Expert Zone
Straight from the Specialists
Is the economy drifting towards a crisis?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Standard & Poor’s India outlook downgrade was expected. What is disturbing — the government managed to do that in less than two years. It was in March 2010 that India was upgraded to ‘stable’ — and now it’s down to ‘negative’. It was not because the government took a wrong step but because it did not take any step at all. And if this continues, the economy will be confronted with a crisis.
Ratings agencies are not taken seriously, more so by governments. Surely, ratings are not a precise science; it is more a matter of judgment. But no one likes being downgraded even when it is deserved. Last year when the U.S. was downgraded from AAA to AA-plus, U.S. officials called the assessment ‘hasty’.
In 2010, the Indian economy was growing at 8.4 percent. That growth also helped the exchequer to mop up more tax revenue and bring the fiscal deficit down to 4.7 percent, with public debt at 62.4 percent of GDP. The balance of payments was sound with current ratio at 2.9 percent which was fully covered by foreign investment and external commercial borrowings, leaving a surplus for the RBI to pile up foreign exchange reserves.
That excitement ended abruptly. By the last quarter of 2011, growth slumped to 6.1 percent. That was accompanied by a serious imbalance in the income and expenditure of the government and the country’s receipts and payments of foreign exchange.
Fiscal deficit in 2011-12 climbed to 5.9 percent, about a half of the increase in deficit having been caused by inflating petroleum subsidies. International oil prices had shot up but administered domestic petroleum prices were static. The government could not pass on the additional cost through higher prices to the consumer because it was resisted by political partners in the coalition government.
Possibly, the government would have increased prices had the UPA come out stronger in the Uttar Pradesh elections. But the results made the Congress lose political ground and the TMC could oppose with greater vehemence the suggested deregulation of diesel prices. The government consequently has to borrow 685 billion rupees to help people buy petrol and diesel cheap.
Investors shouldn’t read too much into repo rate cut
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The last time the Reserve Bank of India (RBI) surprised the markets was when it announced a 75 bps cut in cash reserve ration (CRR) days before its mid-quarter review of monetary policy on March 15. It did so again in its annual monetary policy meeting on April 17, with a 50 bps repo rate cut when the markets were either expecting no rate cut or a 25 bps rate cut at best.
Why did the RBI cut the repo rate by 50 bps, amid growth showing signs of a recovery and the general belief that the worst in industrial growth was already behind us; when food inflation had started rising and with all the suppressed inflation in retail fuel, coal, power and fertiliser prices?
Did it give in to moral persuasion from the government and the industry? Or was it because cutting rates later in the year would have been difficult, if not impossible? As if to mock the rate cut, consumer price inflation for March came in at 9.5 pct the very next day.
As per media reports on April 19, the Commission for Agricultural Costs and Prices (CACP) recommended a hike of 15-40 pct in the minimum support price (MSP) of various kharif crops during FY13. Though these are just recommendations, historically, the actual hike in MSP has almost matched the recommendations. This is again likely to add to food inflation. With the current account deficit likely at 4 pct of GDP in FY12 putting further pressure on domestic currency and the consequent need for overseas inflows to finance the same, a rate cut was the last thing that should have been done.
Also, the uncertainty relating to monsoons, spike in food inflation after the transitional decline in Dec and Jan 2012 and the impending retail fuel price hikes, all create doubts over the continuance of the trend in the foreseeable future.
The RBI Governor said “the reduction in the repo rate is based on an assessment of growth having slowed below its post-crisis trend rate which, in turn, is contributing to a moderation in core inflation. However, it must be emphasised that the deviation of growth from its trend is modest. At the same time, upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates.”
RBI rate cut — too little, too late?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI Governor cut the repo rate on April 17 quite reluctantly, even hinting there wouldn’t be another cut soon. Perhaps, he was under pressure from elsewhere, compelling him to look beyond inflation which had been his sole criterion in raising the repo rate.
The surprise was that the RBI cut the rate by 50 bps in one go. What the market expected was 25 bps because that is the speed at which the RBI has been moving since March 2010, except on one occasion when the rate was raised by 50 bps. Will the drop in repo from 8.5 to 8 percent make all the difference?
A 50 bps reduction does not mean that banks will slash their interest on credit correspondingly. After all, the repo is the rate at which banks borrow from the RBI. These borrowings are a small part of their total operations. What matters more is the interest on deposits which banks may take some time to reduce. Therefore, at best, the reduction in interest on credit can be 25 bps. That is unlikely to rev up the debt market.
Take home loans which are generally for long periods and therefore the interest rate becomes an important consideration. On a loan of 2 million rupees payable in equal instalments over 20 years, the saving in interest with a 25 bps reduction would be 170 rupees a month. That is too little for any home buyer to be excited about. That is also true of the corporate sector though the stock market reacted favourably.
The cut in the repo rate is nevertheless a good beginning. But it has to be carried forward before it can regenerate investment and the economy. The RBI had done it in 2008 when the economy had slowed down following the world financial crisis. The repo rate was 9 percent in 2008 when Lehman Bros collapsed and the RBI cut it by 100 bps in October. That was followed by another 50 bps cut in November and 100 bps in December. In just three months, the repo was down 250 bps from 9 to 6.5 percent. Not that there was no inflation. Going by WPI, inflation was 12 percent in August 2008 which declined thereafter in spite of the sharp cut in interest rates. But consumer prices, mainly due to food inflation, were high. Food inflation is a problem by itself unrelated to the rate of interest.
The choice before the RBI is really to have a high interest rate with low growth and high inflation or to have low rate of interest with high growth and high inflation. The latter would be a better choice. That would require that, as in 2008, the repo rate has to be cut not by 25 or even 50 bps but by 100 bps to get it down to 6.5 percent in the next three months and take investment back to 30 percent of GDP.
Will Subbarao oblige Mukherjee?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
“The government will be forced to take difficult decisions,” Finance Minister Pranab Mukherjee said at a FICCI event while expressing hope of a “reversal of the policy rate which should help in improving business sentiments”.
RBI Governor Duvvuri Subbarao has his own assessment of a rate cut.
On March 15, the day before the budget was presented to parliament, the RBI had its quarterly review but it passed without any change in monetary policy. Only a week before, the RBI had reduced the CRR by 75 bps to supplement liquidity which had dried up. But the repo rate was held steady.
The repo rate had been stepped up to combat inflation since March 2010 by 375 bps in thirteen instalments. Inflation, however, did not budge until November 2011 when there was a larger supply of agricultural commodities, particularly vegetables. Food prices had dropped and headline inflation was down to 6.1 percent — only to recover to 6.9 percent in February.
The reduction in CRR put 450 billion rupees in the banks’ kitty. This money, on which the banks did not earn any interest, was available to be loaned or invested. In response, the banks could have reduced the interest on credit.
The finance ministry had therefore been persuading the banks to lower interest and the State Bank of India agreed to do that selectively.
I would be surprised if he bows down to political/popular pressure – inflation figures shown are very misleading, I don’t understand why is it WPI instead of CPI and also I personally seen how much things have gone up in India being here from 2003-2005 the 2009-2010 and now 2012. Empirical evidence would highlight that inflation is a lot more then what is reflected in the numbers coupled with the invariable need for the government to allow free price movement in Oil/Petrol products which are heavily subsidised and causing severe fiscal strains for the govt (Indian Oil Marketing Companies losing well over Rs 500 Cr – $100 Mn a day by selling cheaper petrol/diesel prices).
Lot of the financial gurus of the world have applauded Duvvuri Subbarao and RBI as one of the best and sound Central Banks in the world that whole image would in my opinion go out the window if he would oblige to cut Repo rates this year but tomorrow is not the day another 1 Max 2 quarters.
Ultimate test of character tomorrow!
Is the fiscal deficit phony?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The stock market did not respond positively to the budget in spite of the cut in Securities Transaction Tax (STT) and the provision of tax benefits to retail investors for investment in equity because of the trust deficit in budget arithmetic. The fiscal deficit is too high and could also escalate during the year considering that the assumptions on which it is based are not realistic.
In the 2011-12 budget, the fiscal deficit overshot the target by a huge margin. The finance minister had planned for 4.6 percent; it turned out to be 5.9 percent. The budget was messed up by the RBI with its interest policy which brought down growth and therefore tax revenues, and by the government which let expenditure shoot up under political pressures.
More precisely, a third of the increase in fiscal deficit came from the fall in tax revenues, mainly corporation tax, and two-thirds from the increase in subsidies, mainly food. That put the budget in a strait jacket. The finance minister did try to bridge the gap with the increase in service tax and excise duties which, along with a concession in direct taxes, would mop up 414 billion rupees. That was not enough and the finance minister had to have a go at the bulging subsidies.
Currently, subsidies are 2.4 percent of GDP and to that extent inflate the fiscal deficit. The finance minister has therefore resolved that subsidies will be curbed next year. Not all but those on petroleum products and fertilisers which are regressive and together account for about two-thirds of total subsidies. The latter will be chopped down in 2012-13 to 2 percent of GDP.
That is undoubtedly brave on the part of the finance minister who had been rebuffed by the Trinamool Congress for the minor offence of permitting an increase in railway passenger fares. That was also how this critical ally in the UPA had reacted to earlier increases in petroleum prices. Against this background, the initiative of the finance minister to slice off petroleum and fertiliser subsidies seems presumptuous in spite of the assurance by the prime minister that, when the time comes, he would bite the bullet. Probably what he means is that time may not come if international oil prices ease.
Not to be discouraged by the fall in tax revenue in 2011-12, the finance minister has budgeted for a 19 percent increase in tax revenues because he expects the economy to grow at 7.6 percent in 2012-13. Even if it does, the 19 percent increase, excluding additional taxation, in unlikely to come. The experience of 2011-12 is that a 1 percent increase in GDP generates 2 percent increase in tax revenues. On that basis, a shortfall in tax revenues in 2012-13 is not unlikely.
Cost of a rate cut delay in India
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI took the first step to ease monetary policy by reducing CRR by 50 basis points on Jan. 24. However, it postponed an interest rate cut, in spite of the advice by the special committee, only to confirm its reputation of being cautious. But excessive caution can also cost the country a pretty penny.
Since then, there have been further developments. Liquidity in the system has been drying up and the RBI has been using open market operations to buy government securities in exchange for cash. That helped maintain the yield on long-term government securities within narrow limits though on short-term debt, like treasury bills, the government had to pay higher interest.
In recent weeks, inflation has climbed down from 9.1 pct in November to 6.7 pct in January. But while the RBI had been quick to raise interest rates with every point increase in inflation, it has been hesitant to cut rates in spite of easing inflation.
The obsession with high rates is causing growth to suffer. Last December, growth in industrial production was a mere 1.8 pct. That was mainly because of the 16 pct fall in capital goods production which reflects the sharp decline in national investment. In July-September 2011, for instance, national investment y-o-y was down from 30.3 pct of GDP to 28 pct. The main reason for holding back investment and income was the sharp increase in interest rates.
Interest rates rose to 8 pct in July 2011 from 5.75 pct in July 2010. Broadly, the rise of 225 basis points in interest rates caused national investment to shrink by 621 billion rupees in the July-Sept quarter of 2011 leading to a GDP loss of 1.03 trillion rupees.
The RBI has been careful to ensure that the interest rate for the government did not increase commensurately. Although the repo rate was up from 4.75 pct at the beginning of inflation to 8.5 pct now, the yield on 10-year government bonds moved in the range 8 – 8.5 pct. The RBI has been buying dollars or buying government securities to replenish liquidity. The full brunt of the rise in interest rates was borne by the private sector either by corporates on bank credit or by individuals on home or car loans.
Why the budget is under stress
(The views expressed in this column are the author’s own and do not represent those of Reuters)
In the first seven months, the fiscal deficit crossed three-fourths of the target set for the year. This was entirely because the liberal expenditure on current account was not covered by the revenue the exchequer earned. It is quite on the cards that fiscal deficit for the year will exceed the target.
The fiscal deficit has been a cause of worry for most finance ministers. That is because the budgets they present to parliament are inevitably overcome by political rather than economic considerations. That is what has put many of the governments in Europe on the brink of sovereign default.
Even the U.S. credit rating was downgraded by S&P precisely because the fiscal deficit was excessive. India is no exception.
It is the revenue deficit that has created the problem for Pranab Mukherjee because nearly 86 percent of the current expenditures are on interest payments, defence and subsidies, leaving no room for manoeuvre.
Subsidies are not on par with interest payments and can be the key to fiscal consolidation. In the budget for 2011-12, the finance minister had provided 1.43 trillion rupees for subsidies on fertilisers, food and petroleum products. That was 13 percent less than the expenditure in the previous year. But actual expenditure in the first seven months of the current year was 8 percent higher. The political appeal of subsidies is irresistible. In the last eight years, subsidies quadrupled when total expenditure only trebled.
Are all the subsidies really necessary? Certainly not because most subsidies benefit sections of people that are quite well off.
Fiscal deficit to kick up growth
(The views expressed in this column are the author’s own and do not represent those of Reuters)
In the first quarter of 2012, the government will be over-crowding the financial market to mop up nearly a trillion rupees. It is forced to borrow mainly because the expected revenue did not come in while the expected expenditures had been met.
Last year, the government had spent 55.7 pct of the budgeted expenditure for the year in the first six months. This year, the expenditure was at about the same percentage but the fiscal deficit was 74 pct of the budgeted amount. That was because of the shortfall in receipts. The tax revenue collected in the first half of the year was only 45 pct of expected revenue.
There is anxiety about the bloated deficit. The RBI had repeatedly warned the excess fiscal deficit was pushing up inflation. Besides, the lack of fiscal prudence was infringing FRBM (Fiscal Responsibility and Budget Management) Act which has targeted fiscal deficit at 3 pct of GDP. That target is looking increasingly illusory.
The government can bring down the fiscal deficit only by cutting expenditure. Many of the revenue expenditures like interest payments, defence, etc., and some capital expenditures like loan repayment are committed and cannot be reduced. The only expenditures that can be brought under the axe are subsidies and investment.
A cut in subsidies, though desirable, is politically difficult particularly now because elections in five states will soon be held. On the contrary, subsidies are bound to increase with the introduction of the food security Bill which is already pending in Parliament.
Inevitably, if expenditures have to be cut at all they will have to be in respect of new investment. That happens most of the time resulting in cost and time over-runs. No wonder capital expenditure in the first half of 2011-12 was only 48 pct of the budgeted expenditure for the year while it was 55 pct of revenue expenditure.
Remittances support to balance of payments
(The views expressed in this column are the author’s own and do not represent those of Reuters)
For quite some time now, exports of goods have trailed behind imports leaving a huge deficit which has been partly made up by the surplus in services trade, an important component of which is remittances from overseas.
In 2010-11, with the surplus in services trade the current account deficit was reduced to 2 trillion rupees. The surplus in services trade comes mainly from household remittances from overseas which exceeded 2.1 trillion rupees. Remittances brought down the goods account deficit by 41 percent.
Remittances from overseas have been substantially more than even FII investment. In 2010-11, which was one of the good years for FIIs, inflow of investment was 1.3 trillion rupees, about half of the remittances that came in. FII and FDI together more or less matched the remittances from abroad.
While foreign investment has been irregular (being sensitive to economic and political risks), can we rely on remittances as a steady and growing resource particularly in the context of a possible recession in the U.S. and EU and the uncertainty in oil prices?
The World Bank has reported that total remittances from migrant workers to developing countries would amount to $353 billion in 2011 and $483 billion inclusive of developed countries. India was the largest beneficiary with an inflow of $58 billion followed by China with $57 billion.
The World Bank expects that the 8 percent growth in remittances may continue in the next three years. Total remittances in 2014 would amount to $593 billion. Remittances to India can increase even faster at around 10 percent with an inflow of $210 billion over the next three years. That would provide a good support to the balance of payments.
Exports on the bounce
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Exports are performing exceedingly well. This does not look like a spark in the pan because the commendable performance has lasted more than 10 months in spite of repeated warnings by the Secretary, Ministry of Commerce, that the escalating trend line will bend down because of the slowing of the U.S. and EU economies.
The export sector is perhaps the only one standing out in the wilting growth of India’s economy. Industry has slumped, inflation is raging furiously, interest rates are shooting up and the stock market is in the dumps. Exports are an exception with an average growth of 55 percent in the six months since April. Why?
For two reasons. First, there was a timely change in the direction of exports. Second, there was a change in the composition of exports which suited the new markets.
It may appear that Indian exporters had an added advantage of currency depreciation. There was a fall in the value of the rupee in terms of the dollar by about 6 percent. But most of the fall came only in September and may, if sustained, help exports in future. But it would not have been an important mover of exports in the past six months.
What helped India most was the change in export destination. The share of exports to developed countries like U.S., France, Germany and Japan which have lost their growth momentum, shrank. That of Asia and Africa which are more progressive, increased. For instance, 43 percent of the increase in India’s exports in April-May went to Asia (including the Middle East) and another 15 percent to Africa, making for more than half the increase in total exports.
The other change was in the composition of exports. The new markets for exports also required new products in which India had a competitive advantage. These were primarily engineering products including electronics, machinery and automobiles. In the increase in total exports in April-May, the share of engineering products was 55 percent. The products that lost markets were textiles and chemicals.
Standard & Poor’s has sent an early shot across India’s bow by downgrading its credit rating. Ironically, Moody’s had patted the country on the back as recently as last December. Undoubtedly, India needs to get its act together and improve its financial status. But what is disturbing is rating agencies’ hubris and often suspicious ways in which a nation’s performance is rated. Besides, rivalry between ratings agencies is frequently brought to the fore. It’s time such ambiguous ratings are disregarded in favour of disinterested observations.