Is India a Goldilocks economy now?

This guidance of slowing inflation and accelerating growth given by the economy has initiated discussions that India may be entering the phase of a Goldilocks economy.

Yesterday, the Reserve Bank of India (RBI) held its first monetary policy statement for the fiscal year 2018-19. It kept its interest rates steady, while pruning its inflation forecasts for the first and second halves of FY19. This led to a rally in the bond markets with the 10 year government bond yield falling to 7.17%, a dip of 17bps, from 7.29% of pervious day. Stock markets joined the rally, with the benchmark S&P BSE index surging 578 points to close at 33,596.8.

Though it was largely expected that the RBI would keep its interest rates steady, the dovish tone of the policy statement surprised on the positive side. RBI reduced its inflation forecasts for the first and second halves of FY19, largely indicating that interest rate cycle is about to begin its downward trajectory after nearly 8 months on hold.

Another highlight of the monetary policy statement was that RBI continues to expect India’s $2.3tn economy to grow at a rate of 7.4% for the fiscal year 2018-19. This means that India is set to continue its reign as the fastest growing economy in the world, outpacing China.

This guidance of slowing inflation and accelerating growth given by the economy has initiated discussions that India may be entering the phase of a Goldilocks economy. But what is a Goldilocks economy?

Goldilocks economy –The genesis

A Goldilocks economy is one which enjoys low inflation, sustained economic growth and market friendly policies. This term was supposed to have been first coined by David Shulman, a former Saloman Brothers investment banker, who said he first used it in a note to clients.

Goldilocks economy derives its name from the children’s story “Goldilocks and the Three bears”. In this fairytale, Goldilocks tastes three different bowls of porridge, before deciding that she prefers the bowl which is neither too hot, nor too cold, but has “just the right temperature”.

Similarly, a Goldilocks economy is broadly characterized as one which is neither “hot” enough to fuel higher prices, nor “cold” enough to bring about a recession. It essentially features the conditions of lower unemployment rate, increasing asset prices, low consumer price inflation and sustained economic growth.

Is India in the Goldilocks spot?

The Indian economy may have finally found the sweet spot between slowing inflation and accelerating growth rate. Recent macro-economic data indicates that industrial production has revived, retail inflation has slowed and growth rate has reverted to the 7% levels.

India’s factory output grew at a robust pace for the third straight month, at 7.5% in January, while retail inflation surprisingly slowed for the second consecutive month to 4.4% in February.

The economy regained its momentum in the Q3FY18, recovering from disruptions caused by demonetization and implementation of GST, to expand at 7.2%, the fastest in five quarters.

RBI in its latest policy statement reiterated that growth has been recovering and the output gap is closing, which has reflected in a pick-up in credit off-take in recent months, and the large mobilization of resources from the primary capital market should support investment activity further.

RBI has revised its Consumer price index (CPI) forecast for the first half of FY19 to 4.7-5.1% from 5.1-5.6% and forecast for the second half of FY19 was revised downwards to 4.4% from 4.5-4.6%. Similarly, RBI projected GDP growth at 7.4% in FY19 vs. 6.6% in the previous year.

RBI expects growth to be influenced by revival in investment activity as is indicative from increase in capital goods production and increasing global demand, which would help improve exports and bring in fresh investments.

Can the Goldilocks economy sustain?

However, there are risks pertaining to the Goldilocks economy situation. Globally, if the trade war between US and China escalates, the turmoil could spill-over to the Indian economy. In India, higher minimum support prices announced by the government and other sops could put pressure on government borrowing. RBI in its statement had flagged upside risks to its inflation target including playout of monsoons, uptick in global crude oil prices.

Fixing banks’ balance sheets, containing fiscal deficit, reviving corporate capex, is what the government must do if it wants Goldilocks to stay.

Source – IIFL

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