ECONOMY MATTERS 2

FOREWORD

T
he month of September 2016 saw two major central banks, the Bank of Japan (BoJ) and the US
Federal Reserve announce their policy decisions. Both of them acted on the expected lines and
delivered little surprise. The Fed decided to leave interest rates unchanged, but it strongly sig-
nalled it could still tighten monetary policy by the end of this year as the labor market improved further.
BoJ meanwhile revealed a new monetary policy framework in order to stimulate Japanese economy
and help it reach the 2 per cent inflation target. Under the new policy framework, the central bank
will target interest rates on government bonds to achieve its elusive inflation target, after years of
massive money printing that had failed to jolt the economy out of decades-long stagnation. The Bank
believes that its monetary policy and the Governments fiscal policy as well as initiatives for strengthen-
ing Japans growth potential will produce synergy effects, and thereby will navigate Japans economy
toward overcoming deflation and achieving sustainable growth.

On the domestic front, although GDP growth moderated to 7.1 per cent during the first quarter of
2016-17 as against 7.5 per cent during the corresponding period last year, there are firm indications
that economic conditions would improve in the coming quarters and new growth opportunities would
emerge when the anticipated boost in demand takes root propelled by good monsoons, the Pay Com-
mission Award and the recent reform initiatives announced by the government. The good performance
of the manufacturing sector, which grew at 9.1 per cent is indeed heartening and points towards better
co-ordinated policies in this area. Inflationary pressure as measured by CPI has moderated sharply on
the back of fall in food prices. The latter has been precipitated by a near normal monsoon so far. Going
forward, we expect CPI inflation to settle within the RBIs target of 5 per cent for March 2017.

In its effort to breathe new life into the Indian corporate bond market, the Reserve Bank of India (RBI)
announced a slew of measures. RBIs measures include, allowing corporate bonds to be accepted un-
der the liquidity adjustment facility, higher ceiling on credit enhancements, providing Foreign Portfolio
investors (FPIs) direct access to bond trading platforms and increasing the risk weightages for non-
rated corporate borrowers. These measures are intended to further market development, enhance
participation, facilitate greater market liquidity and improve communication. An active, well-oiled cor-
porate bond market can help in channelising savings, both from India and abroad, through the bond
route and can complement the traditional banking sector lending.

Chandrajit Banerjee
Director General, CII

1 SEPTEMBER 2016
3 SEPTEMBER 2016
 EXECUTIVE SUMMARY
Focus of the Month: Towards a Vibrant cent in July 2016 as compared to 2.0 per cent growth in
Bond Market & Developments in State the previous month. Contraction in manufacturing and
capital goods output led to the disappointing numbers
Finances
during the month. On the inflation front, WPI inflation
The Reserve Bank of India (RBI) recently announced a
edged up in August 2016 on the back of higher prices
series of measures for the development of fixed income
recorded in fuel and manufacturing sectors. In contrast,
markets. The announcements were quite comprehen-
CPI inflation moderated sharply, providing relief to the
sive and aimed to promote both market efficiency and
policymakers.
liquidity. This came in the backdrop of the recently an-
nounced report of the Working Group on development
Corporate Performance
of corporate bond market in India under the Financial
The corporate results at the end of the first quarter of
Stability and Development Council (FSDC) sub-com-
fiscal year 2017 brought a reason for cheer in the form
mittee. The recommendations in the FSDC report aim
of rising profitability as the financial performance of In-
to promote greater market liquidity, increased market
dian companies, especially manufacturing sector firms,
participation and greater transparency. RBIs measures
improved during the quarter. Manufacturing sector,
included, allowing corporate bonds to be accepted un-
buoyed by a significant fall in inputs costs following the
der the liquidity adjustment facility, higher ceiling on
collapse of global commodity prices, registered a sharp
credit enhancements, providing Foreign Portfolio inves-
pickup in profitability growth in 1QFY17 as compared to
tors (FPIs) direct access to bond trading platforms and
the same quarter a year ago. Worryingly, both bottom-
increasing the risk weightages for non-rated corporate
line and top-line of services sector firms has continued
borrowers. These measures will go a long way in en-
to remain weak so far. The analysis factors in the finan-
hancing investor confidence in the Indian fixed income
cial performance of a balanced panel of 1749 manufac-
markets. To achieve the desired results, it is equally im-
turing companies (excluding oil and gas companies)
portant to ensure active participation from non-bank
and 815 service firms extracted from the CMIEs Prow-
participants. Interlinked with the theme of a vibrant
ess database.
bond market is the importance of healthy condition of
State Finances in India especially with the introduction Global Trends
of GST. In this months Focus of the Month, experts pro- In line with expectations, US Federal Reserve main-
vide their viewpoints on these two important topics. tained status-quo and kept the Federal funds target
range unchanged at 0.25-0.50 per cent in its meeting
Domestic Trends held over two days on 20-21 September 2016 as it await-
GDP growth in the first quarter of the current fiscal
ed more evidence of progress toward its goals, while
came in at 7.1 per cent as compared to 7.5 per cent in
projecting that an increase is still likely by year-end. As
the same quarter last year, while gross value added
regards to its evaluation about the economic activity,
(GVA) at basic prices posted a growth of 7.3 per cent
the Fed upgraded its assessment of the economic activ-
in 1QFY17 as compared to 7.2 per cent in 1QFY16. The
ity on upbeat economic data prints emanating from the
sectoral data print reveals interesting insights into the
economy. Back in Asia, Bank of Japan (BoJ) Governor
data. Even as investment growth contracted in 1QFY17,
Haruhiko Kuroda announced a new monetary policy
government consumption expenditure growth posted
paradigm in order to stimulate Japanese economy and
double-digit growth. Private consumption growth con-
help it reach the 2 per cent inflation target. The intro-
tinued to post respectable growth rate. Going forward,
duction of yield curve control, in which the Bank will
Pay Commission payouts, contained inflation and easy
press for the decline in real interest rates by control-
monetary conditions are expected to support demand.
ling short-term and long-term interest rates, would be
Meanwhile, data on Index of industrial production (IIP)
placed at the core of the new policy framework.
fell back into the negative territory, declining by 2.4 per

5 SEPTEMBER 2016
FOCUS OF THE MONTH
Towards a Vibrant Corporate Bond Market
The Indian Corporate Bond Market in Pursuit
of the Holy Grail
T
he Indian corporate bond market, despite nu-
merous efforts by the regulator, continues to be
stuck in pursuit of the holy grail. A truly vibrant
and efficient corporate bond market would be char-
acterised by a high degree of depth across the credit
curve, greater liquidity, protection of creditor rights
and low information asymmetry, among other things.
The recent measures by the Reserve Bank of India (RBI)
is a welcome step for the development of the bond
market and rightly addresses some of the major supply
ECONOMY MATTERS
side issues. However fails to fully address the demand
side pressure points. The development of bond markets
needs sustained participation of long-term institutional
investors across the credit curve, which is a challenge
the Indian bond market continues to grapple with.
RBIs measures include, allowing corporate bonds to be
accepted under the liquidity adjustment facility, higher
ceiling on credit enhancements, providing Foreign Port-
folio investors (FPIs) direct access to bond trading plat-
forms and increasing the risk weightages for non-rated
corporate borrowers.
RBIs measures for the development of the fixed in-
come and currency markets are a step in the right di-
rection and can help broaden the market over the
medium- to long-term. These initiatives along with the
successful implementation of the bankruptcy laws can
help broaden the markets, assuming some of the other
issues relating to reissuances, stamp duty and asymme-
try of information are addressed in the interim.
6
FOCUS OF THE MONTH
Higher rated corporates will directly benefit in the
short-term due to the last mile efforts of Raghuram
Rajan; however the investment guidelines for most in-
vestor classes will require changes, to move down the
credit curve. Banks and Financial institutions will largely
remain the primary source of funding for corporates,
particularly stressed corporates. India Ratings esti-
mates that the number of borrowers above the thresh-
old of Rs 100 billion debt obligation aggregates 50 - out
of which potentially 24 are either stressed or fairly vul-
nerable.
The measures are likely to give a fillip to the lower rated
category bonds in the long run as the banks reduce their
reliance on loans as an instrument of providing credit to
large corporate issuers. This will incentivise a more dis-
ciplined corporate behavior and not necessarily a more
diversified investor base for them. In the developed
bond markets, the appetite for speculative/non-invest-
ment grade bonds remains high and they are issued and
traded widely. In the Indian bond market however it is
not as easy to place a bond below AA category and
hence a successful and speedy implementation of the
bankruptcy law is keenly anticipated by potential inves-
tors with higher risk appetite.
Measure to increase the aggregate partial credit en-
hancement ceiling to 50 per cent from the earlier 20 per
cent, subject to a single banks exposure of 20 per cent,
will help corporates to raise money through bonds. As-
suming these partial guarantees help improve the rat-
ing of the underlying borrower, this potentially has the
scope of widening the market for potential issuers. The
development of dedicated institutions to provide credit
enhancement and the introduction of the covered bond
regulations, among others can be some of the other
steps which can spur the bond market.
The RBI has made an attempt to provide liquidity in the
bond market by allowing brokers to be part of corpo-
rate bond repo facility. In most developed bond mar-
kets, corporate bonds are permitted to be used as
collateral for liquidity operations. Allowing corporate
bonds as collateral for liquidity operations will improve
the demand for corporate bonds, from the perspective
of banks subscribing to these bonds. This will help de-
velop a robust secondary market for AAA rated bonds
7 SEPTEMBER 2016
(assuming the final guidelines restrict it to AAA paper).
However, this is unlikely to result in investors moving
down the credit curve due to uncertainties relating to
recoveries and asymmetry in information sharing. In a
scenario, where AAA papers remain in short supply due
to bank investments, it could help in the gradual pro-
cess of migrating down the rating curve.
Current measures have not addressed issues with re-
spect to information asymmetry. A bond holder typi-
cally gets information with a lag (especially where the
underlying performance is deteriorating) limiting the
ability of the investors to go down the credit curve and
price the product attractively. Disclosure of covenants
and compliance could be made mandatory to improve
information asymmetry. The recent SEBI circular relat-
ing to information disclosure (including ratios like DSCR
among others) is a positive step and it could be further
strengthened with disclosures on covenants and com-
pliance. This is an international practice that both equity
and debt investors can benefit from.
Long term investors namely pension, provident, gratui-
ty funds among others are major investors in the Indian
bond markets and look for long term investment oppor-
tunities. The investment policies of these funds need to
be aligned with the regulatory changes. The last time
changes were made to the investment policies of these
funds it resulted in some debt market issuers migrating
to the bank loan market. Unless investment policies of
these funds are aligned with other regulatory changes,
it will be difficult to develop a deep and vibrant corpo-
rate bond market in India.
Giving direct access to FPI in the trading platform will
add more vigor, especially in the shorter end of the
curve. However, it will also mean faster transmission
of shocks. Moreover, wide divergences in the normal
ticket sizes for FPIs and retail investors compared to the
normal market lot of Rs 50 million and the price impact
may together deter large scale participation in the near
term.
Listed corporates can now park short term surplus cash
under the repo facility with banks and primary dealers.
Corporates holding on to high short term cash balances
or parking funds with banks may turn to this window;
however with better returns from liquid funds this

mode is unlikely to witness a shift in volumes from MFs
to banks.
India as a country provides a superior rating distribution,
as compared to other emerging markets because of the
RBIs steps to encourage ratings on bank facilities. Fur-
ther, realignment of the risk weightages between low
rated and unrated corporate borrowers, would improve
the quality of information.
RBIs measures address a lot of the supply side issues
facing the corporate bond market. Demand side meas-
ures, however are in the domain of multiple regulators
and each regulator comes with their own set of regu-
lation/investment guidelines. The speed and scale of
developments and innovation in the financial markets
poses a challenge for constantly improving the regula-
tors capacity. Each regulator namely Securities and Ex-
change Board of India (SEBI) Pension Fund Regulatory
and Development Authority (PFRDA), Insurance Regu-
latory and Development Authority of India (IRDA), RBI
though right in their own way but often do not have a
consensus on the larger goal of development of the cor-
porate bond market. Long term measures to develop
ECONOMY MATTERS
FOCUS OF THE MONTH
investor interest with varying risk appetite would also
hinge on increasing the role of alternate investors to
banks, who apportion a large dominant part of financial
savings in the economy.
Over specifying of regulations creates artificial barriers,
thereby leads to distortion and inefficient markets. For
example, the credit enhancement scheme which speci-
fies the amount per bond issue per bank or the rating
grade restrictions for investments by insurance com-
panies. Regulations targeted at tackling the risk arising
out of such provisions without limiting the ability of
markets to innovate would be required. Support from
various stakeholders can lead to a vibrant corporate
bond market in India, which otherwise continues to be
dominated by the public sector and financial institu-
tions.
Globally, the amount of sovereign debt with negative
yields has touched US$13 trillion. This provides a good
opportunity for all the stakeholders to kick start the
corporate bond market in India. Steps to develop masa-
la bonds could also help corporate issuers to develop an
overseas rupee bond market.
(Views expressed are personal)
8
FOCUS OF THE MONTH
Developing the Corporate Bond Market
T
he regulatory initiatives for development of cor-
porate bonds so far have been primarily focused
on product innovation (credit default swaps, cor-
porate bond repo) and infrastructure aspect (manda-
tory trade reporting, exchange based settlement, elec-
tronic bidding platform for private placements). While
product development and robust market infrastructure
are critical enablers, it is equally necessary to have a di-
versified pool of issuers, intermediaries and investors
in order to provide adequate depth and breadth to the
market. A well-functioning corporate bond market can
not only provide the much needed alternative to tradi-
tional bank financing, but can also help reduce borrow-
ing costs for corporates through market based pricing
of credit risk.
The Reserve Bank of India (RBI) has recently announced
a series of measures for the development of fixed in-
come markets. The announcements are quite compre-
hensive and aim to promote both market efficiency and
liquidity. This comes in the backdrop of the recently an-
nounced report of the Working Group on development
of corporate bond market in India under the Financial
Stability and Development Council (FSDC) sub-commit-
tee. The recommendations in the FSDC report aims to
promote greater market liquidity, increased market par-
ticipation and greater transparency.
Firstly, the RBI has issued a discussion paper with a view
to mitigate credit concentration risks in the banking sys-
tem. According to the proposed framework, large cor-
porates would need to rely on debt capital markets for
9 SEPTEMBER 2016
their incremental funding requirements. This measure
will give a major boost to the bond market and will lead
to greater diversity of issuers in the corporate bond
market. However, the investor appetite for issuers
across the credit curve would be a key determinant in
achieving the desired objective. Investment guidelines
of insurance companies and domestic retirement funds
may need to be amended for facilitating investment in
these bonds.
In order to make bond markets accessible to lower
rated issuers, the aggregate limits for partial credit en-
hancement provided by banks to corporate bonds have
now been enhanced to 50 per cent of the issue size in-
stead of 20 per cent earlier. This should enable greater
infrastructure financing through bond markets, as the
credit enhanced bonds can appeal to a wider category
of bond market investors.
In a very significant development, the Parliament has
recently passed the Insolvency and Bankruptcy Code,
2016. The key benefits include time-bound resolution of
corporate defaults (much on the lines of Chapter 11 fil-
ing in the US) and providing a forum to capital market
participants for resolution of disputes relating to corpo-
rate bankruptcies. This is a very positive development,
and once implemented, investors are expected to view
lower rated companies more favorably. However, the
success of the Bankruptcy Code would depend upon
the implementation of the associated legal infrastruc-
ture to support the new framework. The progress on
this front will be crucial to the bond market and will be

watched closely.
RBI has permitted Indian corporates to issue Rupee de-
nominated bonds overseas. This is a win-win product
for both issuers and investors. While issuers can access
new pools of investor capital without assuming curren-
cy risk, investors can access Rupee exposure in an op-
erationally convenient manner. Recently, RBI permitted
Indian banks to issue Rupee bonds overseas, both for
raising capital and infrastructure lending purpose. Since
Indian banks are familiar names in the USD bond space,
there would be investor demand for these bonds. This
would also help develop the offshore quasi-sovereign
Rupee yield curve and will facilitate better price discov-
ery for Rupee denominated bond issuances for corpo-
rates going forward.
In order to promote the repo market for corporate
bonds, RBI has taken positive and concrete measures
toward its development. Corporate bonds would be
considered as eligible securities for liquidity operations,
subject to amendments to the RBI Act. The decision to
include corporate bonds as collateral for LAF transac-
tions may result in spread compression vis--vis govern-
ment securities, leading to lower borrowing costs. An
electronic dealing platform is also being proposed for
repo in corporate bonds. This would introduce central
counterparty facility for corporate bond repo transac-
tions, which would help reduce counterparty risk, mini-
mise documentation and bring more transparency.
For enabling access to markets, RBI has permitted
Foreign Portfolio Investors (FPIs) to trade on NDS-OM
through primary members. FPIs can also trade directly
in corporate bonds without involving brokers. In anoth-
er key initiative, RBI has also permitted individual inves-
tors to invest in government securities through their de-
mat account (even if they dont have a CSGL account).
This would offer operational convenience and liquidity
ECONOMY MATTERS
FOCUS OF THE MONTH
to individual investors and would help increase retail
participation in government securities markets.
A robust corporate bond market demands timely dis-
semination of credit sensitive information and high
standards of transparency. The FSDC sub-committee
recommends mandating credit rating agencies to strict-
ly adhere to the regulatory norms with regard to timely
disclosure of defaults on the stock exchanges and on
their own websites. It also suggests rating agencies
to publish their credit rating transition matrix more
frequently. This would help strengthen investor confi-
dence and increase demand for lower rated issuers.
The measures, as announced by RBI, will go a long way
in enhancing investor confidence in Indian fixed income
markets. To achieve the desired results, it is equally im-
portant to ensure active participation from non-bank
participants. This may be achieved through relaxation
in investment norms of regulated entities like insurance
companies and retirement funds by the respective reg-
ulators. Increased participation of non-bank investors
in corporate bond markets across the credit curve shall
help increase the breadth of the market and will sup-
port in enhancing liquidity in the secondary markets. A
time-bound plan for implementation of the recommen-
dations made in the FSDC sub-committee report is im-
portant in this regard.
The above developments, along with other measures,
would help broaden the issuer and investor base and
would be instrumental in creating a paradigm shift for
the corporate bond markets in India. These reforms will
set the stage not only for widening and deepening the
market itself, but also help to play a supportive role in fi-
nancing the countrys growth. An active, well-function-
ing corporate bond market can channelize savings, both
from India and abroad, through the bond route and can
complement the traditional banking sector lending.
(Views expressed are personal)
10
FOCUS OF THE MONTH
Developments in State Finances
State Finances: Assessing Near Term Prospects
I
ndias federal polity is passing through a historic
phase, in which the states have come to occupy a
prominent position in shaping Indias growth pros-
pects. With central government strongly promoting
the idea of co-operative and competitive federalism,
Indias future growth is likely to be determined by the
dynamism of its federal structure. Promoting both co-
operative and competitive federalism has been an over-
arching theme of the present government. While co-op-
erative federalism encompasses Centres co-operation
with states, competitive federalism involves competi-
tion between the states. The Niti Aayog talks of com-
petitive federalism as a catalyst to achieve the objective
of cooperative federalism.
Reinforcing its Cooperative Federalism agenda, the Gov-
ernment last year took on board the recommendations
of the 14th Finance Commission (FFC). With States now
11
receiving a higher share of tax devolution from the Cen-
tre i.e. 42 per cent as against 32 per cent earlier, along
with greater flexibility in expenditure, their role in driv-
ing regional growth momentum has been enhanced. In
this backdrop, it becomes critical to analyze key issues
that are likely to impact the finances of the states in the
near to medium term. In particular, we assess factors
such as Pay Commission, State Elections and UDAY that
are likely to impact prospects of state finances in India.
Performance of All India state level finances
The data for consolidated All India State-level finances
as released by RBI till FY16(BE) shows that states have
done well to adhere to the mandated fiscal deficit tar-
get of 3 per cent under the FRBM Act while steadily im-
proving the quality of fiscal health since FY05. While the
adverse impact of GFC amid implementation of the 6th
SEPTEMBER 2016

Pay Commission did put some strain on the finances in
FY09 & FY10, states managed to revert to revenue sur-
plus in subsequent years of FY12 & FY13.
However, finances of states deteriorated in FY14 &
FY15 led by lower revenue receipts and higher revenue
spending. In both these years, states at a consolidated
level saw re-emergence of revenue deficit for the first
time since FY10. Moreover, data on 15 state budgets
(mentioned in the table below) shows that trend of
Granular Analysis of FY17 State finances
Granular analysis of 15 state budgets shows that these
states have budgeted for an improvement in their defi-
cit indicators in FY17. Average fiscal deficit ratio as a
percentage of respective state GSDP is expected to im-
prove to 2.7 per cent in FY17 (BE) compared to 3.0 per
cent in FY16 (which worsened by 30 bps as compared to
the Budgeted levels).
Moreover, we find that on average, states diverted
greater quantum of incremental revenue receipts for
ECONOMY MATTERS
FOCUS OF THE MONTH
weakening finances likely continued even in FY16. Our
analysis shows that finances of state governments de-
teriorated in FY16 with average revenue surplus (for 15
states under review) declining to 0.1 per cent of GSDP
from 0.5 per cent budgeted and fiscal deficit rising to
an average 3.0 per cent from 2.7 per cent budgeted for
FY16. The deterioration in finances in FY16 has been
caused mainly by slowdown in states revenue receipts-
both tax as well as non-tax.
capital spending in FY16 compared to budgeted levels
for FY17. On an average, in FY17 ratio of incremental
capital outlay to incremental revenue receipts for 15
states under review is budgeted at 0.25 compared to
0.39 in FY16. State-wise data shows that only UP, Pun-
jab and Odisha failed to divert greater incremental rev-
enue resources to capital spending in post devolution
phase of FY16 & FY17 compared to pre-devolution year
of FY15. As such, transfer of higher resources towards
capex by a majority of larger states following greater
tax devolution from Centre is encouraging.
12
FOCUS OF THE MONTH
Near term factors that could influence state
finances
States endeavor to improve their deficit indicators is
likely to be affected by two factors in the near term:
Pay scale revision on the lines of Seventh Pay Commis-
sion and UDAY. While elections in key states of Uttar
Pradesh and Punjab could add to some pressure on
their finances through possible increase in spending,
astute management of spending priorities could help to
limit the impact.
a) The impact of UDAY
With an objective of financial turnaround of state elec-
13
tricity distribution companies, the government in Nov-
15 announced UDAY (Ujwal DISCOM Assurance Yojana).
UDAY aims at financial revival of DISCOMS through (i)
improvement in operational efficiencies of DISCOMs;
(ii) reduction of cost of power; (iii) reduction in interest
cost of DISCOMs; (iv) enforcing financial discipline on
DISCOMs through alignment with State finances. More-
over, since UDAY seeks to bring to the fore and duly rec-
ognize the contingent liabilities of the states, it adds to
transparency. Additionally, timely intervention to mend
the finances of DISCOMs before the debt on their books
became unsustainable is expected to be long term posi-
tive for the sector.
SEPTEMBER 2016

However, in the short term, UDAY could lead to some
increase in the liabilities of the state governments. For
instance, our analysis shows that while total interest li-
ability is expected to be a lower by Rs 170 billion (due
to lower funding cost) leading to net interest saving for
states and DISCOMS, states may have under budgeted
interest liabilities on SDLs to be issued under UDAY.
Rajasthan, Uttar Pradesh, Chhattisgarh, Punjab, Bihar,
b) Pay Commission
With states having budgeted fiscal consolidation in FY17,
it becomes important to assess the ability of states to
absorb the impact of higher revenue spending that is
likely to come on board for states post implementation
at the Centre. During 6th Pay Commissions, the fiscal
deficit of all States combined deteriorated by 1.6 per
cent between FY08 and FY10. In order to analyze ability
of states to fund Pay Commission relation expenditure,
ECONOMY MATTERS
FOCUS OF THE MONTH
Jharkhand and Haryana are estimated to have under
budgeted their interest liabilities for FY17 by a cumula-
tive of Rs 56.50 billion. Moreover we find that the issu-
ance of bonds under UDAY along with cash compensa-
tion for financial institutions other than banks (leading
probably to issuance of additional SDLs) is likely to in-
crease the outstanding liabilities of all states but Chhat-
tisgarh to a level greater than the mandated 25 per cent
of GSDP in FY17.
we rely on two proxy indicators one, salaries, wages
and pension expenses as per cent of respective reve-
nue expenditure (for 2015-16 BE) and two, proportion of
state government employees in total organized sector.
Basis the above two parameters we arrive at a vulner-
ability matrix for states and find that Kerala and Punjab
stand out in terms of high pension and wages liabilities
while having relatively higher share of state govern-
ment employees in the organized sector and as such
look most susceptible in terms of pay scale revisions.
14
FOCUS OF THE MONTH
Recommendations and Way Forward
States need to complement Centre in its endeavor
towards fiscal consolidation
While the Centre has consolidated its finances each year
between FY13-FY16, by showing restrain in spending,
states have expanded their budget deficits during the
same period. Given the criticality of fiscal consolidation
amid quality spending for inflation management, states
need to prioritize expenditure rationalization to contain
deficits.
Need to divert greater resources towards capex
In light of the continued slack in the private capex de-
mand anticipated for most of FY17, it is vital for states
to complement Centres efforts at reviving capex by al-
locating greater resources towards capital expenditure.
15
Data shows that ratio of incremental capital outlay to
incremental revenue receipts for 15 states under re-
view has been budgeted to decline to 0.25 from 0.39
while being modestly higher than 0.20 in FY15. Given the
transfer of higher tax resources by the Centre, there is
room for states to allocate greater spending towards
capex.
Success of UDAY rests on states
The DISCOM restructuring plan that was launched in
2012 failed to improve the performance of DISCOMS
mainly because of low tariff hikes, lack of progress in
reducing losses, higher electricity purchase costs and
continuous increase in debt. With UDAY making it com-
pulsory for states to absorb losses FY18 onwards, a
failure on part of states to improve the performance of
DISCOMs through timely revision of tariffs would dilute
the purpose for which UDAY was launched.
(Views expressed are personal)
SEPTEMBER 2016

State Finances: Overcoming Fiscal Imbalances
S
tate finances are slated to be subjected to trans-
formational changes with the implementation of
the Goods and Services Tax (GST) and the aboli-
tion of the distinction between plan and non-plan ex-
penditure. Fortunately, they are in a good fiscal position
to handle these changes having overcome the problem
of large fiscal imbalances over the last decade and a
half.
Deficit and Debt
Recent experience indicates that the state governments
have shown significant improvement in the profile of
their fiscal imbalances after enacting Fiscal Responsibil-
ity Legislations (FRLs). In Chart 1, we depict fiscal defi-
cit and revenue surplus relative to GDP from 1990-91 to
2015-16. Individually, states have committed to achieve
a balance on revenue account and limit their fiscal defi-
cit to 3 per cent of their respective GSDPs or equivalent
in terms of interest payments to revenue receipts. The
Twelfth Finance Commission (TFC) had suggested that
state fiscal deficits considered as an aggregate should
be limited to 3 per cent of GDP.
States fiscal deficit was at its peak at 4.7 per cent of
GDP in 1999-2000. In this year, the revenue deficit was
also at its highest at 2.8 per cent. Given these high levels
of fiscal imbalances, the Eleventh Finance Commission
had introduced a States Fiscal Reform Facility (FRF)
ECONOMY MATTERS
FOCUS OF THE MONTH
scheme for the period 2000-01 to 2004-05 to incentivise
states to collectively eliminate revenue deficits. Twelfth
Finance Commission linked substantial debt and inter-
est rate relief to the enactment of State Fiscal Responsi-
bility Legislation. To avail of the incentives recommend-
ed by the TFC, this legislation was required to provide,
at a minimum, for
(a) Eliminating revenue deficit by 2008-09;
(b) Reducing fiscal deficit to 3 per cent of GSDP or its
equivalent defined as ratio of interest payment to
revenue receipts.
The Thirteenth Finance Commission recommended that
the Debt Consolidation and Relief Facility may be ex-
tended to West Bengal and Sikkim, provided they enact
their FRBM Acts.
With these successive incentives given by the Finance
Commissions, states progressively enacted their re-
spective Fiscal Responsibility Legislations (FRLs). Three
states had passed their FRLs even before the central
government. Five states had passed FRBM Acts before
the Twelfth Finance Commission award. Twenty one
states enacted FRBM legislations, incentivised by the
Twelfth Finance Commission award in terms of debt
and interest rate relief. Two states, namely, West Ben-
gal and Sikkim enacted their FRBM legislations in 2010
after the recommendations of the Thirteenth Finance
Commission.
16
FOCUS OF THE MONTH
Clearly, the FRLs have had a beneficial impact in improv-
ing the profile of fiscal imbalances of the state govern-
ments. From 2005-06 onwards, the state governments
considered together, have always been below the
benchmark of 3 per cent of GDP except for 2009-10,
when it marginally crossed this limit at 3.01 per cent. In
the case of revenue balance, states achieved a revenue
surplus in 2006-07 and maintained it up to 2012-13 with
the exception of 2009-10, when revenue deficit was at
0.42 per cent of GDP. However, since 2013-14, there has
been some deterioration in state finances.
The improvement in fiscal deficit also led to a reduction
in the states outstanding liabilities to GDP ratio. At its
peak, this ratio was close to 32 per cent in 2003-04. It
progressively fell to about 22 per cent in 2013-14, that
is an improvement of 10 per cent points. This implied
a fall in the interest payments-GDP ratio for the state
governments facilitating improvement in their revenue
account.
While states successfully improved their fiscal balance
position, there have been considerable inter-state vari-
ations. In Charts 2 and 3, we have shown a comparison
between two points reflecting averages over the peri-
ods 2003-04 to 2005-06 and 2013-14 to 2014-15/ 2015-16.
17
Comparing these ratios with a benchmark line drawn at
3 per cent of GSDP, it is seen that earlier most of the
states were above this benchmark. In the latter refer-
ence period, most of these are below it. The states that
have still not achieved the desired level of fiscal consoli-
dation are Bihar, Karnataka, Jammu and Kashmir, West
Bengal, Himachal Pradesh, Andhra Pradesh and Mizo-
ram.
In the case of revenue deficit also, there is noticeable im-
provement. In the earlier reference period, it is mostly
only the special category states that show revenue sur-
plus. This was not on account of fiscal discipline. Rather
it was the effect of fiscal transfers that they received
from the central government in the form of very large
plan and non-plan grants. In the latter reference peri-
od, a number of general category states show surplus
on revenue account. These are Odisha, Uttar Pradesh,
Bihar, Madhya Pradesh, Gujarat, Jharkhand and Karna-
taka. Further, there are some general category states
which are only marginally in revenue deficit. These are
Rajasthan, Maharashtra, Tamil Nadu and Chhattisgarh.
Thus, there is a widespread improvement in many of
the large states that include some of the low-income
states.
SEPTEMBER 2016
 FOCUS OF THE MONTH

ECONOMY MATTERS 18
FOCUS OF THE MONTH

19 SEPTEMBER 2016

Improvement in Tax Performance
Table 1 shows that the improvement in states fiscal
imbalance profile was largely due to the improvement
in states tax-GDP ratio which increased in two notice-
able phases, first from 1998-1999 to 2006-07 when it
increased from 4.95 per cent to 6.13 per cent. It briefly
fell in 2007-08 and 2008-09 on account of the global
economic crisis also leading to a fall in Indias growth
rate. In the next phase from 2008-09 to 2012-13, it in-
creased from 5.51 per cent to 6.83 per cent. Thus, com-
paring 1998-99 to 2012-13, there was an overall increase
Goods and Services Tax
With the introduction of the GST, there would be major
changes affecting state finances. First, tax autonomy so
far vested exclusively with individual states, will now
be the joint responsibility of the GST Council. Second,
states will share the value added beyond manufactur-
ing with the central government. At the same time,
they will have the additional power to tax value added
in services. In the initial stages, the revenue of the net
consuming and net producing states will be affected dif-
ferently. The net consuming states would gain while the
net producing states would lose but would be brought
on par after compensation. Thus, the net gainers would
be some of the larger but low income states like Ut-
tar Pradesh, Bihar, Madhya Pradesh and Rajasthan. In
the present structure of GST, no explicit allowance has
been made for mineral-rich states such as Odisha, Mad-
hya Pradesh, Jharkhand and Chhattisgarh who are net
exporters of minerals. These minerals are inputs and
not items of final consumption. Therefore, any GST paid
ECONOMY MATTERS
FOCUS OF THE MONTH
in states own tax revenue to GDP ratio of 1.9 per cent
points. This large increase came about first by states
agreeing to floor rates in their sales tax regimes and
preparing ground for the implementation of VAT. Sub-
sequently, they gained from VAT as well as high global
crude prices which resulted in relatively high sales tax
revenues on petroleum products since these were
largely ad-valorem in nature. The fall in the states own
tax-GDP ratio in more recent period starting 2013-14
could also partially be due to the fall in global crude
prices and the corresponding adjustment in the prices
of petroleum products in India.
on these minerals will have to be rebated at later stag-
es. These states will lose revenue in the long run while
suffering from the adverse consequences of the local-
ized pollution related to mineral activities which their
residents will be forced to suffer. As long as alcohol,
petroleum products, electricity and real estate remain
outside the purview of the GST, the tax reforms would
still not be complete.
The impact of GST on states fiscal imbalances would
depend on two factors: first, whether the GST rate
structure proves to be revenue-neutral and second, dis-
tribution of states in the categories of net-consuming
vis--vis net-producing states. If GST involves revenue
losses, at least in the initial stages, the central govern-
ment would be a net loser since through the compensa-
tion mechanism, if it works efficiently, states would be
either net gainers or at least will remain revenue-neu-
tral. However, a net revenue loss to the central govern-
ment will imply a reduction in grants or transfers that it
gives to the state governments.
(Views expressed are personal)
20
DOMESTIC TRENDS
GDP Growth Moderates in 1QFY17

From supply-side, GDP growth driven entire-

ly by services sector

From the supply side, agriculture growth moderated

G
to 1.8 per cent in 1QFY17 as compared to 2.6 per cent
DP growth in the first quarter of the current
growth in 1QFY16. However, farm growth is expected
fiscal came in at 7.1 per cent as compared to
to pick up in line with the improvement in monsoons
7.5 per cent in the same quarter last year,
and the increase in Kharif crop sowing. Manufacturing
while gross value added (GVA) at basic prices posted a
posted robust growth of 9.1 per cent, while construc-
growth of 7.3 per cent in 1QFY17 as compared to 7.2 per
tion sector growth moderated sharply in 1QFY17. Go-
cent in 1QFY16. The sectoral data print reveals interest-
ing forward, lower interest rates and smart recovery
ing insights into the data. Even as investment growth
in private consumption expenditure will help drive in-
contracted in 1QFY17, government consumption ex-
dustrial growth in remaining quarters of FY17. Services
penditure growth posted double-digits growth. Private
sector was the star performer as it grew by 9.6 per cent
consumption growth continued to post respectable
in the reporting quarter cushioned by strong growth in
growth rate. Going forward, Pay Commission payouts,
government spending. However, components such as
contained inflation and easy monetary conditions are
trade, hotels showed moderation as compared to the
expected to support demand.
same quarter last year.

ECONOMY MATTERS 22
DOMESTIC TRENDS
Consumption growth continues to outpace
investment growth
At market prices, private consumption expenditure has
not shown signs of any significant distress and posted a
growth of 6.7 per cent in 1QFY17 from 6.9 per cent in the
same quarter last year. Government spending growth
was very strong for Q1FY17 as it posted 18.8 growth
which was the highest since December 2014. Since the
Going forward, in the short-run, growth will receive a
boost from the cumulative impact of economic reforms
and improved inflationary expectations. Therefore in
23
government has a strong commitment to stick to fiscal
deficit targets, support on this scale is unlikely to con-
tinue in the second half of the year. Gross fixed capital
formation continued to remain a drag on growth and
given the current balance sheet constraints for corpo-
rates, private capex recovery still seems far away. The
external sector showed some recovery as exports grew
by 3.2 per cent in 1QFY17 as compared to a contraction
of 5.7 per cent in 1QFY16.
FY17, CII is projecting a base case of 7.75-8.25 per cent
growth, higher than the 7.6 per cent posted in FY16.
SEPTEMBER 2016
 DOMESTIC TRENDS

Outlook
Although GDP growth moderated to 7.1 per cent during the first quarter of 2016-17 as against 7.5 per cent dur-
ing the corresponding period last year, there are firm indications that economic conditions would improve in the
coming quarters and new growth opportunities would emerge when the anticipated boost in demand takes root
propelled by good monsoons, the Pay Commission Award and the recent reform initiatives announced by the gov-
ernment. The good performance of the manufacturing sector, which grew at 9.1 per cent is indeed heartening and
points towards better co-ordinated policies in this area.
The numbers show that consumption demand has been the main driver of growth in the first quarter of 2016-17
with investment continuing to reflect a subdued performance as compared to last year. CII expects a rebound in
investment, going forward, as the government continues to rev up public expenditure and in the process crowd in
private investment leading to a new demand cycle in the economy.

Industrial Output Contracts in July 2016

The growth in Index of industrial production (IIP) fell
back into the negative territory, declining by 2.4 per
cent in July 2016 as compared to 2.0 per cent growth in
the previous month. Contraction in manufacturing and
capital goods output led to the disappointing numbers
during the month. On a cumulative basis, factory output
in the April-July 2016 quarter contracted by 0.2 per cent
compared to 3.5 per cent growth in the same period a
year-ago. However, going forward, we can expect the
industrial output to recover cushioned by the govern-
ments pro-reform agenda. Overall in FY17, we expect
industrial production to grow at a higher rate as com-
pared to the previous fiscal on the back of policy aided
domestic upturn and low global commodity prices.

Manufacturing output remains lackadaisical
The manufacturing sector contracted by 3.4 per cent in
July 2016 as compared to 0.7 per cent in the previous
month and 4.8 per cent in the same month last year. The
dismal growth in manufacturing sector since November
2015 is a matter of concern and calls for a results orient-
ed action from the government. For the April-July 2016
quarter, the sectors output contracted by 1.4 per cent,
as against a growth of 4.0 per cent a year ago. Growth
also decelerated in the mining and electricity sectors.

ECONOMY MATTERS 24
DOMESTIC TRENDS
Capital goods output contracts for the ninth
consecutive month
According to use-based classification, the capital goods
output witnessed a ninth straight month of contraction
in July 2016, thus raising doubts about the recovery of
investment cycle in the country. The sectors output
contracted by a hefty 29.6 per cent in July 2016 as com-
pared to a decline of 16.7 per cent in the last month
partly due to high base of last year. To be sure, indus-
trial production excluding the output of the capital
goods sector stood at 2.1 per cent during the month as
compared to 4.8 per cent in the previous month. Going
forward, capital expenditure by the Government will be
crucial to support recovery in this segment.
Mirroring IIP output, core sector output too
moderates in July 2016
In tandem with the deceleration witnessed in indus-
trial output growth, core sector output also slowed to
3.2 per cent in July 2016 as compared to 5.2 per cent
growth posted in the previous month, partly due to the
impact of monsoon that hit output in sectors such as ce-
ment. Among the individual segments, cement sectors
growth slowed to 1.4 per cent in July 2016 from of the
impressive 10.3 per cent posted in June 2016. Similarly,
fertiliser production declined to 2.5 per cent in July 2016
from 9.8 per cent in June 2016. Further, electricity gen-
25
Consumer goods output also decelerates
during the month
Consumer goods growth declined to 1.3 per cent in July
2016 as compared to 2.7 per cent in June 2016. Amongst
its sub-sectors, consumer non-durables growth moved
into the negative territory once again in July 2016, after
posting positive growth in June 2016. In contrast, out-
put of consumer durables sector quickened to 5.9 per
cent in July 2016 as compared to 5.6 per cent posted in
the last month. The boost in consumption due to the
implementation of 7th Pay Commission report is expect-
ed to improve the growth of this sector further, going
forward.
eration registered a mere 1.6 per cent in July 2016, which
was the lowest since the zero per cent growth in No-
vember 2015. Steel production also contracted by -0.5
per cent, the lowest since it shrunk by the same margin
in February 2016. Crude oil production also shrunk by
-1.8 per cent in the reporting month. On a cumulative
basis, core sector output stood at 5.4 per cent during
April-July 2016 as compared to 2.5 per cent in the same
period last year. In contrast, output of refinery prod-
ucts accelerated to 13.7 per cent the highest growth
achieved since 17.9 per cent in April 2016. Natural gas
also recorded 3.3 per cent growth in July 2016 after four
months of contraction
SEPTEMBER 2016
 DOMESTIC TRENDS

Outlook
The contraction in industrial output during July 2016 is worrisome as it indicates that industry is performing much
below its underlying potential. What is causing concern is that both manufacturing and capital goods sectors are
witnessing an anemic trend in output implying that growth impulses are still weak. But we hope that going for-
ward, aggregate demand would pick up based on pay rise of government employees and the reform initiatives
recently taken by the government to induce demand in the economy.

CPI Inflation Moderates, While WPI Inflation Inches Up

Wholesale Price Index (WPI) based inflation quickened
to a two-year high of 3.7 per cent in August 2016 from
3.55 per cent in July 2016 on high fuel and manufactur-
ing inflation. This was the fifth straight month of WPI
inflation after continued deflation for over a year. In
contrast to a jump in WPI inflation, CPI inflation cooled
sharply to 5.1 per cent in August 2016 as compared to
6.1 per cent in the previous month. The main driver be-
hind the deceleration in CPI inflation was food inflation
which edged down to 5.8 per cent in August 2016 from
7.96 per cent in the previous month. The most signifi-
cant development was the sharp plunge in vegetables
inflation to 1 per cent in August 2016 from 14 per cent
seen in the previous month.

ECONOMY MATTERS 26
DOMESTIC TRENDS

WPI primary articles inflation moderates in
August 2016
Coming to WPI sub-categories, inflation in primary ar-
ticles slowed down to 7.5 per cent in August 2016 as
compared to 9.4 per cent posted in July 2016. Within
primary articles, inflation in both food and non-food sub
categories decelerated during the reporting month. Pri-
mary food inflation moderated to 8.2 per cent (as com-
pared to 11.8 per cent in July 2016) while non-food infla-
tion stood at 8.4 per cent (as compared to 9.5 per cent
in July 2016). A normal monsoon so far has boded well
for reining in high food prices.
Inflation in fuel category moves to positive
territory after a gap of 21 months
Inflation in the fuel group of WPI moved to the positive
territory after a gap of 21 months in August 2016 as it
stood at 1.6 per cent. The upward movement in global
crude oil prices owing to the ongoing political tensions
in Venezuela, Libya and Nigeria has pushed fuel inflation
into the positive territory. Inflation in high speed diesel
quickened to 12.2 per cent during the reporting month
as compared to 6.6 per cent in July 2016. Petrol infla-
tion too moved to -8.6 per cent as compared to -10.3 per
cent in the previous month.
Manufacturing inflation quickens in August
2016
Inflation in manufactured group quickened to 2.4 per
cent in August 2016 its highest reading since October
2014, as compared to 1.8 per cent posted in the previous
month. Manufacturing food inflation which had moved
to double-digits in July 2016 continued its upward tra-
jectory, rising further to 11.4 per cent in August 2016
from 10.2 per cent in the previous month. Meanwhile
manufacturing non-food inflation (popularly called as
core inflation and a proxy for demand-side pressures in
the economy) too accelerated mildly to 0.6 per cent in
the reporting month from 0.1 per cent in the previous
month. With core inflation recording an increase after a
prolonged period of deflation, there are indications that
demand is returning to the economy.

Outlook
WPI inflation edged up in August 2016 on the back of higher prices recorded in fuel and manufacturing sectors. In
contrast, CPI inflation moderated sharply, providing relief to the policymakers. Going forward, CII expects CPI infla-
tion to settle within the RBIs target of 5 per cent for March 2017 as food prices are expected to ease going forward
on account of a spate of reforms undertaken by the present government to address the supply bottlenecks and
the expectation that monsoon would be normal after two consecutive years of drought. This should spur RBI to
resume its rate easing cycle as investments continue to be sluggish.

27 SEPTEMBER 2016

Monsoon Deficit: Nothing to Worry About
SW monsoon expected to be normal despite
3 per cent monsoon deficit so far
India is heading towards a normal South-west mon-
soon this year, notwithstanding the monsoon deficit
of 3 per cent below long period average (LPA) till 28th
September 2016. The India Meteorological Department
(IMD) categorizes rainfall in the 96-104 per cent long-
period average range as normal and rainfall between
104-110 per cent of LPA as above normal. Much of the
rainfall deficit has been seen in East & Northeast parts
and South peninsula of the country, which are either
predominantly non-agriculture dependent or are well
irrigated.
Record production of kharif foodgrains as
per 1st advance estimate
The importance of a normal monsoon this year is par-
ticularly crucial given the high food inflation rates seen
currently. In this context, the news of 1st advance esti-
mates of total kharif foodgrains estimated at a record
high of 135.03 million tonnes is heartening. This year the
estimated production is higher by 11.02 million tonnes
Kharif crops sowing progressing well, ex-
cept for cotton
Kharif sowing starts with the onset of June and the crop
is harvested during September-October. Area sown un-
der kharif crops increased to 1067.53 lakh hectares by
23rd September 2016. This is 3.6 per cent higher than
the area sown at this time last year. Much of the food
inflation last year was driven by high inflation in pulses,
but encouragingly pulses have recorded the largest in-
crease in area sown to the tune of 29.1 per cent this year
so far. As of 23rd September 2016, area under pulses
measured 145.84 lakh hectare as compared to 112.93
lakh hectare a year-ago. Among pulses, arhar recorded
the maximum increase in acreage. Area sown under
ECONOMY MATTERS
DOMESTIC TRENDS
as compared to last years kharif foodgrains production
of 124.01 million tonnes. Further, kharif foodgrains pro-
duction is also higher by 7.65 million tonnes than the
last five years (2010-11 to 2014-15) average production
of 127.38 million tonnes. Notably, production in pulses
(which has seen double-digit inflation in the last couple
of months) has been estimated at a record level of 8.70
million tonnes which is higher by 3.16 million tonnes
than the last years production of 5.54 million tonnes.
Kerala records the highest rainfall deficiency
so far
Among the major states, rainfall deficiency has so far
been the highest for Kerala, with the rainfall gap (from
1st June to 23rd September, 2016) standing at 32 per cent
followed by Punjab and Haryana (each at 25 per cent
below LPA). North Eastern states have also received
large deficit in rainfall so far. In contrast, the states
which have received bountiful rainfall so far include- Ra-
jasthan (30 per cent above LPA), Madhya Pradesh (18
per cent above LPA), Maharashtra (11 per cent above
LPA), Andhra Pradesh (7 per cent above LPA) and Telan-
gana (3 per cent above LPA).
rice increased by 2.6 per cent to 387.04 lakh hectare
while under coarse cereals expanded by 3.3 per cent to
189.58 lakh hectares in the period 1st June-23rd Septem-
ber 2016. Coarse cereals include jowar, bajra, maize and
ragi.
The acreage under oilseeds, as a group, stood at 189.16
lakh hectares, up 3.0 per cent compared with last year,
with groundnut recording a staggering 29.0 per cent
increase, chiefly due to the higher plantings in Andhra
Pradesh, Rajasthan, Karnataka and Gujarat. A key pres-
sure point with regard to the sowing of major kharif
crops has been that of cotton, whose acreage has fallen
by 11.6 per cent over the last year, mainly due to poor
rainfall in Gujarat, which happens to be the key cotton
growing state in the country.
28
DOMESTIC TRENDS
Going forward, improved reservoir levels and high re-
sidual soil moisture will be supportive of forthcoming
Rabi crop. Rabi crop accounts for nearly 50 per cent
of countrys total food output. In addition, Northeast
monsoon over October to December are important
Magnitude of Contraction in Exports Narrows
Merchandise exports continued to remain in the nega-
tive territory for the second consecutive month, albeit
the magnitude of contraction reduced sharply in August
2016, aided by a favorable base. Exports fell by 0.3 per
cent on year-on-year basis to US$21.5 billion in August
2016 as compared to contraction to the tune of 6.8 per
cent in July 2016.
Export performance improved sharply with 14 out of
30 major commodities posting positive growth as com-
pared to 8 commodities seen last month. The key sec-
tors posting positive growth during the month were
iron ore, fruits & vegetables, marine products, gems
& jewellery and electronics. Cereals, oil seeds and pe-
troleum products exports contracted sharply. On a
cumulative basis, for the period April-August 2016, mer-
29
for 5 metrological subdivisions of southern India (Tamil
Nadu, Coastal Andhra Pradesh, Rayalaseema, Kerala
and south interior Karnataka) as they receive 30 per
cent of their annual rainfall in these months.
chandise exports stood at US$108.5 billion, registering
a contraction of 2.98 per cent on a year-on-year basis.
Imports continue to post contraction
Merchandise imports contracted by 14.1 per cent to
US$29.1 billion in August 2016 as compared to a decline
of 19 per cent in the last month. During April-August
FY17, Indias cumulative merchandise imports stood at
US$143.2 billion, registering a negative growth of 15.89
per cent on a year-on-year basis. Coming to the sector
bifurcation, oil imports during August 2016 contracted
by 8.5 per cent to US$6.74 billion during the month.
Meanwhile, non-oil imports during August 2016 were
estimated at US$22.4 billion which was 15.7 per cent
lower than non-oil imports of US$26.1 billion in August
2015.
SEPTEMBER 2016

Merchandise trade deficit narrowed marginally to
US$7.7 billion in August 2016 from US$7.8 billion in the
previous month. A much steeper fall in imports vis-a-vis
exports, led to this contraction in trade deficit. Cumu-
latively, during April-August 2016, Indias trade deficit
stood at US$34.7 billion, 40.6 per cent lower than the
Current Account Deficit Contained in 1QFY17
Current account deficit (CAD) for the first quarter of the
current fiscal (1QFY17) stood at US$0.3 billion or 0.1 per
cent of GDP, the same as the preceding quarter. In the
same quarter last year, CAD stood at US$6.1 billion or
1.2 per cent of GDP. The contraction in CAD in the June
quarter was primarily on account of narrowing of the
trade deficit to US$23.8 billion from US$34.2 billion a
year ago. On a balance of payments (BoP) basis, mer-
chandise imports declined sharply (by 11.5 per cent) as
compared to merchandise exports (which declined by
2.1 per cent), leading to a lower trade deficit in Q1FY17.
ECONOMY MATTERS
DOMESTIC TRENDS
year-ago period. Going forward, while improving do-
mestic competitiveness through structural reforms is
crucial to improve exports performance; we believe
that this can only materialize in the medium-term. In the
near-term, a weaker rupee can act as a catalyst to revive
competitiveness.
Lower remittances offset by sharp narrow-
ing of merchandise trade deficit
Invisibles related flows were lower at US$23.5 billion in
1QFY17 as compared to US$28.0billion in the same quar-
ter last year. Component wise, net services receipts de-
clined on a y-o-y basis, largely due to a fall in net earn-
ings on account of travel, financial services and other
business services. Private transfer receipts, which rep-
resent remittances by overseas Indians, amounted to
US$15.2 billion, declining from their level in the preced-
ing quarter as well as from a year ago. Going forward
there is a risk of further lower inflows from Middle East
region amid decline in crude oil prices and economic
slowdown in that part of the world.
30
DOMESTIC TRENDS
Concerns persist on lower foreign invest-
ment front
Net capital account moderated sharply to US$7.1 billion
in 1QFY17 as compared to US$18.6 billion in the same
quarter last year mainly on account of lower net foreign
investment. The global financial market uncertainty, led
by the slowdown in China, steep decline in commodity
prices and the likely trajectory of US Fed rate hikes, has
weighed on the capital flows across EM economies and
India was not immune to the trend.
To be sure, net foreign direct investment moderated to
US$4.1 billion in Q1FY17 from US$10.0 billion in Q1FY16
and US$8.8 billion in the Q4FY16. On the other hand,
We expect CAD to come below 1 per cent of GDP in FY17.
The key risk to the outlook is volatility in portfolio relat-
ed flows and deceleration in remittance related inflows.
From a longer term perspective, although the external
31
portfolio investment, recorded a net inflow of US$2.1
billion in Q1FY17 as against a marginal outflow in the cor-
responding period of last year and an outflow of US$1.5
billion in the preceding quarter, primarily reflecting net
inflow in the equity component. Higher repayments un-
der external commercial borrowings led to a net out-
flow under loans to India in Q1FY17 as against net bor-
rowings in the same period last year.
Foreign exchange reserves (on a BoP basis) increased
by US$6.9 billion in Q1FY17 as compared with an accre-
tion of US$11.4 billion in Q1FY16 and US$3.3 billion in the
preceding quarter.
sector performance remains favorable, the sustainabil-
ity of the same is still doubtful. Continued weakness in
exports performance due to global headwinds is a po-
tential risk for the sector.
SEPTEMBER 2016
CORPORATE PERFORMANCE
Corporate Profitability on the Upswing in 1QFY17
Manufacturing firms register rising profit-
ability in 1QFY17 as compared to 1QFY16
The corporate results at the end of the first quarter of
fiscal year 2017 brought a reason for cheer in the form
of rising profitability as the financial performance of In-
dian companies, especially manufacturing sector firms,
improved during the quarter. The manufacturing sec-
tor, buoyed by a significant fall in inputs costs following
the collapse of global commodity prices, registered a
sharp pickup in profitability growth in 1QFY17 as com-
pared to the same quarter a year ago. Worryingly, both
ECONOMY MATTERS
bottom-line and top-line of services sector firms has
continued to remain weak so far. The analysis factors
in the financial performance of a balanced panel of 1749
manufacturing companies (excluding oil and gas com-
panies) and 815 service firms extracted from the CMIEs
Prowess database.
Bottom-line of firms on an aggregate basis
registers a stellar performance in 1QFY17
In the 1QFY17, the bottom-line of the firms improved
to 9.4 per cent on an aggregate basis, as compared to
contraction of 10.1 per cent a year ago. Manufacturing
companies registered growth in PAT as high as 14.7 per
cent as compared to a contraction of 23.2 per cent in
the same quarter previous year. Though, profitability in
service firms moderated to 2.9 per cent in 1QFY17 from
double-digits growth of 13.8 per cent in 1QFY16.
32
CORPORATE PERFORMANCE
In contrast, net sales growth is recovering
slowly
Growth in net sales remained a bit of a sore point, even
though falling input costs provided a respite. In 1QFY17,
net sales growth on an aggregate basis remained low
albeit stable as it stood at 0.7 per cent as compared to
0.5 per cent in the same quarter a year ago. Net sales
growth of manufacturing sector moved to the positive
Struck with weak domestic and external demand, the
Indian companies are trying hard to clutch a straw of
hope. Efforts are in force by firms to improve their own
production efficiencies and employ cost effective meas-
ures. Simultaneously, there are also expectations of
33
territory in 1QFY17 as compared to contraction a year
ago. In contrast, net sales growth of services sector
firms moderated to 1.3 per cent in the reporting quarter
as compared to 2.0 per cent a fiscal ago. Though, net
sales growth has been recovering, it still remains lacka-
daisical, reflecting in part the lack of ample demand in
the economy. The slowing demand in the external mar-
kets has been doing no good either.
some serious economic reforms, some of which have
already come in form of necessary rate cuts by the RBI,
that would elevate the economy, help pick up sales and
raise the profitability for the Indian corporates further
in the months to come.
SEPTEMBER 2016
POLICY FOCUS
POLICY FOCUS
T he important policy announcements by the Government in the months of August-September 2016 are covered in this
months Policy Focus. Our endeavor through this section is to keep our readers abreast of the latest happenings on
the policy front so that they can take an informed decision accordingly.
1. Cabinet approves Agreement and the
Protocol between India and Cyprus for
the Avoidance of Double Taxation and
the Prevention of Fiscal Evasion
The Union cabinet on 24th August, 2016 approved a re-
vised India-Cyprus tax treaty that seeks to plug loop-
holes used by investors to avoid paying taxes in India.
The new agreement, which will replace the 1994 treaty,
will enable Indian authorities to tax capital gains on in-
vestments routed through Cyprus; it will also lead to
the removal of the Mediterranean island nation from
an Indian government blacklist on which it was placed
for not providing financial information sought by India.
The revisions in the treaty are on the lines of the recent
changes notified in the India-Mauritius tax treaty and
those still being negotiated in the India-Singapore trea-
ty. India will get the right to tax capital gains from sale
of shares on investments made by Cyprus-based com-
panies after 1 April 2017.
2. Cabinet Approves Initiatives to Revive
the Construction Sector
The Cabinet Committee on Economic Affairs, chaired by
the Prime Minister Shri Narendra Modi on 31st August,
ECONOMY MATTERS
2016 has approved various measures to revive the con-
struction sector which has been undergoing stress.
Under the proposal put forward by NITI Aayog and ap-
proved by the CCEA, government agencies would pay
75 per cent of the arbitral award amount to an escrow
account against margin free bank guarantee, in those
cases where the award is challenged.
The escrow account can be used to repay bank loans
or to meet commitments in ongoing projects. This is a
major step which will allow recovery of loans by banks
and allow construction companies to speed up execu-
tion of ongoing projects. It will also increase the ability
of construction companies to bid for new contracts and
the resulting competition will be beneficial in contain-
ing the costs of public works. This measure will provide
a stimulus to the construction industry and to employ-
ment.
Government Departments and PSUs have also been
instructed to transfer cases under arbitration to the
amended Arbitration Act which has an expedited pro-
cedure, with the consent of the contractors. In the long
run, other measures are also under consideration, in-
cluding changes to bid documents and model contracts,
34
POLICY FOCUS
and increased use of conciliation. NITI will also examine
the idea of creating claim take out funds financed by
private sector investors, while the Department of Finan-
cial Services will examine a suitable scheme for address-
ing stressed bank loans in the construction sector.
CIIs Reaction
The Cabinet Committee on Economic Affairs (CCEA)s
announcement of a revival package for the ailing con-
struction sector has come at an opportune time as it
seeks to destress the liquidity woes of construction
companies and the infrastructure sector, said the Con-
federation of Indian Industry (CII). Indian industry wel-
comes this positive and timely initiative taken by the
government as this would unclog stressed assets and
revive projects that have been stuck over years in litiga-
tion and courts, said Mr Chandrajit Banerjee, Director
General, CII.
Mr Banerjee added, The revival package for the con-
struction sector by the government will translate into
a huge liquidity boost for the system and would save
many construction companies from being declared
NPAs. The package will also allow recovery of loans by
banks and facilitate construction companies to speed
up execution of ongoing projects. Further, it will in-
crease the ability of construction companies to bid for
new contracts and the resulting competition will be
beneficial in containing the costs of public works, he
said.
One of the major decisions by the CCEA includes a di-
rection to PSUs to pay 75 per cent of award amount to
contractors against a margin fee in cases where the PSU
has lost the Arbitration case and goes in for appeal in
Courts. This amount will infuse liquidity and will be used
by the contractors to repay bank loans or to meet com-
mitments in ongoing projects.
Government Departments and PSUs have also been
instructed to transfer cases under arbitration to the
amended Arbitration Act which has an expedited pro-
cedure, with the consent of contractors. This will help
disputes to be settled expeditiously, with minimum
cost and time overruns and unlock stuck money to go
back into circulation in the economy. It would be worth
mentioning here that an estimated amount of around
Rs 70,000 crores is expected to be unlocked due to this
measure.
35
Given the fact that the construction sector generates
the highest level of direct and indirect jobs employing
about 40 million people with a 2.7x multiplier effect on
the economy and being the second largest contributing
nearly 8 per cent economic activities to the GDP, these
initiatives are all set to trigger massive expansion of the
infrastructure sector, industrialization, urbanization,
rise in disposable incomes and success of various Gov-
ernment initiatives to improve Indias residential and
transport infrastructure.
A few suggestions for possible additional amendments
that will further streamline ease of doing business
could include adoption of ICCs Uniform Rules for De-
mand Guarantees (URDG) which are being followed in
most major countries. Also, revision of clauses in Public
Contracts so that the interest of both the Client and the
Contractor are taken care of, is essential for the full re-
covery of this crucial sector.
While the effect of the amendment may be visible after
a few months, in the long run these initiatives would en-
able Construction Sector to attract foreign investments
and help in reviving sectors crucial for rebooting Indias
growth story.
3. Cabinet approves creation of GST Council
and its Secretariat
The Constitution (122nd Amendment) Bill, 2016, for intro-
duction of Goods and Services tax in the country was ac-
corded assent by the President on 8th September, 2016,
and the same has been notified as the Constitution (101st
Amendment) Act, 2016. As per Article 279A (1) of the
amended Constitution, the GST Council has to be consti-
tuted by the President within 60 days of the commence-
ment of Article 279A. The notification for bringing into
force Article 279A with effect from 12th September, 2016
was issued on 10th September, 2016.
As per Article 279A of the amended Constitution, the
GST Council which will be a joint forum of the Centre
and the States, shall consist of the following members:
Union Finance Minister will be the Chairperson, the Un-
ion Minister of State-in-charge of Revenue will be its
Member and the Minister-in-charge of Finance or Taxa-
tion or any other Minister nominated by the State Gov-
ernments will be its Members as well.
SEPTEMBER 2016

Additionally, the Union Cabinet under the Chairmanship
of Prime Minister Shri Narendra Modi has also approved
setting up of GST Council and setting up its Secretariat
on 12th September, 2016 as per the following details:
(a) Creation of the GST Council as per Article 279A of
the amended Constitution;
(b) Creation of the GST Council Secretariat, with its of-
fice at New Delhi;
(c) Appointment of the Secretary (Revenue) as the Ex-
officio Secretary to the GST Council;
(d) Inclusion of the Chairperson, Central Board of Ex-
cise and Customs (CBEC), as a permanent invitee
(non-voting) to all proceedings of the GST Council;
(e) Creation of one post of Additional Secretary to the
GST Council in the GST Council Secretariat (at the
level of Additional Secretary to the Government of
India), and four posts of Commissioner in the GST
Council Secretariat (at the level of Joint Secretary
to the Government of India).
The Cabinet also decided to provide for adequate funds
for meeting the recurring and non-recurring expenses
of the GST Council Secretariat, the entire cost for which
shall be borne by the Central Government. The GST
Council Secretariat shall be manned by officers taken
on deputation from both the Central and State Govern-
ments.
The steps required in the direction of implementation
of GST are being taken ahead of the schedule so far.
4. Finance Minister announces the exemp-
tion threshold and administrative control
mechanism for GST
The two day meeting of the newly constituted GST
Council comprising of Union Finance Minister, Union
Minister of State for Finance and the State Finance Min-
isters concluded on 23rd September, 2016. Based on the
proceedings of the meeting, the announcements made
by the Union Finance Minister are as follows:
Exemption threshold for GST has been fixed at Rs
20 lakhs for all the States except the North-Eastern
States and other small states. For these states the
exemption threshold has been fixed at Rs 10 lakhs.
ECONOMY MATTERS
POLICY FOCUS
State Authorities shall assess the taxpayers with
annual turnover not exceeding Rs 1.5 crore.
For annual turnover above Rs 1.5 crore, the taxpay-
ers will be cross examined either by the Central or
State Authorities on the basis of risk assessment.
Centre shall continue to assess the existing Service
tax assessees irrespective of their annual turnover
till the state officers are trained for said purposes.
However, new assessees which would be added to
the list shall be divided between Centre and States.
The Council has also agreed that all cesses shall be
subsumed in the GST.
Union Finance Minister further announced that
the GST Council shall try and finalise the tax rate
and slabs in the meeting to be held from17 October
2016 to 19 October 2016.
5. Centre Issues Model Guidelines on Direct
Selling
The Government on 12th September, 2016 issued model
guidelines for State governments to regulate the busi-
ness of direct selling and multi-level marketing with an
aim to protect consumers from Ponzi schemes. The
Direct Selling Guidelines 2016 framework, released
by Food and Consumer Affairs Minister Ram Vilas Pas-
wan, prohibits pyramid as well as money circulation
schemes. In the guidelines, direct selling has been
defined as marketing, distribution and sale of goods
or providing of services as a part of network of direct
selling other than under a pyramid scheme. Pyramid
Scheme has been defined in the guidelines as a multi
layered network of subscribers to a scheme formed by
subscribers enrolling one or more subscribers in order
to receive any benefit, directly or indirectly, as a result
of enrolment or action or performance of additional
subscribers to the scheme.
Amongst the major measures, the guidelines make
it mandatory for e-retailers and online marketplaces
to get prior written consent of the direct selling enti-
ties like Amway before soliciting sales. The norms also
provided for direct selling companies for setting up a
Grievance Redressal Committee to attend to consumer
complaints that will necessarily have to carry a unique
number through which they can be tracked for redres-
36
POLICY FOCUS
sal. The guidelines have also made provision for ap-
pointment of monitoring authority at both the Centre
and State levels to deal with the issues related to direct
selling. Further, the guidelines also place conditions on
the contract between direct sellers and the direct sell-
ing entity, saying that all such agreements should be in
writing describing the material impact of the participa-
tion.
6. Report Released on Incentivising Pulses
Production through Minimum Support
Price (MSP) and Related Policies
Chief Economic Adviser, Dr. Arvind Subramanian sub-
mitted a Report titled Incentivising Pulses Production
through Minimum Support Price (MSP) and Related
Policies to Finance Ministry on 16th September, 2016.
The panel was set up in the wake of a recent surge in
retail prices of pulses. The major suggestions of the re-
port are as follows:
- Government should procure pulses on a war foot-
ing,
- Government should create buffer stock of 2 million
tonnes,
- States should be pushed to delist pulses from Ag-
ricultural Produce Market Committee (APMC) and
promote development of GM technologies. It also
prescribed subsidies to farmers for growing pulses,
- Government should immediately announce higher
MSP of gram (chana) to Rs 4,000 a quintal for rabi
2016 and Rs 6,000 a quintal for both urad and tur
for kharif season 2017,
- It suggested that new agencies should handle pro-
curement under PPP model,
- The report suggested that there should be no bans
on exports of pulses or ad hoc controls.
7. Cabinet approves merger of rail budget
with general budget; advancement of
budget presentation and merger of plan
and non-plan classification in budget and
accounts
The Union Cabinet on 21st September, 2016 approved
the proposals of Ministry of Finance on certain landmark
37
budgetary reforms relating to (i) the merger of Railway
budget with the General budget, (ii) the advancement
of the date of Budget presentation from the last day of
February and (iii) the merger of the Plan and the Non-
Plan classification in the Budget and Accounts. All these
changes will be put into effect simultaneously from the
Budget 2017-18.
Merger of Railway Budget with the General
Budget:
The arrangements for merger of Railway budget with
the General budget have been approved by the Cabinet
with the following administrative and financial arrange-
ments-
(i) The Railways will continue to maintain its distinct
entity -as a departmentally run commercial under-
taking as at present;
(ii) Railways will retain their functional autonomy and
delegation of financial powers etc. as per the exist-
ing guidelines;
(iii) The existing financial arrangements will continue
wherein Railways will meet all their revenue ex-
penditure, including ordinary working expenses,
pay and allowances and pensions etc. from their
revenue receipts;
(iv) The Capital at charge of the Railways estimated at
Rs.2.27 lakh crore on which annual dividend is paid
by the Railways will be wiped off. Consequently,
there will be no dividend liability for Railways from
2017-18 and Ministry of Railways will get Gross
Budgetary support.
The presentation of separate Railway budget started in
the year 1924, and has continued after independence
as a convention rather than under Constitutional provi-
sions.
The merger would help in the following ways:
The presentation of a unified budget will bring the
affairs of the Railways to centre stage and present
a holistic picture of the financial position of the Gov-
ernment.
The merger is also expected to reduce the proce-
dural requirements and instead bring into focus,
SEPTEMBER 2016

the aspects of delivery and good governance.
Consequent to the merger, the appropriations for
Railways will form part of the main Appropriation
Bill.
Advancement of the Budget presentation:
The Cabinet also approved, in principle, another reform
relating to budgetary process, for advancement of the
date of Budget presentation from the last day of Febru-
ary to a suitable date. The exact date of presentation
of Budget for 2017-18 would be decided keeping in view
the date of assembly elections to be held in States.
Merger of Plan and Non Plan classification in
Budget and Accounts:
The third proposal approved by the Cabinet relates to
the merger of Plan and Non Plan classification in Budget
and Accounts from 2017-18, with continuance of ear-
marking of funds for Scheduled Castes Sub-Plan/Tribal
Sub-Plan. Similarly, the allocations for North Eastern
States will also continue.
This would help in resolving the following issues:
The Plan/Non-Plan bifurcation of expenditure has
led to a fragmented view of resource allocation to
ECONOMY MATTERS
POLICY FOCUS
various schemes, making it difficult not only to as-
certain cost of delivering a service but also to link
outlays to outcomes.
The bias in favour of Plan expenditure by Centre as
well as the State Governments has led to a neglect
of essential expenditures on maintenance of assets
and other establishment related expenditures for
providing essential social services.
CIIs Reaction
The decision to merge the rail budget with the Union
Budget and removal of the distinction between Plan
and non-Plan expenditure are commendable initiatives
to simplify and streamline decision-making within the
government and move towards efficiency of resource
use. Purely from a policy point of view, the recent Cabi-
net decisions send a clear message that the govern-
ment is orchestrating big bang reforms in a major way.
Expediting the passage of the Budget is a move in the
right direction as it would facilitate early implementa-
tion of Budget decisions. This is a historic move in the
direction of less government and more governance, the
credo of the present government. Global and domes-
tic business sentiment would get a further fillip and so
would the environment for doing business in the coun-
try.
38

Federal Rate Hike on Cards in
December 2016
I
n line with expectations, US Federal Reserve main-
tained status-quo and kept the Federal funds target
range unchanged at 0.25-0.50 per cent in its meeting
held over two days on 20-21 September 2016 as it await-
ed more evidence of progress toward its goals, while
projecting that an increase is still likely by year-end. In-
terestingly, three members from the hawkish Fed bloc
Esther George, Loretta Mester and Eric Rosengren
dissented from the statement as compared to only
one member dissenting in the previous meeting. In the
policy statement, the Federal Open Market Commit-
tee (FOMC) indicated that the labor market had con-
tinued to strengthen and growth of economic activity
had picked up from the modest pace seen in the first
half of this year. It however added that the household
spending had been growing strongly but business fixed
investment had remained soft. Further, the Fed state-
ment highlighted that it had been concerned about
global developments; particularly the Brexit vote and a
slowdown in China, however the near-term risks to the
economic outlook were put as being roughly balanced.
39
GLOBAL TRENDS
Fed upgrades its assessment of econom-
ic activity
As regards to its evaluation about the economic activ-
ity, the Fed upgraded its assessment of the economic
activity, citing that growth of economic activity has
picked up from the modest pace seen in the first half of
this year as compared to the moderate rate of growth
cited in the last meeting. However, in the Summary
of Economic Projections (SEP) that accompanied the
statement, the FOMC revised slightly lower its projec-
tion for GDP growth for 2016. The median growth pro-
jection for 2016 was cut to 1.8 per cent from 2 per cent,
mirroring the drop in the longer-run forecast, based on
median estimates.
On the inflation front, Fed noted that inflation had con-
tinued to run below the Committees longer-run objec-
tive, partly reflecting earlier declines in energy prices
and decreasing prices of non-energy imports. Hence, it
revised its projection of CPI to 1.3 per cent in the fourth
quarter, down from a forecast of 1.4 percent made in
June 2016. However, it retained its view that inflation
was expected to rise towards the 2 per cent target in
the medium-term.
SEPTEMBER 2016

Notwithstanding the moderation in NFP
seen in August, labour market conditions
remain upbeat
On the labour market conditions, Fed acknowledged
that a range of indicators pointed to continued
strengthening of the labour market. However, the Au-
gust 2016 non-farm payrolls (NFP) came in lower than
expectations, increasing by 151,000 in August 2016 as
compared with the market consensus of 180,000. While
the June 2016 print was revised downwards to 271,000
from 292,000, the July 2016 print was revised up from
255,000 to 275,000. The less volatile three-month aver-
age NFP came in above its psychological 200,000 mark
at 232,000.
Bank of Japan Introduces New Monetary Policy Paradigm
Bank of Japan (BoJ) Governor Haruhiko Kuroda an-
nounced a new monetary policy paradigm in order to
stimulate Japanese economy and help it reach the 2 per
cent inflation target. The introduction of yield curve
control, in which the Bank will seek for the decline in
real interest rates by controlling short-term and long-
term interest rates, would be placed at the core of the
new policy framework.
Large scale monetary easing has released
surfeit of easy money in the economy
More than three years ago, BoJ had introduced Quan-
titative and Qualitative Monetary Easing (QQE) in April
ECONOMY MATTERS
GLOBAL TRENDS
In December 2015, the Fed had signaled that four rate
increases were likely in 2016, but had scaled back these
projections in March 2016 due to a global growth slow-
down, financial market volatility and concerns about
tepid inflation. In the years ahead, the FOMC sees two
hikes in 2017 and three each in 2018 and 2019 that would
bring the funds rate to about 2.6 per cent, assuming
that each increase would come in quarter-point incre-
ments.
Fed rate hike expected in December 2016
Going ahead, incoming data and developments in the
global and financial markets will remain critical for de-
termining the next policy action. However, a rate hike in
December 2016 remains on the cards.
2013. In this period, Japans economic activity and prices
had improved significantly and Japans economy was
pulled out of deflation. However, despite the Banks
large-scale monetary easing, the price stability target
of 2 per cent had not been achieved. In order to com-
plement this policy, in January 2016, the Bank had intro-
duced QQE with a Negative Interest Rate. Since the
introduction of this measure, Japanese government
bond (JGB) yields, lending rates and interest rates on
corporate bonds and commercial paper had declined
considerably, implying that the measure has had sub-
stantial effects.
40
GLOBAL TRENDS
BoJ introduces QQE with Yield Curve
Control
But still, price target of 2 per cent had remained elu-
sive. Hence, BOJ decided to introduce a new monetary
policy framework called as QQE with Yield Curve Con-
trol, which consists of two major components: the first
is yield curve control in which the Bank will control
short-term and long-term interest rates; and the second
is an inflation-overshooting commitment in which the
Bank has committed itself to expanding the monetary
base until the year-on-year rate of increase in the ob-
served consumer price index (CPI) exceeds the price
stability target of 2 per cent and stays above the target
in a stable manner.
In order to achieve the yield control, BoJ has speci-
fied guidelines for market operations which enunciate
a short-term policy interest rate and a target level of a
long-term interest rate. Specifically, short-term interest
rates will be decided by applying a negative interest rate
of minus 0.1 per cent to the policy-rate balances in cur-
rent accounts held by financial institutions at the Bank.
The long-term interest rates will be the rate at which the
Bank will purchase Japanese government bonds (JGBs)
and also ensure that the 10-year JGB yields will remain
more or less at the current level (around zero per cent).
Bank of England Adopts Dovish Policy Stance
In line with market expectation, the Bank of England
(BoE) in its monetary policy meeting held on 15th Sep-
tember, 2016 kept key policy rate unchanged at 0.25 per
cent and Asset Purchase Facility (APF) at GBP 435 billion.
All nine members of the Banks Monetary Policy Com-
mittee (MPC) voted to leave interest rates at a record
low, following signs that businesses and households
have largely shrugged off the initial shock of Brexit.
BoE adopts dovish stance; rate cut ex-
pected most likely by end of 2016
However, the accompanying statement was broadly
dovish on the stance front but BoEs assessment of in-
coming data was mildly positive, with the Committee
highlighting the need to act further if data disappoints.
The Monetary Policy Committee (MPC) admitted that
41
The experience so far with the negative interest rate
policy shows that a combination of the negative inter-
est rate on current account balances at the Bank and
JGB purchases is effective for yield curve control.
Further, the Bank also decided to introduce the follow-
ing new tools of market operations so as to control the
yield curve smoothly:
(i) Outright purchases of JGBs with yields designated
by the Bank (fixed-rate purchase operations) and
(ii) Fixed-rate funds-supplying operations for a period
of up to 10 years (extending the longest maturity of
the operation from 1 year at present).
Achieving inflation target of 2 per cent
remains critical for BoJ
To sum it, BoJ has showed resolute determination in
pursuing QQE with Yield Curve Control and achieve
the price stability target of 2 per cent at the earliest pos-
sible time. The Bank believes that its monetary policy
and the Governments fiscal policy as well as initiatives
for strengthening Japans growth potential will pro-
duce synergy effects, and thereby will navigate Japans
economy toward overcoming deflation and achieving
sustainable growth.
a number of indicators of near-term economic activity
had been somewhat stronger than expected. It now
expects less of a slowing in UK GDP growth in the sec-
ond half of 2016. For now, an internal judgment by Bank
staff suggests GDP growth will come in at about 0.2-0.3
per cent in the third quarter, the minutes said. That was
stronger than their view at the time of the August rate
cut, when they forecast that growth would be close to
zero.
The meeting record showed a majority of policymak-
ers were still open to another rate cut, probably to 0.1
per cent, before the end of the current year. However,
much will depend on the Banks next inflation report
due on 3rd November, 2016, when it produces new fore-
casts for the economy based on the latest indicators.
SEPTEMBER 2016
ECONOMY MONITOR

ECONOMY MATTERS 42
ECONOMY MONITOR

43 SEPTEMBER 2016