(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.

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The year 2012 has begun well for the stock market. In just six weeks, the Sensex was up 13 percent which made up more than a half of the fall in the previous 52 weeks. Will this trend survive the rest of the year?

In 2011, the market had come into the firm grip of the bears and the Sensex was down 23 percent. Surely, many other markets had also underperformed. But the Indian market was hit much harder possibly because it has greater exposure to FIIs. The recovery of the stock market in January-February was mainly the correction of the excessive fall.

The Indian market is sensitive to FII investment which, last year, was influenced more by risk aversion from fears about European sovereign debt default, more particularly of Greece. Consequently, in 2011 there was a net $357 million outflow of FII investment. In 2010, the net inflow was $29.4 billion.

There are some positive trends that can prolong the recovery. The rupee has hardened and increased the return on FII investment in dollar terms. Inflation has eased and will ease further with bumper production of food grains if international commodity prices do not jump. The RBI has infused additional liquidity and will reduce the interest rates as well which will stimulate investment. These trends should boost the market.

Equally, there are discouraging elements. The fiscal deficit is, by all accounts, likely to exceed budget expectations. S&P has already hinted at downgrading India’s credit rating. The finance minister will therefore be tempted to go in for revenue raising measures rather than offer any incentives to the corporate sector. Even the proposed DTC and GST will be postponed. Besides, the industry does not seem to have enough steam to push forward and the CSO has estimated GDP growth at 6.9 percent, the lowest in three years.

The market also responds to changes in the political climate. To some extent, it has improved with recent court judgments. But Uttar Pradesh is going to the polls and the results, out on March 6, will have a significant impact on the government and the market.

(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.

(The views expressed in this column are the author’s own and do not represent those of Reuters)

It will not be before February that the euro zone GDP numbers are out. The available information so far indicates the economy is already in recession. This will have serious consequences for all countries, including India.

The data for November is disturbing. Unemployment has hit a new peak of 10.3 pct and is possibly the worst in Spain where it has touched 23 pct. Naturally, consumption expenditure has declined in the euro zone by about 1 pct and will have a depressing effect on GDP growth.

Factory orders are down even in Germany which is the largest euro zone economy. The fall exceeded 4.8 pct although the industry was still flashing positive signals.

Indications are that the euro zone economy is already in recession and growth may have slipped 1.75 pct with some countries diving deeper. The debt crisis and subsequent agreements entered into by EU (excluding the UK), to bring about better fiscal consolidation, have forced a number of countries to cut public spending. While this may reduce fiscal deficit — the original sin — it will deepen recession further.

The recession in the euro zone will have adverse consequences for many countries. In India, the impact of the European debt crisis was visible right from the beginning of 2011 though it intensified since August. India was hit most in comparison to other countries. The stock market lost nearly 20 pct in 2011 in the absence of FII investment which also pushed the rupee down from 45 to 53 to the dollar. Simultaneously, there was a fall in direct foreign investment.

The recession in the euro zone will have a crippling effect on our exports which, presently, account for 21 pct of our total exports. Italy and Spain, which are more prone to debt crisis and recession, together share more than 3 pct of our exports. Already, the export growth is down. It was 4 pct in November.

(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.

(The views expressed in this column are the author’s own and do not represent those of Reuters)

There was a good deal of hesitation on the part of government to introduce the Food Security Bill even after it was recommended by the NAC. The bill, which is now before the parliament, would be adopted with every political party wanting to earn some leverage at the polls at the cost of the exchequer.

The initial hesitation was precisely because the cost of food security is too high. The provision for food subsidy in the last budget was Rs. 606 billion, about 11 percent of the total tax revenue of the centre. With food security, that is bound to double making it impossible for the government to conform to the self-imposed discipline of the FRBM Act.

Apart from the financial burden of food security it is also necessary to consider whether there will be enough grain to feed the public distribution system (PDF) and, even if there is, whether it will be delivered to the identified beneficiaries. On both counts there are serious doubts.

The total production of cereals (rice + wheat) was 181 mt (million tonnes) in 2010-11 and, with good monsoons, is expected to cross 243 mt in the current year.  Of this, about 36 mt will be retained by  farmers for seeds and self-consumption. Government procured nearly 36 mt for PDS, leaving 109 mt for the open market.

The food security bill requires that 63 percent of the population will be supplied with grain at subsidised prices. That is possible only if the government procures an additional 35 mt. This diversion of grain to PDS will reduce the supply to the open market by more than one third.

Surely, the number of consumers who used to buy from the market will also be reduced because a part of them will be eligible beneficiaries under food security. Even so, the fact that grain will be available to them at reduced prices would mean that consumption will increase and the market supply will fall significantly short of demand and generate inflation.

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The first big jolt to the market after the 2008 crisis had come last August when FIIs disinvested 95 billion rupees worth of equity and moved into liquid assets. That brought the Sensex down by 1500 points and pulled the dollar up by 4 rupees.

The FIIs wanted to reduce their risk which had been heightened by the EU crisis. It was not Greece alone but even Italy, the third largest European economy, which was in danger of sovereign debt default. These governments could borrow only at interest rates over 7 pct, about 2 pct more than the average rate for EU countries.

Undoubtedly, the prospects for the Economic and Monetary Union (EMU) were grim and there could have been sheer chaos had a weak state like Greece or a strong state like Germany left the Union. France and Germany did finally persuade other members to accept fiscal consolidation and establish a permanent bailout fund. An early agreement failed mainly because of the veto exercised by Britain. Hence, a new treaty will have to be signed which is not likely before March.

The promise of a new treaty was not enough to create confidence among investors in the solidarity of the EU or the European banking system. For that reason the recovery of world markets did not come through. The BSE Sensex hardly changed its mood and, with the added fear created by the 5 pct fall in industrial production, declined further.

There were triggers that could have kicked up stock prices. A good opportunity for market recovery was lost when the government almost withdrew the earlier amendment to facilitate FDI in retail. With a fractured parliament and undependable allies, it is unlikely that any major reform will come through before the elections in Uttar Pradesh.

The next budget can be a trigger but is unlikely to be one. For, the kind of pressure under which it is at present requires the finance minister to seek approval to borrow another 550 billion rupees, mainly to fund subsidies. As such, it may be difficult to even maintain the fiscal deficit at 4.6 pct as provided in the last budget.

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The economy seems to be heading for a hard landing. The problem is not entirely of our making; partly it is the spillover of the crisis in Europe. Other Asian countries have also been affected but we were hit the hardest.

Surely, the economy was exposed to inflation for nearly 25 months now. The RBI initiated conventional measures. The repo rate was raised in 13 instalments from 4.75 to 8.5 pct. It made no change to inflation. The high cost of credit only inhibited investment. New investment, for instance, dropped from 6 trillion rupees per quarter to 3 trillion rupees.

Inflation was initially confined to select food articles. The increased expenditure on food diluted demand for manufactures and slowed down industrial growth. Further, food inflation increased wages and salaries since these are linked to cost of living, spreading inflation to all sectors.

The stock market was hit initially by the European crisis. Investors lost appetite for risk and the scramble for liquidity led FIIs to disinvest. Stock prices tanked and with the increase in demand for dollars depreciated the rupee.

These trends drastically distorted corporate finances. The fall of the rupee which increased external debt servicing and the hike in domestic interest rates took a big bite of profitability. In the July-September quarter, the margin was the lowest in the past seven years.

The problems are many. Inflation is high, stock market is down, interest rates are excessive, investment has dropped, trade deficit is too large, the rupee is low, and industrial production is nearly static. The only silver lining is a 3 pct increase in agricultural production. With these inputs, GDP growth in 2011-12 will be less than 7 pct.

(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.

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The rupee sank to its lowest on Tuesday with pressures from the market and absence of support from the RBI. The fall really began in August and in the last four months took the rupee down 18 percent against the dollar.

What has gone so seriously wrong with the rupee?

Many other currencies also weakened but the rupee underperformed the most because a significant demand supply gap for dollars had developed. There are two important causes for this sharp fall in such a short time. First, the usual inflow of dollars from investment by FIIs had stopped and even significantly reversed.

In the four months since August, disinvestment was more than $2 billion which pushed prices of stocks down and raised the price of dollars up. The fall of the stock market and of the rupee go together because they are two sides of the same transaction.

And why did the FIIs disinvest? It was mainly because of the crisis in Europe which killed risk appetite, driving investors into dollars or gold. Partly also it was because the earnings of companies shrank and caused fall in industrial growth. Profit margins of Sensex companies are at a seven-year low which has brought the price/earnings ratio from 22 to 16.

Second, the pressure on the rupee was intensified by the bulging trade deficit. It increased from $10 billion in September to $20 billion in October. The expected fall of the rupee also gave rise to hedging particularly by the oil companies which are large importers and further inflated demand for dollars.