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

China has been under strong pressure from the US to revalue the yuan because in the US balance of trade deficit, China has the lion’s share.

More recently, the emerging market economies have also raised their voice having encountered almost a similar problem. Last week the RBI brought out a Working Paper (WP) which offers a quantitative assessment of China’s tied exchange rate.

From 14th largest exporter in 1990 China became the largest exporter in 2010. This was mainly because the currency was manipulated to sharpen China’s competitive edge. To keep the yuan tied to the dollar China had to buy $1 billion a day and stack it in its foreign exchange reserves.

India’s two-way trade with China, even by 2001-02 was small, less than $3 billion. In the next eight years, it jumped to over $42 billion, with adverse balance against India at $19 billion. India exported iron ore, other ores and metals, raw cotton, chemicals, gems and jewellery which constituted nearly 60% of total exports to China. The bulk imprints were electronic goods and machinery.

Trade expansion was partly due to GDP growth. The manipulated exchange rate also had its impact though the rupee depreciated against the yuan. In 2001-02 the yuan exchanged for Rs.5.5; now the yuan is up at Rs. 6.5 or by 18%. What is relevant, India’s exports responded much less to cheaper rupee than imports.

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

The Sensex jumped 465 points on 25th March to close at a two-month-high of 18,815. That was in response to economic recovery in the US and better performance by IT companies. Another 5 percent  jump can take the Sensex to 20,000. How soon can that be?

The Sensex had crossed its previous peak in September 2010 but had retracted in subsequent months. Partly it was because of the assessment that stocks were over-priced. The P/E ratio had touched 20 which was far in excess the P/E in most other markets. In Taiwan it was 15, in Philippines 14.6 and in South Korea 13.6.

Sensex dropped possibly for other reasons. First, the FIIs pulled out $2.2 billion partly for fear of inflation which had touched 8.7 percent and fall in industrial growth to 3.7 percent (January). This had prompted the RBI to jack up the interest rates which would have induced some shift from shares to bonds.

Second, the Indian companies’ January-March performance was not as good as in the last quarter of 2010. Third, the rupee depreciated lowering the return in terms of dollars.

The whole of January and February the Sensex gradually climbed down from over 20,000 to 17,825, pulling the P/E to 17. The budget, however, was a good trigger and kicked up the Sensex 5.8 percent in four days. But the rally survived only two weeks to bring the Sensex down again by 3 percent in mid-March.

Since then the market has been in a stalemate until 25th March when the Sensex jumped led by aggressive buying of IT, banking and realty stocks.

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

On March 17, the RBI will review the quarterly performance of the economy and readjust the repo rate. In the past one year the rate was jacked up seven times at 25 bps on each occasion from 4.75 to 6.5 percent. The target was inflation.

Obviously, even after 12 months inflation remained untouched by the repo rate though it created other expected but undesirable side effects.

There were two reasons why the attempt did not succeed. First, inflation was not caused by overheating of the economy and therefore could not respond to monetary policy. It originated in the agricultural sector. The worst hit were vegetables, fruits and meat. In the manufacturing sector inflation was mild and was caused mainly by the spread effect of inflation in the agricultural sector and higher international prices of industrial raw materials.

Second, the baby steps of 25 bps at a time did not create the shock effect that is necessary to curb demand. If the 175 bps increase had been made in a single sweep, perhaps the result, as far as inflation is concerned, would have been significant. However that would have caused serious dislocation which would have hit growth badly. For that reason, most central banks prefer to increase interest rates in small doses so that adjustments become easy.

The situation now seems to have significantly changed. Food inflation which had shot up to 18 percent in December has slowed down to single digits and may be back to normal in another month or so, pulling down headline inflation with it. Therefore further hikes in repo are not necessary particularly because the adverse side effects of higher interest rate are gathering momentum.

It is true that the repo rate is not the only reason for increase in interest rates across the board. There has been liquidity shortage. Credit has outpaced deposits. Further, the auctioning of 3G spectrum and divestment in public sector enterprises transferred 850 billion rupees to the RBI, though government borrowing  became less aggressive.

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

Finally debt is receiving serious attention. The finance minister reminded the states about the road map laid out by the 13th Finance Commission which requires that they eliminate the revenue deficit and restrict the fiscal deficit to 3% of their respective Gross State Domestic Product so that the combined state debt will not exceed 24.3% of GDP by 2014-15.

The Centre has its own debt to manage which will now be entrusted to a separate debt management office. But the larger question is whether public debt should be subject to a ceiling. There are no accepted norms to go by though the fiscal responsibility and Budget Management Act, which was observed more in breach than in substance and will now be made more flexible, indicated limiting fiscal deficit to 3% of GDP.

Every government borrows, some more than others. There are occasions when governments borrow for emergencies. In 2008-09, for instance, almost every government borrowed far too much to counter the crisis that had spread worldwide. That was not without problems either. Some of the European countries could not service sovereign debt and had to be bailed out by the IMF and ECB.

External debt can be a greater danger. No wonder Indian government has been giving close attention to external debt though there is some indifference towards rupee debt possibly in the belief that it can always be repaid from tax revenues or additional borrowing.

Of the total public debt of Rs.39.3 trillion, only 4% is external debt. That would be less than 2% of the GDP well within safe limits.

The government has however recklessly indulged in rupee debt largely to fund the revenue deficits. This had adverse consequences. First, more than a third of the tax revenues of the centre are now eaten up by interest on public debt.

The bottom line in the Budget is the fiscal deficit. It reflects to what extent the Finance Minister will draw on private savings to fund current and capital expenditures.

The part that is used to fund revenue deficit is the erosion of savings and increase in government consumption. In any case, the higher the deficit, the more the crowding out of the bond market, less funds for the corporates and higher consequently inflation and interest rates.

Against all odds, the Finance Minister has managed to bring down the fiscal deficit by a whopping 0.5%. Partly it is because he expects tax revenues to rise faster and partly because he expects the expenditures to rise slowly.

Surely, more money will come in because of the high buoyancy in tax revenues. In the current year they will be up 29% against the budget provision of 19%. This additional revenue came in not because of under-estimation of GDP growth but because of underestimation of inflation.

If the projected buoyancy in revenues is to continue, both growth and inflation have to be higher. The budget expects GDP in 2011-12 to be up 9%, and inflation to be at 5%.

Even that would not bring the deficit down to 4.6%. It would also require that the buoyancy in tax revenues must increase with the ratio of tax revenues to GDP going up from 10% to 10.4%. If that ratio remains the same fiscal deficit will climb to 5%.

There are reasons why buoyancy may not rise. Nearly 35% of the gross tax revenue comes from the corporate sector. Lately, the earnings of companies have been shrinking which is why the market got a severe knock. If the performance of the corporate sector does not improve, tax buoyancy will not rise.

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

The economy is under some stress. Inflation has relapsed and interest rates have jumped. Industrial growth has plunged but exports have been performing well. Parliament is paralysed. That puts the 2011 budget under pressure.

Budget expenditures will increase but revenues will not be buoyant and the fiscal deficit may not drop any further unless the Finance Minister initiates steps to put some pep into the economy with reforms.

The additional expenditures can be quite substantial. The Railways have demanded doubling budgetary support to 360 billion rupees. With West Bengal going to the polls in May, this demand will have to be at least partly accepted. The National Advisory Council headed by Sonia Gandhi has pitched its demand for widening of the PDS which will involve not only larger subsidies but also shortfall in market supply which will kick up food grain prices.

Further, the food inflation has necessitated larger investment in agriculture and irrigation. On top of that, an investment of 50 trillion rupees has to be made in infrastructure in the next five years starting with the next budget.

But the revenue budget may not be rosy. With industrial growth down to 1.6 percent, the buoyancy in tax revenues seen in 2010-11 will not be maintained next year since the bulk of the revenues from corporation tax, customs and excise come from industry. Besides, any new non-tax revenues are not in sight except possibly some penal realisations from 2G spectrum allottees.

The government has appointed a committee to suggest a formula for efficient and transparent distribution of scarce resources like telecom spectrum, coal mines, etc. which may reduce corruption and bring in some small revenue. Disinvestment is another resource but is subject to political limitations.

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

January was a big disappointment to the stock market. The Sensex which had crossed the earlier peak was already down to 20,000 at the beginning of 2011. It gradually slumped further during the first three weeks and dropped with a thud towards the end of the month. There were reasons not all very apparent.

The Sensex was undoubtedly hammered by the global trends. The Egyptian crisis meant not only a setback to some of the Indian companies operating in Middle East but also a sharp increase in commodity prices. Oil shot up to more than $100 a barrel. International prices of food products also jumped. That meant higher costs and lower profits. There were also fears that the Suez Canal could be closed.

The domestic reasons were even more convincing. Inflation had relapsed. Food inflation crossed 17 percent and the headline inflation for December touched 8.5 percent. Besides, the many tales of widespread corruption had created doubts about effective governance.

The RBI reacted to inflation the usual way. It put up the repo rate by 25 bps threatening at the same time that further action may follow. That was more than a cue to the banking sector which pushed up the interest rate on lending as also borrowing.

Added to all this was the rather tame performance of the corporate sector in the last quarter of 2010. That was enough to knock down the Sensex.

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

The rise in food inflation was a shocker. Prices jumped 18.3 percent giving the government and the RBI an uneasy feeling and the stock market a big disappointment. In spite of promises, it looks like headline inflation will not drop below 6 percent by March.

The return of food inflation was unexpected. Production and prices of cereals were steady and prices of pulses and sugar had actually come down. What kicked up the price index were the prices of vegetables, meat and eggs. These are only about 13 percent of the consumer basket.

But the price rise was too sharp and too sudden and in a matter of three weeks pushed up the food price index more than 6 percent. That will jack up headline inflation by more than one percent in December.

Inflation has affected most of the developing countries. In China, inflation is at 5.1 percent with food inflation running at 11.7 percent. In Russia, inflation is at 8 percent, in Indonesia at 7 percent and so on. There is a fall in world food production and international food prices have been aggressively moving up. What is unusual about India is that inflation which had receded, with food prices remaining nearly steady since June, suddenly spiked in December.

The reason is that the rains were unusually excessive and irregular and production either dropped or there was exposure to pests. The prices of onions shot up more than 46 percent in the first three weeks of December and 67 percent over the year. In contrast, demand for fruits and vegetables increased with the expansion in population and improvement in incomes of urban and rural consumers.

This mismatch between demand and supply is not temporary. Production of fruits and vegetables is in the unorganised sector and the cultivation follows conventional methods. It is time that the vegetable sector receives greater attention. It has to be better organised using modern technology. ICAR and a number of universities have developed transgenic varieties of crops which are herbicide-tolerant and insect-resistant.

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

The rupee has gone through a rollercoaster ride in the past year, being pushed up by foreign investment and down by trade deficit.

On balance, the rupee appreciated, reaching its lowest value in terms of dollars in July and the highest in October.

Trade and FII investment are not independent of the rate of exchange. The rate of return for foreign investors is the expected increase in stock prices plus the expected appreciation of the rupee.

When investment comes in, both these expectations get automatically fulfilled. It is a similar thing with trade as well. When the rupee is low, exports increase and imports decline both of which reduce the trade deficit and consequently harden the rupee.

These market pressures influence the exchange rate unless the RBI steps in. Such interventions in recent months have not been significant.

Not all countries allow the currency and the trade markets to function normally. The crisis of 2008-09 has made these temptations even stronger. That is what has perturbed the high-powered Financial Stability and Development Council which met on the eve of the new year.

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

In 2009 the market was in a recovery mode; in 2010 it consolidated. Next year prices will reflect the performance of the corporate sector and respond less to the external shocks.

The fundamentals are strong. With average 8.9% growth in the first three quarters of 2010 the economy is well poised to rush into 2011 with good performance. Consumer demand is strong, exports are rising and investment is building up. The only threats are relapse of inflation and shortage of liquidity, both of  which may compel the RBI to rig up interest rates.

Corporates should be able to repeat satisfactory performance in 2011 in spite of labour shortage and higher wages and salaries and steeper international commodity prices. These costs will be passed on and profitability will not be disturbed. Broadly, earnings per share should be rising at 20% over the year.

In 2010 stock prices increased 25% almost all the rise being in the second half of the year though corporate performance was better in the first half. The difference was the investment by FIIs to which the market is extremely sensitive. The RBI has estimated that a 10% fluctuation in FII investment results in a 35% variation in stock prices. In the first half of 2010 FII net investment was a mere Rs. 300 billion; in the second five months it rose to Rs. 1010 billion.

In the last 24 months there has been 125% increase in stock prices even though the Sensex is still below the earlier pre-crisis peak. With price/earnings ratio at 23 the Indian market appears over-priced in comparison with other Asian markets. It is therefore possible that FII investment in 2011 may not be as high and the Indian market will be more governed by corporate performance.