The Union Government wants us to believe that the economy is on the road to recovery. But it needs a lot to do to steer the ailing economy out of a sub-five per cent growth. It is not the time to cheer up
It is not at all rosy for the Indian economy. Despite high inflation, not only in food but even in the general wholesale price index, the breather by the Reserve Bank of India in holding on to the interest rate, is being seen as the possible beginning of a new era, though that may not be a great hope. The RBI’s move should hold on to the cost of funding at least for some time. That does not free the path of development, particularly as the US Federal Reserve Bank cuts $10 billion in bond-buying from the early months of 2014.
This may create a reverse tsunami of funds-flow to the US and a further strengthening of the dollar. Many global markets, including India, may have to take a hit as funds are withdrawn for investing in the US. The RBI in its policy stated that there are obvious risks to waiting for more data, including the possibility that tapering of quantitative easing by the US Fed may disrupt external markets and that the RBI may be perceived to be soft on inflation. Even though the RBI maintains status quo in its mid-quarter review of monetary policy, it can help guide market expectations through a clearer description of its policy reaction function.
If the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the coming times, or if inflation excluding food and fuel does not fall, the RBI will act, so that inflation expectations stabilise and an environment conducive to sustainable growth takes hold. The Federal Open Market Committee, the arm of the US Federal Reserve Bank, in contrast to its decision of keeping $85 billion-a-month stimulus programme unchanged in September this year, concluded tapering of its Asset Purchase Programme to $75 billion, starting from January 2014.
This has begun creating a scenario where investors fear that chances of a capital flow to the US and a strong dollar are real. It has already caused many currencies to tumble. The most immediate impact was on the Japanese yen which fell quite a few notches to touch 104 yen to a dollar, one of the lowest in recent times. Union Minister for Finance P Chidambaram’s hope that India’s increased bilateral currency swap with Japan, from $15 billion to $50 billion, would help stabilise the rupee, is to be seen in the context of the US Fed decision. With the yen falling, the gains for India may be limited.
The rupee is finding difficulty to hold on to the present rate of around Rs 62 to a dollar. If it falls further, which seems quite likely, the hope of containing current account deficit may get dashed to the ground. The official fall in gold imports may give a kind of window-dressing for the CAD, but in reality the higher smuggling and monitoring costs negate the little gains that are seen in fall of gold imports. The stock market has correspondingly shown a fall of 151 points in a day — much more than the perceived gains during the last few weeks. The sensex fell from 20,859 to 20,708 after the US Fed decision. As the US Fed move is aimed at boosting the flow of funds to the US, it might create a difficult situation for the Indian economy, particularly in terms of foreign direct investment.
The perceived political change in the country after the lok Sabha poll too may lead to a situation of wait-and-watch by the investors. The last quarter of the economy may not be a booming season of activity. Since most foreign institutional investors and FDI flows come from the West, a crisis-ridden Europe may turn to the US for its recovery. A developing India has many challenges that European investors would best like to avoid. The Government had a tough task in finding investment in the retail sector. Walmart so far has not agreed and the Government is pressuring UK’s Tesco. Despite an agreement with Tatas, the Tesco management is reconsidering its decision.
It is not just the external factors that are not so favourable. Even internal factors, including headline inflation, both retail and wholesale, are an issue of concern for the investor. The high energy prices and the latest move to double the gas price for a private firm from $ 4.2 per mmBtu to $8.1 per mmBtu is likely to increase electricity and other fuel prices to rise sharply. The decision was taken against the wishes of public sector power and gas companies. The gain for the private party would be a direct loss to public sector power generation and fertiliser companies. Overall, it would add to inflation.
Despite many assurances from the Government to the contrary, this may again create a situation that would vitiate the appropriate conditions for private investment. Another decision that might alert the foreign investors is the decision to slap another $604 million tax demand on UK’s Vodafone, adding to its tax disputes since it bought Hutchison-Essar in $11 billion (then Rs 51,000 crore) in 2007. India needs a lot to do to streamline and steer the economy out of a sub-five per cent growth. It is yet not the time to cheer up.