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Sreejith Balasubramanian

The rural agrarian distress in India is now widely acknowledged, as food inflation fell to historical lows and wage growth slowed. With deficient pre-monsoon rainfall and diminishing reservoir levels, the south west monsoon season (June to September) rainfall is back in the spotlight. The season is a crucial driver of rural sentiment and consumption expenditure, as it witnesses more than 70% of India’s annual rainfall, coincides with the Kharif crop sowing season and given that ~50% of food grain cultivation continues to be rain-fed. Further, with the India Meteorological Department (IMD) forecasting a ‘near-normal’ event and global agencies issuing El Niño alerts, the season assumes greater significance this year.
 

What are the weathermen saying this year?
 

The IMD forecasts monsoon rainfall to be 4% below normal while private forecaster Skymet is at 7% below normal. The Australia Bureau of Meteorology recently downgraded its forecast for El Niño, a warming of the Pacific Ocean typically associated with lesser rainfall in South Asia, to ‘watch’ (50% probability) from ‘alert’ (70% probability). It also expects positive Indian Ocean Dipole (IOD) conditions, a warming of the western Indian Ocean which is good for rainfall in India, to prevail during the season.
 

It is worthwhile to note:
 

All El Niño years are not deficient-rainfall years and vice versa (Figure 3). The onset, duration, strength and timing of the peak of El Niño during the season matters. For e.g., a late-season occurrence might cause an early withdrawal of the monsoon rainfall which reduces soil moisture (and impacts sowing) in the following Rabi season. Similarly, a weak and/or short-lived occurrence may not impact rainfall much
 
• Ultimately, it is the spatial and temporal distribution of the monsoon rainfall which matters and not just the headline numbers. The progress of rainfall alongside crop sowing in key regions holds the key
 
• Positive IOD could offset the impact of an El Niño to some extent. However, the interaction between El Niño and IOD phenomenons is still an evolving area of research
 

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IMD forecasts: Under-estimation bias in deficient years
 
We looked at the IMD’s forecasts (made in April and June each year) vs. the actuals in the last ten years (Figure 4).
 

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We found:
 
• The IMD under-estimated (in April each year) occurrences of monsoon rainfall deficiency in 7 of the last 10 years, while it under-estimated rainfall surplus in the remaining 3
 
• The magnitude of IMD’s under-estimation in rainfall is higher for deficiency, compared to surplus
 
• It got the direction (deficient/surplus) wrong in its April forecasts for 4 of the 10 years – 2010, 2011, 2013 and 2016
 
• It got the direction (deficient/surplus) wrong in its June forecasts for 3 of the 10 years – 2011, 2013 and 2016
 
• It changed its June forecast (from April) in the wrong direction in 2 of the 10 years – 2011 and 2017
 
The run-up to the season – deficient rainfall and low reservoir levels
 
It is not the performance of monsoon rainfall on a standalone basis that matters. The run up to the season – rainfall pattern in previous months, reservoir levels in regions with higher irrigation levels – also matters. For e.g., monsoon rainfall with poor temporal and/or spatial distribution on the back of prolonged dry conditions could be more damaging for agri production than otherwise.
 
• The 2018 monsoon season rainfall was 9% deficient, with 31% of the country’s area receiving below-normal or deficient rainfall
 
• The post-monsoon season (October-December 2018) rainfall ended 44% below normal, with 80%+ of the country’s area receiving below-normal/deficient rainfall
 
• The winter season (January-February 2019) rainfall ended above normal, but the normal absolute rainfall during this season is very low and January had ended in deficit
 
• The pre-monsoon season (March-May 2019) just ended 25% deficient with ~61% of the country’s area receiving below-normal/deficient rainfall
 
• Western states of Gujarat and Maharashtra seem to be the worst hit through the above periods – reservoir levels here are the lowest among all the regions.
 

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The crops and states that matter
 
The main food grains grown during the kharif season are rice, coarse cereals and pulses which had a share of 72%, 22% and 6% respectively in FY19 annual production. Looking at the recent rainfall and current reservoir situation in the top five producer-states of these food grains, if monsoon rainfall here turns out to be deficient, we could see an impact on production in:
 
• Uttar Pradesh, a major producer of all the 3 food grains, as pre-monsoon rainfall was deficient and reservoir levels are low
 
• Maharashtra (major producer of coarse cereals and pulses) as the state is already reeling under acute water shortage and heat wave conditions
 
• Other states such as Andhra Pradesh, Telangana, Tamil Nadu and Bihar which together accounted for 22%, 20% and 10% in the production of rice, coarse cereals and pulses respectively in FY17
 
In terms of the impact on crops:
 
• Pulses have the highest area-concentration, with the top 5 producer-states accounting for 74% of the production (Madhya Pradesh alone has a share of 27%). Deficient rainfall in few of these states could impact production
 
• Coarse cereals are quite concentrated too, with the top 5 producer-states accounting for 62% of the production. Further, sowing was already 21% below normal in the previous Rabi sowing season
 
• Rice production is geographically better distributed, with the top 5 states accounting for only 50% of the production (next 5 has a share of 27%). Fall in production in any one region could thus be offset by production from other regions
 
• While a production hit could dampen rural income and consumption, the inflation impact, if any, could occur only if production of rice or pulses are majorly hit because 1) coarse cereals have a very low weightage of ~0.4% in the Consumer Price Index (CPI) unlike rice (4.8%) and pulses (2.4%) and 2) market-offload of the sufficient government stock of rice (and more recently of pulses) would mostly smoothen any price impact
 

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Rainfall impact: more on agri production and consumption than food inflation
 

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Impact on food inflation has waned over the years owing to:
 

• Cereals, which have a high weightage of 9.7% in the CPI, but enjoy steady government stocks that smoothen any price fluctuations
 

• Recent food inflation being driven more by price fluctuations in perishables such as vegetables and fruits
 

• Supply-side government measures
 

What else matters?
 

Apart from the monsoon rainfall and reservoir levels, the overall agri scenario is also impacted by various factors such as global commodity prices, government stock levels, farm input costs and agri trade.
 

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Conclusion
 
• The IMD has forecasted ‘normal’ monsoon rainfall this year, but it has historically under-estimated deficiency. Possibility of a weak El Niño stays afloat despite forecast downgrades
 
• If El Niño turns out to be weak/short-lived or positive IOD plays out, this could aid monsoon rainfall in India, although not all El Niño years have been deficient rainfall years
 
• Spatial and temporal distribution of monsoon rainfall alongside timely crop sowing matters more than headline numbers. Any major delay in sowing could reduce crop yield/quality/price-realization
 
• Pre-monsoon rainfall and/or reservoir levels are deficient in states such as Uttar Pradesh, Maharashtra and a few southern states, which play a crucial role in kharif season crop production. Further deficient rainfall here could impact agri production
 
• Concentration in top-five producer states is the highest for pulses, followed by coarse cereals, which increases the impact of deficient rainfall in key states on production. Rice production is better distributed
 
• Any serious shortfall in monsoon rainfall would most likely impact agri production and private consumption expenditure more than food inflation. The food-inflation impact of monsoon rainfall has been waning more recently due to abundant cereal stocks, higher impact from perishables, government supply side measures and the meagre weight coarse cereals have in the CPI basket
 
• In addition to the above factors, it is important to keep track of global grain prices which have been falling, government rice stock levels which are more than sufficient, farm input costs which could move in line with crude oil prices and agri exports which have stayed relatively flat.
 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the security may or may not continue to form part of the scheme’s portfolio in future.  Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Sreejith Balasubramanian

PM-KISAN, NYAY and the Indian Economy..

By: Sreejith Balasubramanian

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Amidst this season of poll promises, one common scheme announced by both the Bharatiya Janata Party (BJP) and the Indian National Congress (INC) is income support through direct cash transfer. Wrapped in different names, sizes and targets, the broad cost and the operational feasibility of these plans have already been widely debated. We endeavour to gauge the impact of these plans, if implemented, on the core economy, through growth, fiscal and inflation. Given the impact is entirely contingent on 1) the time taken for maximum or full implementation and 2) the level and pace of operational scaling-up during this period, we examine scenarios which depict possible paths of implementation and the corresponding macroeconomic impact.
 
Growth
 
According to a September 2017 study published by the Development Research Group (DRG) of the RBI, for a 10% rise in government expenditure, direct consumption boosts real Gross Domestic Product (GDP) by 85 bps in the first year vs. transfers to households (whether to all or only the bottom 70%) only by 30 bps, with the latter’s impact declining over time. The reasons are:
 
– Unlike direct government consumption, transfer increases the disposable income of households (HHs), part of which is saved (also as cash) depending on the marginal propensity and only the rest is spent on consumption after paying any taxes, etc.
 
– HHs consume more agricultural and industrial goods, which have a lower weight in output (~46% in FY19), while government consumes more services. This reduces the impact of transfers on GDP, tax revenue growth, and therefore investments which determine future growth. One could argue the resulting lower fiscal balance creates higher growth impulse, but 1) the damper direct GDP impact more-than offsets this and 2) the lower skilled and semi-skilled employment generated via household expenditure reduces second round demand creation and future growth.
 
If we paint inflation with the same brush, the impact on the Consumer Price Index (CPI) from any income support plan would be higher than direct government consumption as goods have a much higher weight (76.7%) in the inflation basket than services (23.3%). Further, given the sharp drop in food prices (read farm distress) in the last few years, any incremental consumption could be more heavily skewed towards food items, potentially channelling reflationary pressures there. Rural food & beverages have a weight of 29% in the All-India CPI basket.
 
So far, the merit of direct cash transfers has largely been evaluated only vs. the current system of multiple subsidies, as it is widely acknowledged to plug leakages and thus better for growth. However, the impact on growth of direct transfers vs. other forms of public/private measures needs to be studied and debated more.
 
The fiscal, consumption and inflation impact
 
The BJP’s Pradhan Mantri Kisan Samman Nidhi (PM-KISAN), initially launched targeting families of ‘Marginal & Small’ farmers as per the FY20 interim budget, will be extended to all the farmer families as per its election manifesto (Figure 1).
 
Figure 1: BJP’s PM-KISAN
 

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The key questions are 1) what is the fiscal cost?, 2) how much will this boost household consumption expenditure and 3) what will the likely CPI impact be? The total fiscal cost will be 0.42% of GDP in FY20, if implemented fully (Figure 1). Even if we assume the number of marginal & small land holdings increases in the next agriculture census (which will have data for FY21) by the same amount it did from 2010-11 to 2015-16, the additional cost will only be ~0.02% of GDP. Moreover, the 2020-21 agriculture census is not likely to be released before 2023, based on previous releases.
 
To answer the second and third questions, we need to ascertain households’ Marginal Propensity to Consume (MPC), which is the amount of consumption spending created from every additional rupee of income. The RBI study mentioned previously notes the top 30% of HHs contributed to 84% of HH savings, implying very high consumption for HHs in the bottom 70%. It also notes 68% of all HH earnings is spent on consumption (implying high average propensity to consume). Our own estimate of MPC, derived using linear regression of growth in domestic HH consumption expenditure and gross disposable income as per the new national accounts series (R2 = 0.74), was ~87%. Assuming a slightly conservative MPC of 80%, Figure 2 depicts the likely increase in private consumption generated by the plan, over and above the previous five-year-average growth of 12% (0.53-0.62%), and the likely CPI impact (15-45 bps) ceteris paribus and depending on the pass-through from consumption growth to CPI.
 
Figure 2: Likely impact of BJP’s PM-KISAN scheme on consumption and inflation

 
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Source: CEIC, Agriculture Census 2015-16, India Budget, BJP election manifesto, IDFC MF Research

 

The INC’s Nyuntam Aay Yojana (NYAY) guarantees a cash transfer of Rs. 72,000 per year to ~ 5 crore (the poorest 20%) families, after a year of design, pilot & testing. INC estimates it to cost <1% of GDP in the first year of implementation and <2% of GDP in the second year and thereafter. We explore multiple scenarios, with varying level and pace of implementation, to gauge the likely economic impact (Figure 3).
 
Figure 3: INC’s NYAY
 

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Source: India Budget, INC election manifesto, IDFC MF Research. Note: In each of the three scenarios, we assume 3% of people move out of poverty each year, 5% of FY20 subsidies are discontinued from FY21 and the nominal GDP grows by 11% each year.

 

Again, assuming an MPC of 80% as before, Figure 4 depicts the likely increase in private consumption generated by the plan, over and above the previous five-year-average growth of 12% (0.48-1.95%), and the likely CPI impact (12-146 bps) depending on the pass-through from consumption growth to CPI.

 

Figure 4: Likely impact of INC’s NYAY scheme on consumption and inflation
 

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Source: CEIC, India Budget, INC election manifesto, IDFC MF Research. Note: PFCE is Private Final Consumption Expenditure
 

• Needless to say, the more time it takes for maximum implementation, the lesser the cost as nominal GDP grows and people move out of poverty each year. The possible disincentive for people to move out of ‘poverty’ to remain beneficiaries of the scheme is not considered here for the sake of simplicity
 
• The CPI impact is also lower and smoother (i.e. more evenly spread out) with higher implementation time
 
• While the PM-KISAN scheme is already in the execution phase, the NYAY scheme is still in the strategy & design phase where the finer details such as sources of funding, non-merit subsidies to discontinue, process to identify and verify the target population, estimate of the number of people who move above the scheme-threshold each year, etc. are being chalked out
 
• Therefore, we see the range of outcomes for the fiscal and inflation impact of NYAY at this stage is higher than for PM-KISAN, although the quantum of impact seems higher due to NYAY’s higher transfer However, the actual economic impact will entirely depend on the final size of target population identified, the level and pace of implementation explored using the above scenario-based framework
 

Ultimately, it is worth reminding ourselves all economic resources are limited. For every additional rupee one spends, a rupee is parted with or not received by another. It is essentially only channelisation, but this bigger picture might become visible only in the longer term. Thus, for a holistic assessment, one needs to also consider the longer term and the population not immediately benefited by such government schemes. We need to see more than meets the eye.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Sreejith Balasubramanian

Interim Budget FY20 – What Lies Beneath..

By: Sreejith Balasubramanian

The debate on whether the interim budget was populist (owing to the direct income support for land-owning farmers and higher income tax exemption threshold of Rs. 5 lakhs) and was akin to a full budget (which set a new precedent for election year budgets) continues. In our budget-day note (Interim Budget FY20: Fixed Income Takeaways), we looked at the likely incremental fiscal impulse, higher scheduled borrowing and the key takeaways. In this note, we dig deeper to evaluate how the fiscal situation could eventually play out in FY19 and FY20. For this, we look at the year-to-date revenue/expenditure, year-on-year growth estimates and the conditions under which the estimates could be met. While we gauge how realistic the budget is, we also focus on the accounting details and the rising off-budget transactions.
 
FY19 RE vs. BE – Corporate tax strong but Income tax and GST estimates optimistic; Keep an eye for details and off-budget expenditure
 
1. Net tax revenue stays flat, despite a fall in gross tax revenue (read GST), essentially due to lower transfer to states. This is not just lower CGST-transfer owing to lower collections. Surprisingly, IGST transfer to all states is shown as zero in FY19 Revised Estimate (RE) vs. 21,000cr in FY19 Budget Estimate (BE).
 
2. Within gross tax receipts, Corporate Tax estimates could be met but Income Tax and GST could still disappoint.
 
– Corporate tax has been growing strongly this year. Further, the collection for a full FY was 1.48-1.55 times the April-December collections, in each of the previous four years. The ratio now required to meet FY19 target is very similar at 1.57.
 
– Income tax growth has been well below FY19 target. The collection for a full FY was 1.51-1.56 times the April-December collections, in each of the previous four years. The ratio now required to meet FY19 target is higher at 1.75.
 
– FY19RE CGST of Rs. 5.04 lakh crore assumes a monthly run rate of Rs. 42,000 crores vs. ~ Rs. 37,600 in April-January (CGA numbers for January 2019 are IDFC MF estimates based on PIB data). With only two months to go, we could see a shortfall of Rs. 8-10 thousand crores. However, higher retained-IGST and/or sharing of surplus compensation cess between the centre and states could offset this.
 
3. Overall non-tax revenue stays flat based on the assumption of ~ Rs. 20,000cr extra dividend from the RBI.
 
4. Disinvestments have been slow, but catching up, with ~ Rs. 34,200cr completed in April-December vs. the retained target of Rs. 80,000cr (43% of target completed)
 
5. Expenditure through the budget is only marginally higher, due to higher Capital expenditure. However, off-budget expenditure, better known as ‘Resources of public enterprises’ (excluded from the fiscal deficit calculation) is higher by ~1.6 lakh crore (0.9% of GDP). This is primarily on account of borrowing from Food Corporation of India (FCI), over and above the food subsidy provided by the government through the budget.
 
– Further, funding through ‘Other’ sources apart from Internal Resources, Bonds/Debentures and ECB/Suppliers credit increased by Rs. 1 lakh crore (0.5% of GDP).
– Such heavy and indirect off-budget expenditure questions the quality of the budget and the headline fiscal deficit number. Inclusion of FCI off-budget expenditure, state fiscal deficit and borrowings by the central and state PSEs push the fiscal deficit much higher.
 
6. Capital Expenditure through the budget could eventually fall slightly short, as it did in FY18, particularly when CapEx through PSEs has been revised much higher (although latter is primarily for FCI).
 
7. Despite the additional Rs. 20,000 crore expenditure on the direct income support for farmers, overall revenue expenditure for FY19BE and FY19RE is the same. On closer examination, while expenditure on ‘Central Sector Schemes/Projects’ increased by 19,200 crore (due to the farm package), ‘Other grants/loans/transfers’ reduced by Rs. 41,500 crore. This is owing to a cut in ‘Transfer to GST Compensation Fund’ (under the Department of Revenue) of Rs. 38,300 crores.
 
Figure 1: Budget and year-to-date numbers
 
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Source: CEIC, India Budget, IDFC MF Research. Note: FY19 y/y growth for Central GST, Integrated GST and GST compensation cess is calculated based on annualised FY18 numbers.
 
FY20BE – achievement of FY19RE holds the key
 
1. Gross tax revenue growth is estimated to be slower in FY20, partly due to the higher income-tax-exemption threshold of Rs. 5 lakhs.
 
2. Total central government GST collections is estimated to grow 18% y/y (21% for CGST) vs. nominal GDP growth of 11.5%. This assumes a monthly run rate of Rs. 63,400 crores in FY20 vs. ~Rs. 48,100 in April-January of FY19. This is not impossible but can be achieved only if much stronger compliance (invoice matching) is enforced and improves collections and, as anecdotal evidence suggests, the still-occurring CGST-set-off against the previous regime CENVAT on capital goods is completed at the earliest.
 
3. Non-tax revenue growth slows as the jump in receipts from dividends and economic services (mainly petroleum, roads & bridges and communication-services/spectrum-auctions) falls. Upside risk is the transfer of higher RBI surplus, subject to the decision of the recently constituted RBI Committee on Economic Capital Framework.
 
4. Although difficult to say whether the disinvestment target is realistic, given the current pace and quality, better and early planning next year should definitely help.
 
5. The recent preference for using higher portion of small savings to fund the deficit looks set to continue in FY20.
 
6. Growth in expenditure through the budget is set to slow as CapEx slows sharply and revenue expenditure picks up mildly.
 
7. Off-budget capital expenditure is estimated to fall from FY19 levels, but given the sharply higher FY19RE numbers (due to FCI borrowing), this may not materialise.
 
It is borrowing that finally matters but government guidance could improve.
 
1. Both gross and net borrowing (excluding switch, buyback and short-term borrowing) falls in FY19 vs. budget estimates, but rises vs. the numbers announced during the year.
 
2. Recent government guidance on gross borrowing has not been the best, owing to multiple and frequent revisions during the year (Figure 2). This could improve.
 
3. In FY20, bond supply from gross borrowing increases sharply and so does redemptions to ease following year pressure. Including buybacks, net borrowing is estimated to stay flat.
 
Figure 2: Government guidance on gross borrowing

 
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Source: CEIC, India Budget, IDFC MF Research. Note: 1) Gross borrowing excludes switch, buyback and short-term borrowing, 2) The month of announcement is indicated in brackets in the X-axis
 
Key takeaways
 
1. Within the revised estimates for FY19, Income Tax and GST collections appear a bit optimistic, while corporate tax collections are robust and should meet target.
 
2. This does not mean FY19 actuals exactly slip but a) slightly different revenue mix or b) proportionate expenditure cuts if tax revenues disappoint are possible.
 
3. Expenditure through the budget is only marginally higher in FY19, keeping the fiscal deficit at 3.4%, but expenditure through PSEs has risen.
 
4. Important to note are the accounting details such as a) IGST transfer to all states being shown as zero in FY19RE vs. 21,000cr in FY19BE, b) spike in off-budget expenditure (0.9% of GDP), particularly for FCI, c) the increased preference for funding these expenditures through ‘Other’ channels and d) the sharp cut in ‘Transfer to GST Compensation Fund’ (under the Department of Revenue) to keep revenue expenditure flat despite the outgo towards the farm package in FY19.
 
5. For FY20, meeting receipts would depend on increased GST compliance (invoice matching), RBI dividend transfer and realised disinvestments, but FY19 targets being met is even more crucial. If tax revenues eventually fall short in FY19, FY20BE y/y estimated growth would become higher and thus more difficult to achieve.
 
6. Finally, we are faced with higher-than-expected gross borrowing in both FY19 and FY20, but more importantly, there is scope for improvement in government guidance.

 
While the government has retained the glide path towards the fiscal deficit of 3% in FY21, the feasibility of achieving this has to be evaluated as the actual expenditure on newly announced schemes play out and the full budget is presented by the newly elected government in June/July of this year.
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the security may or may not continue to form part of the scheme’s portfolio in future. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

Tag:

Sreejith Balasubramanian

The Reserve Bank of India (RBI) recently cut its CPI inflation projections for Q3 FY19 sharply, by 90bps in October and 120 bps in December. It cited ‘heightened short-term uncertainties’, amidst unusually low food inflation and volatile crude oil prices. In this context, we look at RBI projections in the last one year – the magnitude of its revisions, directional bias (if any) and precision when compared with the actual numbers. However, for a holistic and fair evaluation of the projections, it is important to factor in the economic context and the corresponding uncertainties it entails. For this, we do a detailed study of the RBI’s fan chart of CPI projections – from the bi-monthly Monetary Policy Committee (MPC) resolution statement – to gauge the RBI’s thinking about the future CPI trajectory, the underlying degree of uncertainty in its projections and how this changed in the last one year.
 
What do the fan charts tell us?
 
Figure 1: RBI’s fan chart of quarterly CPI projections
 

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Source: RBI (MPC resolution statement, 5th December 2018). Note: Data for the 50% CI range is obtained based on visual observation.
 
The RBI’s fan charts on quarterly headline CPI projections (Figure 1), tell us two things – 1) the baseline projection (also mentioned in the statement text) and 2) how confident the RBI is in its projections. For the latter, we look at the range of outcomes associated with a particular probability of occurrence. For e.g., the 50% Confidence Interval (CI) below, on which we focus our study in this note, implies there is 50% probability that the actual outcome will be within the range represented by the thick red shaded area. Higher the width of the range (upper bound minus lower bound), greater the uncertainty or lower the confidence.
 
To decipher the trend in the direction, magnitude and uncertainty of projection-revisions, we look at the data through a series of charts below. Important to note is the RBI’s CPI projections that matter most are the antepenultimate (second before the last) and penultimate (one before the last), given the final projections are either made well into or after the quarter ends.
 
Upside bias despite sharper downgrades
 
Figure 2 depicts the CPI projections for a particular quarter vs. actual, at the last 3 MPC meetings when the forecast for that quarter is provided (after which actual data becomes available), and the economic context.

 
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Source: RBI. Note: Q3 FY19 actual data is the average of October 2018 and November 2018 readings.
 
The key observation is:
 

• The consistent upside bias (over-estimation) in RBI’s projections from Q4 FY18. However, it must be noted that most estimates on the street during the period were also high, given food inflation has stayed unusually soft.

 

Uncertainty fuels volatility while the unusual fuels the margin of error
 
Higher uncertainty (crude oil price, exchange rate) and the unusual (soft food inflation) has defined India’s economic landscape in the last few months. The impact of this feeds into projections as well. See Figure 3 below, which depicts the magnitude of difference in RBI’s projections vs. actual.

 

Figure 3: Recent revisions – impact of the uncertain and the unusual
 

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Source: RBI. Note: Q3 FY19 actual data is the average of October 2018 and November 2018 readings.
 
We observe:
 
• Revisions have been quite heavy and volatile

 
• The margin of error, particularly in the projections for the last 2-3 quarters, have been high
 
• The upward bias in projections

 

To understand this further, we look at the 50% CI range-width for the last three projections of a quarter (Figure 4). While lower width represents lower uncertainty, it should be noted that the width typically reduces as we move into the quarter because actual CPI and market-price data becomes available. Q2 FY19 was an exception, a sheer case of heightened short-term uncertainty.

 

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Source: RBI. Note: All CPI fan-chart related data is based on visual observation of the chart in the MPC policy statement
 
We now look at uncertainty from a different angle. For this, we address the question ‘How confident has the RBI been, at each of its MPC meetings, when making CPI projections for the immediate three quarters?’.
 
Figure 5:  Uncertainty when making projections at the last nine MPC meetings – above average in August and October 2018
 

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Source: RBI. Note: Dotted lines above depict the average for each of the category.
 
Two major inferences from Figure 5 are:
 
• High fluctuation in the degree of confidence within current and next quarter projections vs. quarter-after-next projections
 
• Jump in average uncertainty from the current quarter to the next quarter projection, but only a moderate increase from the next-quarter to the quarter-after next projection.
 

Thus, although the RBI’s confidence is higher when making current quarter projections (which is reasonable given availability of concurrent data), it’s degree is very volatile. Particularly, August 2018 and October 2018 witnessed a sharp fall in RBI’s confidence when making current and next quarter projections. However, as we mentioned earlier, a fair and holistic evaluation of the projections demands an understanding of what transpired in the real economy. In this regard, the table below (Figure 6) captures the volatility in specific economic variables then and how this justifies some of the uncertainty RBI faced. Nevertheless, the magnitude of revisions, the margin of error and even the general upward bias are all still debatable.

 

Figure 6: Economic variables at the last four MPC meetings

 
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Source: RBI, CEIC, IDFC MF Research         Note: Red color = Increase; Green color = Decrease
 
The bottom line
 
Fan-charts, of particular interest due to RBI’s recent sharp downgrades of CPI projections, reveal critical information. The key takeaways from analysing the charts released by the RBI in about the last one year are:
 

    • Consistent upside bias in projections, despite sharp downgrades
     

  • • Sharp revisions to projections more recently
  •  

  • • Higher margin of error (vs. actual), especially in the last 2-3 quarters
  •  

  • • Higher short-term uncertainty evident from episodes of a) higher confidence in projections revised in the wrong direction and b) increasing uncertainty (ideally should be decreasing) about a quarter
  •  

  • • Volatile degree of confidence when making current-quarter projections; particularly low confidence recently at the August 2018 and October 2018 MPC meetings
  •  

  • • The uncertainty around crude oil price and the exchange rate, and the unusually soft food inflation, partially justifies the recent revisions but their magnitude, margin of error and general upward bias are debatable.

 

Finally, there could be two types of errors:
 
• The first is caused by the false-perception of higher certainty. This could cause an error in the direction of the projection made (e.g. the penultimate projection for Q4 FY18).
 
• The second is caused by higher uncertainty. This could cause revision in a projection, despite being in right direction, to be insufficient in terms of its magnitude (e.g. revisions in projections for Q3 FY18, Q1 FY19 and Q2 FY19).

 

Based on the above episodes, it seems the RBI is committing more of the latter. However, this could be because the unusual persistence of softer food inflation continues to surprise.
 
Thus, it is important to keep in mind the above inferences when interpreting RBI’s CPI projections and acknowledge the higher scope and margin for error during uncertain times.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the security may or may not continue to form part of the scheme’s portfolio in future.  Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Sreejith Balasubramanian

Global growth – The case for a Synchronous Slowdown
 
After the synchronous global growth pick up in 2017, growth in the U.S. continued to accelerate and diverged from that in the EU, Japan and China. This was owing to the one-off fiscal stimulus, which included tax cuts and repatriation benefits to corporates, the impact of which is estimated to peak at the end of this year. We explore the case for a synchronous global growth slowdown ahead as the U.S. fiscal impact fades, the Fed continues to hike rates as expected and the economic climate in other advanced countries stays meek (Figure 1).

 

Figure 1: Real GDP growth in the U.S., Japan, EU and China
 

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Global growth – shifting to the slower lane?
 
The PMI heat map below (Figure 2), a good proxy for manufacturing growth, suggests 2018 witnessed lower production growth vs. 2017 in most of the economies except the U.S. The shift is more obvious if we look at the regional aggregates. PMI readings for developed markets, particularly the EU, have decreased almost consistently since the beginning of 2018.

 

Figure 2: Manufacturing PMI heat map – 2018 slips
 
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Growth divergence vs. the U.S.
 
Below, we gauge the extent of the current growth divergence in the EU, Japan and China vs. the U.S through a series of parameters.

 

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Given the economic link through trade, Asian exports too have moderated in 2018 (Figure 11).

 

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What lies ahead

 

In 2018, we witnessed capital outflows and currency depreciation in many Emerging Markets, U.S. Fed rate hikes, rise in crude oil prices (which have eased a bit of late), initial signs of a slowdown in China and escalating tensions of a trade war. Cost of capital in many EMs became dearer due to interest rate hikes in response to the rapid currency depreciation and fear of pass through to inflation.

 

Figure 12: U.S. Fed real GDP median projections (%y/y)
 
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As the impact of fiscal stimulus on growth fades in the U.S. (Figure 12), China is tackling the after-effects of its own deleveraging-drive to curb shadow banking amid further tariff threats from the U.S. and the EU is dealing with Brexit related worries, a high budget deficit in Italy, etc. If 2019 does turn out to be a year of synchronous global growth slowdown, it is unlikely other economies, including India, will remain insulated from such deterioration in the global backdrop.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Sreejith Balasubramanian

India monsoon and agri snapshot: What does normal sowing in a deficient rainfall year mean?
 
The monsoon season (June to September), which coincides with the Kharif crop sowing season in India, draws to a close in four days. Its impact on crop output and rural consumption stems from the fact that rainfall during the season accounts for ~75% of the annual rainfall in a country where 50% of the area under food grain cultivation is still rain fed. This year, rainfall has been deficient for most part of the season. As on 25th September 2018, monsoon rainfall from 1st June is 9% below normal and 30% of the country’s area received below-normal rainfall. Temporally, each of the three months from June to August witnessed 5-6% deficient rainfall and September looks no different. It was particularly weighed down by consistently weak rainfall in East & North East India which has recorded 20%+ deficiency from the start of the season (Figure 1).

 

Figure 1: 2018 monsoon season rainfall till 25th September
 

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Benign impact on crop production and food inflation
 
The impact on crop production could be more benign than what the headline rainfall numbers imply. This is mainly owing to good reservoir levels and a strong pickup in sowing in August (Figures 2-7). That said, lower-than-expected yield from crops sown late into the season and the recent damage to paddy and cotton crops in the north western states of Punjab and Haryana (which together accounted for 15.3% of rice produced in FY16) from torrential rains could dampen the prospects of a bumper crop this year. Instead, crop production could be flat (the Government’s first estimates of production of major Kharif crops for 2018-19 is due this month).
 
Food inflation, even in the consecutive drought years of FY15 and FY16 (when monsoon rainfall was 12% and 14% deficient respectively), averaged only 5% and 5.9% y/y respectively in H2 (8.2% and 4.4% in H1). Better spatial and temporal rainfall distribution this year, adequate food grain stocks and supply side measures by the government should help contain prices of at least cereals and pulses, which are already quite soft.

 

Sowing: Better late than never
 
Crop sowing in July, when typically more than 50% of the season’s sowing occurs, was below normal this year. However, it picked up thereafter in August and total area sown is now above both normal and last year levels for most crops. This is particularly true for rice sowing, which is well above last year levels in most of the southern states and thus more than offset the minor shortfall in eastern states where rainfall has been consistently deficient this year. On the other hand, sowing of coarse cereals has been lagging this year as major producer-states Maharashtra, Rajasthan and Karnataka recorded mildly deficient rainfall and area under irrigation has always been very low. However, coarse cereals have a very low direct weight of only 0.45% in the CPI basket. The direct CPI impact from below-normal sowing of oilseeds could be similarly mild.

 

Figure 2: Sowing summary
 

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However, headline data may not capture the ground-level crop sowing dynamics. To verify, we look at how sowing progressed alongside rainfall in the top five producer-states (Figures 5, 6). The trend augurs well for food grain production this year.
 
Figure 5:Sowing of rice in the main states stabilized in July-August
 
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Figure 6: Sowing of pulses in the main states picked up sharply since July and has stayed high

 
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Reservoir levels
 
Reservoir levels, critical for irrigation during Kharif and Rabi (October-December) seasons, picked up since July. These are currently above the ten-year-average and last year levels in three of the five regions, despite falling slightly in September (Figure 7). The deficit in the western region is from lower levels in Gujarat and Maharashtra which are major producers, but currently lagging in sowing, of oilseeds and coarse cereals.
 
Figure 7: Overall and regional reservoir levels are high except in North and West India
 
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Conclusion
 
1. Rainfall during this year’s south west monsoon season has been mostly deficient. Despite this, Kharif season crop sowing has almost ended at normal levels due to a sharp pick up in August sowing and healthy reservoir levels.
 
2. This could effectively translate into flat crop production and impact food inflation (through cereals and pulses) only mildly, based on previous episodes.
 
3. Further, international weather forecasting agencies currently predict only a weak El Niño event (El Niño is historically associated with weak rainfall in the Indian subcontinent) by end-2018 or early 2019. This alongside the delayed withdrawal of the on-going monsoon should support sowing in the following Rabi season also (accounts for 50% of the annual food grain production) through soil moisture retention and higher reservoir levels for irrigation.

 
4. Moreover, comfortable food grain stocks with the Food Corporation of India (rice stock in September was the highest in five years) and softer global prices (particularly for rice) should help allay any potential price pressures from higher farm input costs (read oil) and Minimum Support Prices (MSPs) announced this year by the government.
 
5. The impact of MSPs is already incorporated in the RBI’s H2 FY19 headline CPI forecast of 4.8% and could only have an impact of 30-40bps this year, given historically inadequate crop procurement except for rice & wheat and the government’s proposal to cover only oilseeds under the Price Deficiency Payment Scheme.<   6. In this backdrop, any meaningful revival in real rural wages for agriculture labourers (currently negative) could be further away.   Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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