A lot of optimism was generated by the government when definite policy actions were announced from September 2012 onwards. The epithet ‘policy paralysis’ was put aside and almost forgotten, as a modicum of dynamism had entered our lexicon. We were told to wait for some time for more reforms after which things would change in the economy.
In February, when the Budget was announced, the FM ensured that the fiscal deficit target for FY13 was adhered to giving one confidence that the target for FY14 will also be achieved. The RBI also provided some support through interest rate cuts and while industry is asking for more, one cannot deny that there has been affirmative action taken on all ends. Further, the FM has assured us that there will be no expenditure cuts and all ministries have been asked to spend money allocated in the Budget. Add to this the announcement that all projects held up by the government on various grounds would be passed and there was a reason for hope. How much has been achieved so far?
The results at the ground level are not too encouraging as revealed by various data points that are available. Industrial growth for the first 2 months of the year has slumped to just 0.1% (0.6% last year). This means that stagnation continues. Typically one does not expect to see a bounce back in these months, which earlier were part of what was called the slack season. Mining, capital goods and consumer goods have negative growth rates, which mean that neither consumer spending nor industrial investment, have taken off. This was also the period when gold imports increased, which makes one reason that incomes generated in these two months through the farm sector (rabi harvest) or organized sector (corporate bonuses) could have gotten diverted away from consumption. Also the infra projects that were to take off, have not really made a start as even the core sector data (that accounts for around 38% of the IIP), grew by just 2.4%. With the monsoon season now beginning, there would be a tendency for a natural slowdown in any construction project.
If we turn to the credit situation, which in a way reflects what goes on in the real sector, growth in credit has been sluggish. In the first quarter of the year, growth has been 2.9% as against 3.3%. This means borrowing has not taken off for either retail or wholesale segments, which is a concern. Liquidity has generally been adequate though bond yields have increased sharply over time which can be attributed more to the developments in the external sector. The 10-years yield has settled at around 7.5% after declining sharply from 7.8% to 7.25% during the interim period. The stiffening of yields was more on account of the market now factoring in an unchanged RBI stance this month.
The rupee value which is the final result of all that happens in the external sector has gone down by 10.5% up to July 15th from the start of the financial year. The reasons have been repeated often enough now. The fundamentals are weak which is again shown by our trade data for the first quarter. Exports are down by 1.4% which is a blow because it disproves the theory that rupee depreciation is good for exports. Low growth conditions in our export markets – USA, Euro, East Asia, Africa and China has affected demand. Imports – both oil and non-oil have increased by 6% which is quite impressive. But the non-oil component is more due to the high import of gold in the first 2 months, which has subsequently come down on account of intervention by the RBI and government through duty hikes and credit and sale curbs. This had put pressure on the rupee which when laced with the Bernanke effect of blowing hot and cold on the premature withdrawal of the QE programme has taken the rupee down. The RBI has not been open about intervention in the market, but the data from the central bank shows that forex reserves have declined by around $ 12 bn since March end. There has hence been considerable intervention, with limited impact on the rupee depreciation.
Rupee depreciation has spelt the dangers for monetary policy for sure. With FII investment in debt being a negative $ 5 bn since April 1st, the concern on lowering interest rates now is palpable. Now, relatively higher inflation numbers will give further ammunition to the RBI to be conservative in its approach towards interest rate cuts. WPI inflation at 4.9% and CPI inflation at 9.9%, though stable relative to last month is higher with some strains of latent inflation. Rupee depreciation should impact import of manufactured goods which should put pressure on their prices – something not witnessed so far. Global crude oil prices are increasing which combined with the depreciation will lead to higher inflation. So, there is a stronger case for the RBI to wait and watch before lowering interest rates. Also as we near the end of the season when the kharif crop of last year will be used up, there could be the tendency for prices of food products to increase too. Therefore, inflation also appears to be a concern, albeit a minor one today.
The stock market of course has been an enigma as always. Notwithstanding the economic environment, the Sensex has ranged between 18500-20000 most of the time giving a feeling of confidence. This is even when FIIs have withdrawn around $ 1.7 bn in June 2013 and $ 44 mn in July (up to 11th).
Therefore, the picture that we get now is quite hazy about growth and control of inflation. The green shoots have certainly not appeared and the monsoon period is not exactly the time when there is much private activity. Inflation will stabilize at a higher level once the impact of rupee depreciation gets embedded in the system. While there is no need to despair, there could be a call for more urgency on the part of the government to actually start spending money on projects a la Keynes. The private sector will not spend because they still have surplus capacity and with demand being muted and interest rates high, there is no compelling reason for them to expand now. Global conditions will be volatile and consumer spending can be witnessed only when the time comes, which will be in August. The ball, by some irony, is back in the government’s court.