With the emerging economic scenario in India posing a stiff challenge, the macroeconomic and monetary policies need to be carefully calibrated to achieve the immediate objective of maintaining stability without compromising growth, Dr. M.S. Kapadia infers from this analysis of RBI’s Annual Report 2012-13, a report card which is keenly awaited for its expert economic overview.

The current year has begun with tumultuous changes. After early signs that growth was picking up in the US and Japan, the indication by the US Federal Reserve that it would unwind part of the monetary stimulus earlier than anticipated, has led to tightening in financial conditions. Bond yields firmed up across the curve and across geographies. Currencies of the Emerging Markets and Developing Economies depreciated speedily.

This, in turn, led to a decline in equity prices as portfolio shifts occurred from EMDEs to US markets. Global commodity prices, which had exhibited a softer bias during February-April 2013, firmed up. Political unrest in parts of the Middle East also put upward pressure on global oil prices.

After the Fed Chairman’s comments on May 22, until July 15, 2013, foreign institutional investors on a net basis disinvested $8.3 billion of their bond portfolio and $2.1 billion of their equity portfolio in cash markets in India. The resultant net outflows brought the rupee under immense pressure. Considering the heightened exchange rate volatility, RBI announced several measures to stabilise the rupee.

EXTERNAL SECTOR VULNERABILITY INDICATORS
AT THE END OF 2012-13 (PER CENT)
Indicators
2010-11
2011-12
2012-13
Total Debt to GDP
17.5
19.7
21.2
Short-term to Total Debt (Original Maturity)
21.2
22.6
24.8
Short-term to Total Debt (Residual Maturity)#
42.2
42.6
44.2
Concessional Debt to Total Debt
15.5
13.9
11.7
Forex Reserves to Total Debt
99.7
85.2
74.9
Reserves Cover of Imports (in months)
9.5
7.1
7
Debt Service to Current Receipts
4.4
6
5.9
Net International Investment Position ($ billion)
-207
-249.5
-307.3
# RBI Estimate

Better outlook
The emerging macroeconomic scenario for the year is challenging amid a wide CAD, risks to fiscal targets, persistence of high consumer price inflation, risk of exchange rate depreciation feeding into inflation, slowing growth and deteriorating asset quality. As such, macroeconomic and monetary policies need to be carefully calibrated to achieve the immediate objective of maintaining stability without compromising growth.

Recovery can take shape later in the year, but is predicated on better governance, the removal of supply constraints and maintenance of stability. Despite the new risks, as a baseline the real GDP growth outlook for the year is better than that in 2012-13, following the growth-supportive measures taken by the government and the southwest monsoon that has performed well so far.

Weakness in industrial activity has persisted and global growth has been tepid. However, normal and spatially well-distributed rainfall so far during the southwest monsoon augurs well for the agriculture sector and is expected to boost rural demand for industrial goods and services.
The effects of government efforts to resolve key policy impediments to investment, such as land acquisition, environmental clearances and raw material shortages, particularly coal, should translate into ground-level execution.

External sector: Even though CAD is expected to widen during Q1 on account of higher trade deficit, it is likely to moderate thereafter. Nevertheless, CAD may continue to be much above the sustainable level of around 2.5 per cent of GDP, underscoring the importance of the need for medium-term correction to improve export competitiveness, discourage avoidable imports, and to improve more stable capital inflows.

Inflation: Although headline inflation had moderated in Q1, risks on the inflation front are still significant. This is evident in a rebound in inflation to 5.8 per cent in July. Creeping inflation pressures are visible arising from rising food and fuel prices, the latter in large part due to exchange rate depreciation. Also, while WPI inflation has moderated, CPI inflation remains close to double digits. Nevertheless, on the whole, the inflation outlook appears to be better than in the previous year.

Financial markets: Over the current year and the next, utmost attention is needed to contain financial stability risks that are rising with the deteriorating asset quality of banks. Given the current fluid situation with respect to key asset prices in currency, equity, bond and commodity markets, the external finance premium facing a firm could go up and impact access to finance. The asset quality of banks has deteriorated significantly recently due to the slowdown in the economy and the emergence of sector-specific issues amid structural bottlenecks in the economy.

Government finance: The budget estimates for 2013-14 and the rolling targets set for 2014-15 & 2015-16 indicate a continuation of the momentum of fiscal consolidation. However, achieving revenue targets would depend on the revival of investment climate and growth. Also, while the impact of National Food Security Ordinance on the food subsidies is manageable in the current year, in the years to come it will add to the fiscal pressures. Over the next few years the growing subsidies could restrict investment opportunities, including those in agricultural sector.

Looking ahead
The Indian economy is currently going through a difficult period. However, the problems are not unique to India. Growth has also slowed down in many other Emerging Markets and Developing Economies. What is important at this stage is to preserve the country’s growth potential by arresting the downtrend and maintaining stable macroeconomic conditions. For this, the focus needs to be on implementation of measures aimed at removing structural constraints so that production and investment activity could gather momentum. With consumer price inflation, fiscal deficit and current account deficit being amongst the highest in EMDEs, the need to preserve macroeconomic stability has emerged as a binding constraint.

The momentum of recovery could come from reengineering focus on unclogging the stalled investment projects, giving an impetus to investment in key infrastructure sectors, supporting productivity enhancements.


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