Financial Scene: Problems don’t come singly


Prime Minister Manmohan Singh, perhaps, had no other option except to strike an optimistic note on India’s immediate growth prospects. On August 11, a few days after the global rating agency Moody’s lowered India’s growth forecast for 2012-13 to 5.5 per cent, the Prime Minister, while admitting that the downgrade was a cause for concern, maintained that India can prove the agency wrong and do even better than last year when it clocked 6.5 per cent. According to him, India has among the highest savings and investment rates in the world.

Fundamentals strong

Elaborating on the same theme in his Independence Day speech, the Prime Minister lamented that his government was not able to spur economic growth because of the lack of consensus in “many issues” adding that “the time has come to view the issues that hindered development as matters of national security”.

Obviously, he was referring to the so-called reform measures which the UPA government was unable to push through either through Parliament (as with finance bills such as relating to pension and banks) or by simply winning over opposition. The opening of the retail sector to foreign direct investment has been a very contentious issue but did not require parliamentary approval. Even so, the UPA government dithered and finally withdrew the proposal, hoping to work out a consensus with individual state governments. Rationalising subsidies —petroleum and food — has been an important task before all recent governments. With each passing day, the issues become more complex.

In the meantime, how credible are the optimistic growth forecasts?

The Prime Minister is not alone in hoping for an above the trend growth. Evidently, statements such as those, coming from the top political leadership, are meant to revive the flagging sentiment and, if possible, talk up growth. Unfortunately, neither has happened nor will they happen automatically.

Correcting deficiencies

In fact, there is a contrary view which states that it would be good if political leaders discover “the bottom” of the economy and take feasible steps to correct the deficiencies rather than take some innate “strengths” for granted. India’s high levels of savings and investment are no doubt important factors but it would be naive to think that these will not be adversely affected as the economic deceleration becomes pronounced. Besides, policies meant to address the slowdown can have a negative impact on these. A soft interest rate policy, strongly canvassed for by large sections of industry and commerce, might result in a slower rate of growth of deposits in banks and institutions. Depositors will get an even worse deal than now.

The government’s predicament is particularly acute because a number of adverse developments from India and abroad have surfaced at the same time and reinforce each other in their deleterious consequences. Take, for instance, the twin deficits — fiscal and current account — existing simultaneously. There has been a succession of bad news here. Recent trade figures point to a contraction in exports for the month of July. The trade deficit figures obviously matter in estimating the extent of the current account deficit. What is most worrying here is that while the dependence on short-term flows continues, a combination of factors, both domestic and external, are drawing attention to the dangers ahead in relying almost exclusively on one single source. Simply put, India cannot take the flows for granted. The continuing euro crisis has kept risk aversion high. There is a danger of short-term capital flows moving out of India into the safe sanctuary of the U.S. Also, the threat of downgrade is particularly worrisome as it might adversely affect investor behaviour. It will raise the cost of borrowing by Indian companies abroad.

Fiscal deficit

Failure to rein in the fiscal deficit so far will be costly for the government. Already the monetary policy has to fight inflation single-handedly without the support of the fiscal policy. The budget’s target of keeping the fiscal deficit at 5.1 per cent of GDP (gross domestic product) was not considered to be sufficient for achieving consolidation but even that distinctly un-ambitious target is unlikely to be met.

As if all the above are not enough, the data on industrial output (IIP index) for June once again underlines the weakness of manufacturing. Industrial output declined by 1.8 per cent in June, dragging down the April-June figures to minus 0.1 per cent.

Finally, in what should be seen as a telling commentary on the prevailing mindset, even the rare bit of good news is not considered to be so. The WPI inflation fell below 7 per cent to 6.87 per cent in July. This should give some comfort — inflation has remained sticky and well above the RBI’s comfort zone. Yet, sceptics point out that the July figure is only provisional and in the past, revisions have always resulted in a higher figure. Also, (1) the July figures have not taken into account the hike in power tariffs implemented in many key states during the first half of the year. (2) The government has not raised the retail prices of diesel, kerosene and LPG for well over a year. In the case of urea, the price has been frozen for more than two years. Sooner, rather than later, these retail prices will have to be adjusted in line with the high global petroleum prices. When that happens inflation will surge.

Evidently, prevailing mindsets play a large role in conditioning inflation expectations.

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Printable version | Jan 22, 2020 7:57:25 PM |

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