) were the key actions that helped reduce the CAD and hence reliance on foreign financing.
1.9 At the same time, the external environment has turned in India's favour. In this fiscal year,there has been a substantial reduction in the global prices of India's major commodity importspetroleum, gold, coal, vegetables oils, fertilizers, and silver (that together constitute 51 percent of total imports and 12 percent of GDP). The reduction in prices has been substantial in some cases- 40 percent in the case of oil, so that the average reduction weighted by GDP is about 1.8 percent of GDP (around 1.5 percent of GDP if India's exports of oil are also taken into account). The collateral benefit has been an improvement in the current account, moderating pressures on inflation, and relief for the fiscal situation as oil subsidies which accounted for about 1 percent of
GDP have also come down.
Short-term Growth Outlook
1.10 The Economic Survey 2013-14 (published in July 2014) observed that during 2014-15 the Indian economy was expected to recover only gradually with growth in real GDP likely in the range of 5.4 - 5.9 per cent. It also noted the possibility of growth remaining on the lower side of the range for the following reasons:
(i) lagged effects of reforms undertaken to restart the investment cycle;
(ii) weak growth outlook in some Asian economies, particularly China that would depress Indian exports;
(iii) elevated levels of inflation that limit the scope of RBI to reduce policy rates;
and
(iv) expectation of below-normal monsoons. The prospect of economic reforms and a strongerthan- expected recovery in some major advanced economies, especially the United States, were expected to bolster the Indian recovery.
1.11 Investment is yet to pick up significantly. But on the upside, inflation has come down dramatically, the monsoons failed to extract as much of a toll on growth as expected, and India received a large supply side shock in the form of reduced commodity prices that amounted to about 1.5 percent of GDP. The year could end with growth around 5.5 percent.
2. OUTLOOK AND CHALLENGES FOR SPECIFIC SECTORS
Fiscal Challenges
1.12 This is an especially challenging year for four reasons that are elaborated in Box below:
The tax base was weaker than expected thanks to unanticipated moderation in inflation;
The revenue projections were over-optimistic;
The budget was unduly burdened by a legacy of carried-over expenditures; and
Above all, the deficit target represented strongly pro-cyclical fiscal policy-consolidation
when growth was below potential-which is ambitious at the best of times and also unusual amongst the major economies today.
Box 1.1: The Challenging FY2015 Budget In line with the Government's commitment to medium term fiscal consolidation, and to ensure macroeconomic stability in the short run, the budget inherited a targeted fiscal deficit of 4.1 percent of GDP, down from 4.5 percent in the previous year. How ambitious a target was this? Evaluating the budget from the revenue side suggests that the target was ambitious. The budget assumed nominal GDP growth of 13.4 percent and a tax buoyancy (relative to nominal GDP) .1.5.1 An overestimation of revenue can result from an overestimation of nominal GDP growth as well as an overestimation of buoyancy.
We attempt here a simple decomposition of the overall overestimation of revenue into these two factors.2 Our estimate is that these two factors together may have led to total tax revenue optimism by about ` 1,05,000 crores or 0.84 percent of likely FY2015 GDP which is broadly the shortfall that now looms ahead. Overestimation due to growth optimism: Significant inflation moderation in India combined with still tepid real growth below potential--will mean that nominal GDP growth will be about 10.6 percent instead of the 13.4 percent assumed in the budget. This will entail revenue optimism to the extent of ` 27,000 crores or 0.22 percent of GDP. Overestimation due to buoyancy optimism: The second reason for the revenue optimism relates to the buoyancy assumptions. The table below shows the average buoyancy for the major revenue items for the previous five years and compares them with the implied assumption in the budget. In many cases, the assumed buoyancy was far in excess of historical performance.
The optimism was greater in relation to indirect taxes than for direct taxes. In the case of service taxes for example, the assumed elasticity over-estimated revenue by 26,000 crore rupees (0.2 percent of GDP). Some of this optimism may have been on account of the expansion of the tax base for services but the assumed buoyancy was apparently not realized. In aggregate, the elasticity assumptions may have led to revenue optimism by about `78,000 crores (0.62 percent of GDP). This experience should inform the forthcoming budget. In addition, the budget was strained by a legacy effect, reflecting the excess carryover of subsides from the past. This amount is difficult to quantify precisely but could range from 0.3 to as much as 1 percent of GDP.
Therefore, evaluating the fiscal performance this year should take account of the legacy costs and the ambitious targets that were inherited. They were ambitious because of optimistic revenue projections, of unanticipated moderation in inflation (the consumer's gain being the Government's loss), and also because of below-potential growth. The latter implies that India is-unusually amongst the major economies according to the IMF-pursuing pro-cyclical fiscal policies. The
Government is committed to meeting the fiscal targets for FY 2015, despite the difficult odds engendered by a combination of these factors. 1 Tax buoyancy is defined as the ratio of revenue growth to the growth in the corresponding base, typically nominal GDP. Tax elasticity is essentially the tax buoyancy controlling for changes in either the tax base or tax rates. The historical buoyancy estimates are roughly also elasticity estimates because for the period under consideration and with some exceptions, there were no major changes in the tax base or rates. We examined the buoyancy estimates with alternate tax bases (for example, manufacturing GDP for excise taxes, services GDP for service taxes) and obtained broadly similar results. 2 Note that the percentage change in revenue generated can be written as the product of the buoyancy and the GDP growth rate. Overestimation in revenue in FY15 resulting from overestimation of buoyancy (col.5 in Table), then, is the product of buoyancy overestimation (difference between the budgeted buoyancy and the 'historical' buoyancy), the nominal growth rate for FY15 and tax collections in FY14 (provisional actual). A similar method is followed to calculate the overestimation resulting from an over-optimistic GDP growth projection Table: Estimating the Revenue Over-Projection in the Union Budget 2014-15
Tax Base Historical
1.9 At the same time, the external environment has turned in India's favour. In this fiscal year,
there has been a substantial reduction in the global prices of India's major commodity importspetroleum,
gold, coal, vegetables oils, fertilizers, and silver (that together constitute 51 percent of total imports and 12 percent of GDP). The reduction in prices has been substantial in some cases- 40 percent in the case of oil, so that the average reduction weighted by GDP is about 1.8 percent of GDP (around 1.5 percent of GDP if India's exports of oil are also taken into account). The collateral benefit has been an improvement in the current account, moderating pressures on inflation, and relief for the fiscal situation as oil subsidies which accounted for about 1 percent of GDP have also come down.
Short-term Growth Outlook
1.10 The Economic Survey 2013-14 (published in July 2014) observed that during 2014-15 the
Indian economy was expected to recover only gradually with growth in real GDP likely in the
range of 5.4 - 5.9 per cent. It also noted the possibility of growth remaining on the lower side of the
range for the following reasons: (i) lagged effects of reforms undertaken to restart the investment
cycle; (ii) weak growth outlook in some Asian economies, particularly China that would depress
Indian exports; (iii) elevated levels of inflation that limit the scope of RBI to reduce policy rates;
and (iv) expectation of below-normal monsoons. The prospect of economic reforms and a strongerthan-
expected recovery in some major advanced economies, especially the United States, were
expected to bolster the Indian recovery.
1.11 Investment is yet to pick up significantly. But on the upside, inflation has come down
dramatically, the monsoons failed to extract as much of a toll on growth as expected, and India
received a large supply side shock in the form of reduced commodity prices that amounted to
about 1.5 percent of GDP. The year could end with growth around 5.5 percent.
2. OUTLOOK AND CHALLENGES FOR SPECIFIC SECTORS
there has been a substantial reduction in the global prices of India's major commodity importspetroleum,
gold, coal, vegetables oils, fertilizers, and silver (that together constitute 51 percent of total imports and 12 percent of GDP). The reduction in prices has been substantial in some cases- 40 percent in the case of oil, so that the average reduction weighted by GDP is about 1.8 percent of GDP (around 1.5 percent of GDP if India's exports of oil are also taken into account). The collateral benefit has been an improvement in the current account, moderating pressures on inflation, and relief for the fiscal situation as oil subsidies which accounted for about 1 percent of GDP have also come down.
Short-term Growth Outlook
1.10 The Economic Survey 2013-14 (published in July 2014) observed that during 2014-15 the
Indian economy was expected to recover only gradually with growth in real GDP likely in the
range of 5.4 - 5.9 per cent. It also noted the possibility of growth remaining on the lower side of the
range for the following reasons: (i) lagged effects of reforms undertaken to restart the investment
cycle; (ii) weak growth outlook in some Asian economies, particularly China that would depress
Indian exports; (iii) elevated levels of inflation that limit the scope of RBI to reduce policy rates;
and (iv) expectation of below-normal monsoons. The prospect of economic reforms and a strongerthan-
expected recovery in some major advanced economies, especially the United States, were
expected to bolster the Indian recovery.
1.11 Investment is yet to pick up significantly. But on the upside, inflation has come down
dramatically, the monsoons failed to extract as much of a toll on growth as expected, and India
received a large supply side shock in the form of reduced commodity prices that amounted to
about 1.5 percent of GDP. The year could end with growth around 5.5 percent.
2. OUTLOOK AND CHALLENGES FOR SPECIFIC SECTORS
Fiscal Challenges
1.12 This is an especially challenging year for four reasons that are elaborated in Box 1.1
below:
The tax base was weaker than expected thanks to unanticipated moderation in inflation;
The revenue projections were over-optimistic;
The budget was unduly burdened by a legacy of carried-over expenditures; and
Above all, the deficit target represented strongly pro-cyclical fiscal policy-consolidation
when growth was below potential-which is ambitious at the best of times and also unusual
amongst the major economies today.
1.12 This is an especially challenging year for four reasons that are elaborated in Box 1.1
below:
The tax base was weaker than expected thanks to unanticipated moderation in inflation;
The revenue projections were over-optimistic;
The budget was unduly burdened by a legacy of carried-over expenditures; and
Above all, the deficit target represented strongly pro-cyclical fiscal policy-consolidation
when growth was below potential-which is ambitious at the best of times and also unusual
amongst the major economies today.
Monetary Policy and Inflation
1.13 One of the dramatic macroeconomic developments in recent months has been the decline in inflation, see Figure 1.3. November inflation printed at 4.4 percent. This represents a dramatic decline from the peak level of 11.2 percent reached in November 2013. These low numbers are not just due to base effects (high inflation today because of low inflation at this time last year).
Even the momentum of headline inflation for the latest three months (average) is 2.4 percent, down from 11.8 percent in (the third quarter of FY2014), a staggering decline.
1.14 Moreover, these developments were unanticipated. Even as recently as September 2014, the RBI's projection for January 2015 was 7.4 percent, representing an over-estimate of nearly 200 basis points. The same was true for most financial market assessments.
1.15 Understanding the latest trends is critical to an assessment of the inflation outturn for
2015 and for the stance of monetary policy going forward. The decline in inflation owes to four factors that are discussed in some detail subsequently:
A. A decline in agricultural prices;
B. A decline in commodity prices, especially oil;
C. Continued economic weakness relative to potential; and
D. Credibility of policy making
1.15 Understanding the latest trends is critical to an assessment of the inflation outturn for
2015 and for the stance of monetary policy going forward. The decline in inflation owes to four factors that are discussed in some detail subsequently:
A. A decline in agricultural prices;
B. A decline in commodity prices, especially oil;
C. Continued economic weakness relative to potential; and
D. Credibility of policy making
A. Agriculture: Since, agriculture constitutes almost 50 percent of the consumer price index
(CPI), it has a decisive impact on the headline. The following developments are particularly
noteworthy:
(CPI), it has a decisive impact on the headline. The following developments are particularly
noteworthy:
Between January 2011 and October 2014, the World Bank's Food Price Index for
food, oil and meals, and grains declined, respectively by 20, 27, and 29 percent.
Moreover, the rate of growth of rural wages, after having averaged 18 percent (26
percent at its peak) for the previous five years, has now decelerated sharply into single
digit territory (see Figure 1.5). This reflects strong disinflationary pressures in agriculture
and signals a slack in the labour market.
Further, the Government has consciously moderated the rate of growth of minimum
support prices (MSPs). After having averaged at over 12 percent from 2007 to 2013,
the MSP for rice and wheat has been brought down to 3.8 percent in the current fiscal
year.
B. Oil prices: Declining commodity prices, especially of oil, have driven inflation down. Oil
and petroleum accounts for about 37 percent of imports and 9 percent of GDP. Oil prices
have declined by about 40 percent this year and have contributed positively and substantially to declining inflation.
C. Economic activity: Despite the sprouting of green shoots, a robust recovery has still to fully take hold (an overview is contained in Chapter III).
food, oil and meals, and grains declined, respectively by 20, 27, and 29 percent.
Moreover, the rate of growth of rural wages, after having averaged 18 percent (26
percent at its peak) for the previous five years, has now decelerated sharply into single
digit territory (see Figure 1.5). This reflects strong disinflationary pressures in agriculture
and signals a slack in the labour market.
Further, the Government has consciously moderated the rate of growth of minimum
support prices (MSPs). After having averaged at over 12 percent from 2007 to 2013,
the MSP for rice and wheat has been brought down to 3.8 percent in the current fiscal
year.
B. Oil prices: Declining commodity prices, especially of oil, have driven inflation down. Oil
and petroleum accounts for about 37 percent of imports and 9 percent of GDP. Oil prices
have declined by about 40 percent this year and have contributed positively and substantially to declining inflation.
C. Economic activity: Despite the sprouting of green shoots, a robust recovery has still to fully take hold (an overview is contained in Chapter III).
In the most recent quarter, the economy grew at 5.3 percent largely due to a positive
performance of agriculture.
Private investment has not yet picked up, and is being held back by the legacy of
distressed corporate balance sheets.
The performance of indirect tax receipts, which grew at 5.6 percent in the first six months,
and the muted pick-up in credit also point to ongoing weakness relative to potential.
D. Credibility of monetary policy: For a long time, the Indian economy had been drifting without a credible monetary anchor. Since late 2013, however, this has been laudably reversed.
Figure 1.4 illustrates this.
1.16 For nearly six years (2007 third quarter to 2013 third quarter), India lost monetary policy credibility, reflected in the fact that real policy interest rates were consistently negative at a time when inflation was persistently in the double-digit territory. For the first time in decades, inflation in India exceeded that in comparator countries (Figure 1.4).
performance of agriculture.
Private investment has not yet picked up, and is being held back by the legacy of
distressed corporate balance sheets.
The performance of indirect tax receipts, which grew at 5.6 percent in the first six months,
and the muted pick-up in credit also point to ongoing weakness relative to potential.
D. Credibility of monetary policy: For a long time, the Indian economy had been drifting without a credible monetary anchor. Since late 2013, however, this has been laudably reversed.
Figure 1.4 illustrates this.
1.16 For nearly six years (2007 third quarter to 2013 third quarter), India lost monetary policy credibility, reflected in the fact that real policy interest rates were consistently negative at a time when inflation was persistently in the double-digit territory. For the first time in decades, inflation in India exceeded that in comparator countries (Figure 1.4).
1.17 That has been reversed since the end of 2013, with real interest rates climbing back into positive territory, and as of today stand just above 2 percent (on a 3-month forward-looking basis). Monetary policy credibility has been gained through important actions both by the RBI and by the Government. For its part, the RBI raised policy rates since July last year and published the Urjit Patel Committee Report, both of which signalled the move towards a flexible inflation targeting regime. In doing so the RBI has clearly demonstrated the capacity to rein in inflation.
1.18 But the Government's contribution to inflation control has been important if somewhat
under-recognized. By releasing stocks at a time that food availability seemed worrisome, and crucially by reining in the increase in MSPs, Government actions, along with declining world prices have moderated the inflationary impulses stemming from agriculture.
1.18 But the Government's contribution to inflation control has been important if somewhat
under-recognized. By releasing stocks at a time that food availability seemed worrisome, and crucially by reining in the increase in MSPs, Government actions, along with declining world prices have moderated the inflationary impulses stemming from agriculture.
Inflation outlook
1.19 The stance of monetary policy will be determined not just by the past developments but an assessment of inflationary impulses going forward. Of the four factors considered above, the most important will be agriculture. But before we discuss agriculture, it is useful to review the outlook for the other factors.
1.20 Oil Prices: The risk that the decline in oil prices will reverse itself always exists. However, the persistence of tempered oil prices seems highly probable for at least three reasons. Demand is softening because of slowing growth in major areas of the world economy, including China and Europe. Noteworthy supply shifts are occurring related to the increase in oil and shale gas production in the U.S. and the concomitant decline in the oligopolistic power of OPEC (notably its swing producer, Saudi Arabia). Finally, the anticipated end to the abnormally low interest cycle in the US and the prospect of future rate increases will favour extraction of oil over keeping it in the ground, thereby further boosting supply and keeping prices soft. Higher rates will also lead to financial asset-reallocation away from commodities, especially oil, as a class into US financial instruments.
1.21 Economic Activity: Shortfalls in the ambitious revenue target in the current fiscal year will likely lead to expenditure cuts, which impact growth especially since expenditure multipliers tend to be high. Therefore, aggregate demand pressures on future inflation from the fiscal side will remain muted.
1.22 Agricultural Inflation: A useful perspective can be gained by categorizing the agriculture
sector into tradable and non-tradable components (recognizing as always that the boundaries between the two are blurred). Tradability and non-tradability vary according to commodity, more in the case of oilseeds and pulses, and also across time as Government policy attempts to insulate the economy from foreign prices, not always symmetrically depending on whether the priority is accorded to producers or consumers. More recently, domestic prices have converged toward international prices.
1.23 Broadly, the determinants of agricultural inflation are external and domestic. On the former, a combination of international prices and the concomitant pressures to adjust minimum support prices influence inflation. Domestic demand pressures depend on the strength of the economy and the fiscal deficit; domestic cost pressures are related to wage growth that may stem from Government programs.
1.24 Looking ahead, we need to assess the outlook separately for these external and domestic determinants of agricultural inflation. According to World Bank projections, global agricultural prices will remain muted, a likely decline of 1 percent in 2015 relative to 2014. This will have a key impact on MSP increases. In wheat and rice, the FOB price and the MSP are close. For this reason, it is likely that the recent trend of modest MSP price increases (of 3-3.5 percent percent) will continue, moderating inflationary pressures.
1.19 The stance of monetary policy will be determined not just by the past developments but an assessment of inflationary impulses going forward. Of the four factors considered above, the most important will be agriculture. But before we discuss agriculture, it is useful to review the outlook for the other factors.
1.20 Oil Prices: The risk that the decline in oil prices will reverse itself always exists. However, the persistence of tempered oil prices seems highly probable for at least three reasons. Demand is softening because of slowing growth in major areas of the world economy, including China and Europe. Noteworthy supply shifts are occurring related to the increase in oil and shale gas production in the U.S. and the concomitant decline in the oligopolistic power of OPEC (notably its swing producer, Saudi Arabia). Finally, the anticipated end to the abnormally low interest cycle in the US and the prospect of future rate increases will favour extraction of oil over keeping it in the ground, thereby further boosting supply and keeping prices soft. Higher rates will also lead to financial asset-reallocation away from commodities, especially oil, as a class into US financial instruments.
1.21 Economic Activity: Shortfalls in the ambitious revenue target in the current fiscal year will likely lead to expenditure cuts, which impact growth especially since expenditure multipliers tend to be high. Therefore, aggregate demand pressures on future inflation from the fiscal side will remain muted.
1.22 Agricultural Inflation: A useful perspective can be gained by categorizing the agriculture
sector into tradable and non-tradable components (recognizing as always that the boundaries between the two are blurred). Tradability and non-tradability vary according to commodity, more in the case of oilseeds and pulses, and also across time as Government policy attempts to insulate the economy from foreign prices, not always symmetrically depending on whether the priority is accorded to producers or consumers. More recently, domestic prices have converged toward international prices.
1.23 Broadly, the determinants of agricultural inflation are external and domestic. On the former, a combination of international prices and the concomitant pressures to adjust minimum support prices influence inflation. Domestic demand pressures depend on the strength of the economy and the fiscal deficit; domestic cost pressures are related to wage growth that may stem from Government programs.
1.24 Looking ahead, we need to assess the outlook separately for these external and domestic determinants of agricultural inflation. According to World Bank projections, global agricultural prices will remain muted, a likely decline of 1 percent in 2015 relative to 2014. This will have a key impact on MSP increases. In wheat and rice, the FOB price and the MSP are close. For this reason, it is likely that the recent trend of modest MSP price increases (of 3-3.5 percent percent) will continue, moderating inflationary pressures.
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