With state expenditure unlikely to be reduced, RBI will have a hard time managing the national balance sheet
The fiscal deficit number is relevant for two reasons. First, it tells us about the ability of the government to match its expenditure and income; second, it gives an indication of the borrowing programme for the coming year. While theory suggests that the government’s budgetary exercise targets expenditure first and then works out how to garner revenue—with the fiscal deficit becoming a residual item—things are different today. The fiscal deficit ratio—the deficit as a percentage of gross domestic product (GDP)—appears to be the starting point of the exercise. But how much will the government in New Delhi be able to do about it?
As the government draws closer to presenting the Union Budget, two issues are being debated: Will the budgeted fiscal deficit ratio of 6.8% be maintained for 2009-10, and what would the ratio be for 2010-11? The Reserve Bank of India (RBI) has indicated that the number for 2010-11 could be in the region of 5.5%.
The Union government can take credit for keeping the fiscal deficit ratio at less than what was budgeted in the first four of the five years that comprised its first term in office (the exception was 2008-09). This was managed through the twin horns of controlling the numerator and growing the denominator: The lower numerator (fiscal deficit in rupee terms) suggests control of the deficit in nominal terms, while a higher denominator (nominal GDP at current market prices) was, in a way, fortuitous.
The 2009-10 Budget presented in July assumed that the denominator would grow by 10.1%, which is much below the normal growth of 14%. Based on RBI’s revised forecasts of 7.5% GDP growth and inflation at 8.5% for this fiscal year, the nominal GDP at current market prices would increase by 16%.
Based on the denominator growing at a higher rate, the government could actually increase the fiscal deficit from Rs4 trillion to Rs4.22 trillion for 2009-10, and still adhere to the target of 6.8%. This implies that the fiscal deficit in monetary terms can be exceeded by around Rs22,000 crore.
The government’s borrowing programme for this fiscal year is almost complete and further borrowing to this extent should not upset the apple cart. The fiscal deficit ratio target can still be met despite the fact that tax revenues may not have been very buoyant. Therefore, slippages on tax collection or expenditure will not affect the final ratio within this limit.
The other issue pertains to budgetary numbers for 2010-11. The view that the ratio can be capped at 5.5% is debatable. This is so because it would mean that nominal GDP has to grow by 17.5%: This will be difficult as real GDP growth could go up maximum to 8.5% and inflation would be at 5-6%, bringing the nominal GDP growth number, the sum of these two components, only to 14.5%. The only way out would be for the fiscal deficit number to come down in absolute terms. But is that possible?
The starting point would be expenditure, where around 70% comes under non-Plan expenditure—spending that doesn’t finance the Five-year Plans. The overall expenditure of Rs6.95 trillion for 2009-10 would be difficult to lower. Interest payments for the enlarged borrowing programme will anyway increase by at least Rs30,000 crore. Subsidies will be difficult to lower. In fact, subsidies would increase to alleviate the condition of the poor through interest rate subventions (in the aftermath of a drought year) and loan write-offs. Also, defence expenditure has never been lowered in the past.
The brakes then have to be applied to Plan expenditure, which again looks unlikely given that development schemes such as the National Rural Employment Guarantee Scheme have to be sustained to create the balance of inclusive growth. Besides, Plan expenditure has never declined: It has usually increased by 20-30% annually in the last five years. The onus thus falls on revenue generation.
With a delayed goods and services tax (GST) and a direct tax code still in draft form, tax reforms aren’t on the cards. The crux will be on having the economy grow at a rapid rate and using the inherent buoyancy in the tax system to generate revenue. In the last five years or so, indirect taxes such as customs and excise duty collections have tended to decline.
So corporate profits have to be more buoyant to provide funds for the government. Unless the government focuses more on service tax—a challenge given that only around 50% of the services are in the organized sector, the rest being virtually outside the tax ambit— the increase in tax collections can, at best, only keep pace with growth of individual sectors in the economy.
Therefore, it would be quite a task to rein in the fiscal deficit and, hence, the borrowing programme. That means RBI will have a tough time balancing liquidity and interest rates with growth and inflation.
So, one way or the other, the pressure may not be really on the finance ministry in New Delhi, but remains with the central bank in Mumbai, which will have to be accommodative to bring about growth and the requisite tax collections. But a buoyant economy triggers demand-pull pressures—more money chasing goods—which call for hardening rates and absorption of liquidity. RBI does have tools at its disposal. But the next year would nevertheless be one where, to borrow an analogy from the examination system, RBI has to appear for regular unit tests.
Saturday, February 20, 2010
Base lending rate ensures transparency : Economic Times: 19th Feb 2010
The base lending rate is an improvement over the PLR as it reflects the actual cost to banks that has to be covered through their lending operations. The PLR has lost relevance, given the opacity in its determination and the tendency for several loans to be reckoned at sub-PLR rates.
The guidelines announced by RBI on base rates of banks are interesting for several reasons. The definition provided by RBI has four components: cost of deposits, negative carry on CRR and SLR, overheads cost and returns on net worth.
Based on this formula and the numbers available for 2008-09, the base rate has been calculated for a set of banks.
Based on the 2008-09 numbers, the base rate varies from 5.22% for Citi to 8.91% for OBC. Broadly speaking, foreign banks have the lowest rate followed by public sector banks and then private banks. Given that the present PLR is 11-12%, the difference with the calculated base rate varies from 3-7% points, which is quite significant. However, there is a major exclusion here in the base rate calculation, which is a provision for NPAs. Given that the ratio of gross NPA to total advances varies between 1% and 2% points for banks, this has to be included for the base rate calculation. By including this provision, the base rate moves up to between 6.5% and 11%.
The basic question is, how should these components be fixed? The past profit ratio may not be indicative of the future, as normally adaptive expectations are followed where banks factor in an increase in this ratio, which will impart an upward bias to this number. Similarly, overhead costs by their nature are fixed in size and increase at a trend rate and are not linked with movements in business numbers. While the SLR and CRR would be more or less fixed or change proportionately for all banks, the cost of deposits will change dynamically, depending on how overall policy rates move, and will hence be variable.
The reason for having a base rate as a substitute for the PLR is that today there are a number of loans that are reckoned at sub-PLR level, which makes this benchmark irrelevant. In fact, the average return on advances for most loans lie in the region of 8-11%, of which only part may be explained by the legacy issue of loans being provided at a lower rate in the past. Housing loans, for example, are usually at sub-PLR while there are others which are fixed by RBI and linked to the PLR such as farm loans or export finance. The creation of a base rate will provide the minimum that has to be covered by the bank. The final lending rate would simply be the base rate, plus the risk-cost attached to the credit rating perception of the borrower by the bank.
At the ideological level, the question to be posed is whether RBI should be fixing such a formula in a free-banking system. While transparency is needed, as banks should let the customers know about their rates, the method of arriving at the rate should be left to the banks as they should have the power to decide on the levels for each of the components, especially overheads and profits. In fact, RBI should decouple various kinds of finance to the base rate or PLR as the case may be, to reflect free pricing, especially since there are anyway quantitative norms to lending that have to be adhered to by banks.
Today, the PLR of banks are more or less the same across banks. An interesting outcome would be that once the base rate scale is known to all and varies according to a uniform predetermined formula, potential customers would have a choice provided the banks have the willingness. It would be interesting to observe as to how would the higher base-priced banks respond in such a situation.
The guidelines announced by RBI on base rates of banks are interesting for several reasons. The definition provided by RBI has four components: cost of deposits, negative carry on CRR and SLR, overheads cost and returns on net worth.
Based on this formula and the numbers available for 2008-09, the base rate has been calculated for a set of banks.
Based on the 2008-09 numbers, the base rate varies from 5.22% for Citi to 8.91% for OBC. Broadly speaking, foreign banks have the lowest rate followed by public sector banks and then private banks. Given that the present PLR is 11-12%, the difference with the calculated base rate varies from 3-7% points, which is quite significant. However, there is a major exclusion here in the base rate calculation, which is a provision for NPAs. Given that the ratio of gross NPA to total advances varies between 1% and 2% points for banks, this has to be included for the base rate calculation. By including this provision, the base rate moves up to between 6.5% and 11%.
The basic question is, how should these components be fixed? The past profit ratio may not be indicative of the future, as normally adaptive expectations are followed where banks factor in an increase in this ratio, which will impart an upward bias to this number. Similarly, overhead costs by their nature are fixed in size and increase at a trend rate and are not linked with movements in business numbers. While the SLR and CRR would be more or less fixed or change proportionately for all banks, the cost of deposits will change dynamically, depending on how overall policy rates move, and will hence be variable.
The reason for having a base rate as a substitute for the PLR is that today there are a number of loans that are reckoned at sub-PLR level, which makes this benchmark irrelevant. In fact, the average return on advances for most loans lie in the region of 8-11%, of which only part may be explained by the legacy issue of loans being provided at a lower rate in the past. Housing loans, for example, are usually at sub-PLR while there are others which are fixed by RBI and linked to the PLR such as farm loans or export finance. The creation of a base rate will provide the minimum that has to be covered by the bank. The final lending rate would simply be the base rate, plus the risk-cost attached to the credit rating perception of the borrower by the bank.
At the ideological level, the question to be posed is whether RBI should be fixing such a formula in a free-banking system. While transparency is needed, as banks should let the customers know about their rates, the method of arriving at the rate should be left to the banks as they should have the power to decide on the levels for each of the components, especially overheads and profits. In fact, RBI should decouple various kinds of finance to the base rate or PLR as the case may be, to reflect free pricing, especially since there are anyway quantitative norms to lending that have to be adhered to by banks.
Today, the PLR of banks are more or less the same across banks. An interesting outcome would be that once the base rate scale is known to all and varies according to a uniform predetermined formula, potential customers would have a choice provided the banks have the willingness. It would be interesting to observe as to how would the higher base-priced banks respond in such a situation.
Where are prices going from here? Financial Express Feb 19, 20
Inflation this year has been the most difficult variable to interpret for three reasons. The first is the issue of a statistical base year effect, which has often not shown a high number even when prices were rising. The second is that prices are always defined at points in time that have been volatile over weeks, rising and falling alternately, thus giving confusing signals. The third is that there is the reality of the marketplace where we continue to pay high prices even as we are told that prices are coming down. What is the right picture going forward? The CPI indices for December show some shocking numbers that are generally out of the purview of public discussion. The CPI for industrial workers shows an increase of 15%, for agricultural labourers 17.2% and rural labourers 17%. The WPI for January at 8.56% reflects only a part of this. The problem with the inflation numbers is that they are calculated over previous year’s indices. There is a statistical bias that will be imparted to the fuel and manufactured products’ indices in the coming months. The fuel numbers were benign till May 2009 and manufactured products till August 2009, which means that there will be an upward thrust statistically. Unless prices actually decline, we will end up with higher price indices for these two sets of products, which account for 78% of the WPI. Primary products started showing an increase in March 2009, which, if one recollects, did lead to a situation in June 2009 when there was a debate on deflation as the WPI turned negative. These statistical mirages will continue to cloud our judgement on account of base year effects. What about signs of lower food prices being witnessed today? Here one must realise that we have two seasons in agriculture—kharif and rabi. If the kharif crop is unsatisfactory, then we have to live with lower output unless we supplement the supplies through imports. We are trying to do so with pulses and sugar, and to an extent have reined in prices. If the crop has a good rabi season, then there can be compensation in output and hence prices can decrease. But crops like tur, soybean and moong are primarily kharif and a shortfall will remain till the next harvest. Therefore, even though we are expecting an excellent wheat WPI may come down, we will continue with higher prices for other products. Further, the government’s own actions have propped up food prices through the MSP—the government, in its quest to build up stocks, hiked the price of rice and wheat to higher levels which, some critics feel, was not justified. Therefore, even a bumper crop may not mean lower prices if the MSP is higher.
So far, all the inflation talk has been on the supply side, but what about demand? There are signs that the economy may be heating up as evidenced by the very high IIP growth numbers (though understandably the low base has again contributed to part of this spectacular IIP growth). A fast-growing economy generates demand-pull pressures as there is an increased demand for manufactured products, in particular, as investment and production accelerates. This, in turn, puts pressure on industries such as machinery, metals, chemicals, cement, fibres and so on. Therefore, while on the supply side we can be optimistic that output will improve when the crops are harvested, there is a question mark when it comes to demand-pull inflation. Globally, it has been observed that while agricultural product prices have been benign (barring sugar), those of metals have started moving upwards, ostensibly on the saddle of the growth process that has picked up not just in China but also in the US and the Euro region. This has meant that there is greater demand for associated products, which will put some pressure on prices going ahead as there are always lags before capacities are created which result in output. Finally, the oil factor remains an enigma to us today, as one can never really guess which way it would move. While this would have been less serious in an administered pricing regime, if the recommendations of the Kirit Parikh Committee Report are accepted, there is a feeling that higher retail prices for oil products may fuel inflation. While it would be outrageously bold to take segmental calls within the WPI, notwithstanding the base year effects, inflation will be a concern in 2010-11. While the current levels of double-digit rates may not persist, a high single-digit number does not seem out of place if oil reforms and industrial growth take off.
So far, all the inflation talk has been on the supply side, but what about demand? There are signs that the economy may be heating up as evidenced by the very high IIP growth numbers (though understandably the low base has again contributed to part of this spectacular IIP growth). A fast-growing economy generates demand-pull pressures as there is an increased demand for manufactured products, in particular, as investment and production accelerates. This, in turn, puts pressure on industries such as machinery, metals, chemicals, cement, fibres and so on. Therefore, while on the supply side we can be optimistic that output will improve when the crops are harvested, there is a question mark when it comes to demand-pull inflation. Globally, it has been observed that while agricultural product prices have been benign (barring sugar), those of metals have started moving upwards, ostensibly on the saddle of the growth process that has picked up not just in China but also in the US and the Euro region. This has meant that there is greater demand for associated products, which will put some pressure on prices going ahead as there are always lags before capacities are created which result in output. Finally, the oil factor remains an enigma to us today, as one can never really guess which way it would move. While this would have been less serious in an administered pricing regime, if the recommendations of the Kirit Parikh Committee Report are accepted, there is a feeling that higher retail prices for oil products may fuel inflation. While it would be outrageously bold to take segmental calls within the WPI, notwithstanding the base year effects, inflation will be a concern in 2010-11. While the current levels of double-digit rates may not persist, a high single-digit number does not seem out of place if oil reforms and industrial growth take off.
Commodity Shopping in 2010 : Forbes: Jan 21 2010
Commodities could sizzle again in 2010 if global growth returns. They could offer the alert investor, ever ready to track key changes real-time, a happy hunting ground
Commodities in the Indian context have progressively become an exciting prospect for investors as they could be positioned somewhere between boisterous equities and the more conservative government securities in the pecking order of returns. They have received a boost in the last five years on account of the idiosyncratic commodity cycles which at times have yielded returns of over 75 percent on products such as copper, furnace oil, spices and pulses. Commodity prices are driven by fundamentals rather than sentiment. While this appears to be assuring, it is actually difficult to judge commodity trends due to their complexity.
Prices were subdued during the first half of 2009 since the world economy’s attention was focussed on the financial sector as overall growth had slowed down. Crude and metal prices declined and stable farm output kept prices in balance. However, with the global economy staging a recovery earlier than anticipated, prices of crude and metals have started moving upwards. This has caused renewed interest in commodities which will probably remain through 2010. If the expected U-shaped recovery becomes more like a V-shaped one, then the commodity cycle could look good in the years to come.
Commodity price trends can change all too suddenly. A transport strike, frost, unscheduled holiday or a roadblock can cause disruptions in supplies that can move prices in a certain direction, only to be reversed when normalcy is restored. Therefore, one needs to understand the difference between a disturbance or shock and a fundamental. Lower area sown or crop damage is an irreversible event while breakdown of vehicles or non-availability of fuel in a mandi centre is a one-day distortion. Knowing and interpreting these events is the major challenge of investing intelligently in the mlayman should ideally take a longer term view to reduce risk because short term variations need to be understood very clearly before entering the market. Cash and carry is just not possible given that contracts end in physical delivery. This means that an investor must enter and exit at the right time. Long-term contracts are not yet available in India and the farthest contract doesn’t exceed six months. Therefore, it is all the more important to be better informed before entering the market as one will be dealing with a single-season outlook.
Presently the Indian regulatory system does not allow for Indians taking positions international exchanges. But on account of globalisation, the correlation between global and domestic prices has tended to get closer. This holds quite clearly for bullion, crude and metals (over 90 percent) where price setting takes place on international exchanges and India is a price takeBut in agriculture, too, this bond has thickened for global products like soya (80 percent), corn (60 percent), wheat (60 percent) and sugar (80 percent). In fact, India’s influence on global prices can be gauged from the fact that whenever the government had reckoned imports of wheat and sugar, global prices started moving up in anticipation. In other products like spices, where India is the price setter, investment decisions are based on domestic considerations.
In 2010, maybe the world will get on a higher growth trajectory leading to an increased demand for commodities, especially metals. To begin with, supplies will be available but countries have to start investing in capital to meet these future demand requirements. Crude oil would once again be in demand as the hype around bio-fuels has melted presently and higher growth would necessarily mean greater demand for oil. At the same time growth in population, higher income and changing consumer preferences to value-added food products will keep demand for agricultural products buoyant.Can one take a guess at the commodity cycle in future? It is a tough call because there are two sets of factors at work. The first is that inflation is always positive (most of the time) which means that prices must rise over time.
The other set of factors is product specific in the sense that one has to choose the product to invest just like the individual scrip in the equity market. The moot question is which are the ones that would provide high returns on investment? Again, this is not an easy one to answer as individual product prices would be driven by their own fundamentals which have to be analysed individually. The value of the dollar is important for gold while US stocks of crude will continue to provide hints on the price. Crop prospects can never be known in advance in the country or the rest of the world.
In that case how does an investor go about using this market? When it comes to farm products there are seasons, and a crop out of season would not generally see much interest as the hedgers, which is the class that initiates trade, would be missing. Investing in this segment means conjecturing the supplies expected in the country as well as in the rest of the world. While such information is available, one needs to really track them on a real time basis. A rebel attack in Nigeria can send the price of crude upwards while a flood in Andhra Pradesh can ruin the chilli crop for the entire season.
Non-farm products are probably easier to track over the long run as we get some sense of the trends of growth prospects in the developed world. Investments in farm products would still be a challenge as it was observed this year, where it was only in late September that it was agreed officially that there was a drought. In fact, prices started moving at a quicker pace once this announcement was made.Therefore, given that this market is still new and less understood, the uninitiatedmust make a thorough study of the factors that guide prices. The key risk is failing to understand the commodity and blindly following a price direction. The second risk is getting caught in a relatively less liquid contract where one cannot exit easily. One could get caught being forced to make or take physical delivery in case one cannot exit or roll over before expiry.
As far as speculative bubbles go, it is theoretically true that it holds in any market. However, in the commodities markets, prices have generally followed fundamentals and there has not been any such bubble or even deviation from what is expected. In fact, the futures markets have given several early warning signals on the state of final harvest as in wheat and sugar. Hence, if one does one’s homework and operates, one can take judicious decisions.
There is need to step in with caution and be prepared to get one’s feet wet, much like Macbeth’s: Letting ‘I dare not” wait upon ‘I would,’ Like the poor cat i’the adage.”
Commodities in the Indian context have progressively become an exciting prospect for investors as they could be positioned somewhere between boisterous equities and the more conservative government securities in the pecking order of returns. They have received a boost in the last five years on account of the idiosyncratic commodity cycles which at times have yielded returns of over 75 percent on products such as copper, furnace oil, spices and pulses. Commodity prices are driven by fundamentals rather than sentiment. While this appears to be assuring, it is actually difficult to judge commodity trends due to their complexity.
Prices were subdued during the first half of 2009 since the world economy’s attention was focussed on the financial sector as overall growth had slowed down. Crude and metal prices declined and stable farm output kept prices in balance. However, with the global economy staging a recovery earlier than anticipated, prices of crude and metals have started moving upwards. This has caused renewed interest in commodities which will probably remain through 2010. If the expected U-shaped recovery becomes more like a V-shaped one, then the commodity cycle could look good in the years to come.
Commodity price trends can change all too suddenly. A transport strike, frost, unscheduled holiday or a roadblock can cause disruptions in supplies that can move prices in a certain direction, only to be reversed when normalcy is restored. Therefore, one needs to understand the difference between a disturbance or shock and a fundamental. Lower area sown or crop damage is an irreversible event while breakdown of vehicles or non-availability of fuel in a mandi centre is a one-day distortion. Knowing and interpreting these events is the major challenge of investing intelligently in the mlayman should ideally take a longer term view to reduce risk because short term variations need to be understood very clearly before entering the market. Cash and carry is just not possible given that contracts end in physical delivery. This means that an investor must enter and exit at the right time. Long-term contracts are not yet available in India and the farthest contract doesn’t exceed six months. Therefore, it is all the more important to be better informed before entering the market as one will be dealing with a single-season outlook.
Presently the Indian regulatory system does not allow for Indians taking positions international exchanges. But on account of globalisation, the correlation between global and domestic prices has tended to get closer. This holds quite clearly for bullion, crude and metals (over 90 percent) where price setting takes place on international exchanges and India is a price takeBut in agriculture, too, this bond has thickened for global products like soya (80 percent), corn (60 percent), wheat (60 percent) and sugar (80 percent). In fact, India’s influence on global prices can be gauged from the fact that whenever the government had reckoned imports of wheat and sugar, global prices started moving up in anticipation. In other products like spices, where India is the price setter, investment decisions are based on domestic considerations.
In 2010, maybe the world will get on a higher growth trajectory leading to an increased demand for commodities, especially metals. To begin with, supplies will be available but countries have to start investing in capital to meet these future demand requirements. Crude oil would once again be in demand as the hype around bio-fuels has melted presently and higher growth would necessarily mean greater demand for oil. At the same time growth in population, higher income and changing consumer preferences to value-added food products will keep demand for agricultural products buoyant.Can one take a guess at the commodity cycle in future? It is a tough call because there are two sets of factors at work. The first is that inflation is always positive (most of the time) which means that prices must rise over time.
The other set of factors is product specific in the sense that one has to choose the product to invest just like the individual scrip in the equity market. The moot question is which are the ones that would provide high returns on investment? Again, this is not an easy one to answer as individual product prices would be driven by their own fundamentals which have to be analysed individually. The value of the dollar is important for gold while US stocks of crude will continue to provide hints on the price. Crop prospects can never be known in advance in the country or the rest of the world.
In that case how does an investor go about using this market? When it comes to farm products there are seasons, and a crop out of season would not generally see much interest as the hedgers, which is the class that initiates trade, would be missing. Investing in this segment means conjecturing the supplies expected in the country as well as in the rest of the world. While such information is available, one needs to really track them on a real time basis. A rebel attack in Nigeria can send the price of crude upwards while a flood in Andhra Pradesh can ruin the chilli crop for the entire season.
Non-farm products are probably easier to track over the long run as we get some sense of the trends of growth prospects in the developed world. Investments in farm products would still be a challenge as it was observed this year, where it was only in late September that it was agreed officially that there was a drought. In fact, prices started moving at a quicker pace once this announcement was made.Therefore, given that this market is still new and less understood, the uninitiatedmust make a thorough study of the factors that guide prices. The key risk is failing to understand the commodity and blindly following a price direction. The second risk is getting caught in a relatively less liquid contract where one cannot exit easily. One could get caught being forced to make or take physical delivery in case one cannot exit or roll over before expiry.
As far as speculative bubbles go, it is theoretically true that it holds in any market. However, in the commodities markets, prices have generally followed fundamentals and there has not been any such bubble or even deviation from what is expected. In fact, the futures markets have given several early warning signals on the state of final harvest as in wheat and sugar. Hence, if one does one’s homework and operates, one can take judicious decisions.
There is need to step in with caution and be prepared to get one’s feet wet, much like Macbeth’s: Letting ‘I dare not” wait upon ‘I would,’ Like the poor cat i’the adage.”
Monday, February 8, 2010
A green revolution for lentils: Economic Times Febraury 2, 2010
In the last decade, the production of pulses in the country peaked at 14.91 million tonnes in 1998-99 . Since then, while the country’s population has grown at an average rate of 1.3-1 .5% per annum, our pulses production level has never touched this mark. The result : a higher dependence on imports and substantial rise in domestic prices. In fact, during this period, prices have risen on an average annual basis by 6.3% for chana, 6.1% for tur (or arhar), 6.5% for moong and 8.6% for urad. Given erratic production trends, prices have been declining in one year and rising the next year. This, however, is a problem with almost all farm products as domestic productivity levels are stagnant.
When prices are rising, it is logical that there is an incentive for farmers to produce more of these crops to earn higher incomes. When this happens, in course of time, the deficit in production should disappear. However, this has not happened as there is no sign of crop migration and, consequently, every year, there has been a problem with pulses production.
One theory usually put forward is that the higher minimum support prices (MSP) offered on rice and wheat militates against farmers taking the risk of growing any other crop. Hence, pulses and oilseeds are not given the same attention considering that these MSPs always rise and never fall, which assures the farmers higher incomes. But what is more important is the net income that a farmer can earn from growing any crop as there are variations in the productivity levels as well as cost of cultivation, with inputs such as water having a premium when the region is dependent on monsoon. Therefore, the cost of production has to be juxtaposed with the price received as well as the yield per hectare to compare net incomes across the menu available for farmers.
Two points need to be kept in mind. Tur, moong and urad are kharif crops that compete with rice during the season. Likewise, chana competes with wheat in the rabi season. However, if dual cropping is possible, urad and moong can be grown along with wheat in the rabi season. But will this work? The second point is that the cost of cultivation and prices vary significantly across states because these inequalities mean that farmers in some states are handicapped with low productivity , higher cost of production and lower prices The table below provides a view of the net income to be received on one hectare by cultivating various crops in different states. The cost of production numbers are based on what has been provided by the ministry of agriculture for 2005-06 — the latest official data available — while the prices used are averages for the state for 2008-09 harvest season. It is assumed that the cost has not changed or even if it has, would be proportional. The productivity numbers too are assumed to have not changed.
The table reveals interesting facts. The first is that rice and wheat are the most-remunerative crops and there is no incentive for farmers to move to pulses as the returns are lower. The high MSP being provided with the assurance of procurement has set benchmarks in the market for these commodities . Secondly, urad and moong are the least remunerative crops, so it is not surprising that their share in total pulses production is just 13%.
Thirdly, tur provides better returns than even chana. However, the two do not compete as one is kharif and the other is rabi. Fourth, there is scope for migrating more farmers to chana in Uttar Pradesh where its return is better than wheat (at least for this year). However, it must be mentioned here that, typically, chana has not been a problem for the country and it is the other three that have had to be imported in the past. At times, we have exported chana.
Now, what are the lessons to be drawn from these numbers? The government evidently has to focus on improving the yield of pulses as this would be the only way to enhance production . We need to revisit the Green revolution concept of providing better seeds, fertiliser, irrigation and pesticides to farmers if we have to get out of this trap. Simultaneously, the cost has to be brought down through subsidies across states. This is so because market prices are higher than the MSPs — which makes MSPs irrelevant — and they are not within the purview of the procurement and distribution system of the government.
Further, a critical decision has to be taken on whether to migrate cultivation to pulses from cereals. Also, the inter-state variations in income have to narrow down. For example, in the case of urad, prices have ranged from Rs 1,700 in Chhattisgarh to Rs 3,139 in Tamil Nadu. Moong prices have varied from Rs 2,647 in Andhra Pradesh to Rs 3,673 in Orissa. The difference is not just on account of quality and transportation costs. Quite clearly, spot market reforms are needed to even out prices so that farmers are able to get a better deal. The operation of electronic spot markets would take one closer towards these goals with price knowledge being made available to all.
The takeaway is that the issue of being on the edge in case of pulses is a deep-rooted problem that can’t be resolved by piecemeal measures. Only an intensive campaign can provide a solution.
When prices are rising, it is logical that there is an incentive for farmers to produce more of these crops to earn higher incomes. When this happens, in course of time, the deficit in production should disappear. However, this has not happened as there is no sign of crop migration and, consequently, every year, there has been a problem with pulses production.
One theory usually put forward is that the higher minimum support prices (MSP) offered on rice and wheat militates against farmers taking the risk of growing any other crop. Hence, pulses and oilseeds are not given the same attention considering that these MSPs always rise and never fall, which assures the farmers higher incomes. But what is more important is the net income that a farmer can earn from growing any crop as there are variations in the productivity levels as well as cost of cultivation, with inputs such as water having a premium when the region is dependent on monsoon. Therefore, the cost of production has to be juxtaposed with the price received as well as the yield per hectare to compare net incomes across the menu available for farmers.
Two points need to be kept in mind. Tur, moong and urad are kharif crops that compete with rice during the season. Likewise, chana competes with wheat in the rabi season. However, if dual cropping is possible, urad and moong can be grown along with wheat in the rabi season. But will this work? The second point is that the cost of cultivation and prices vary significantly across states because these inequalities mean that farmers in some states are handicapped with low productivity , higher cost of production and lower prices The table below provides a view of the net income to be received on one hectare by cultivating various crops in different states. The cost of production numbers are based on what has been provided by the ministry of agriculture for 2005-06 — the latest official data available — while the prices used are averages for the state for 2008-09 harvest season. It is assumed that the cost has not changed or even if it has, would be proportional. The productivity numbers too are assumed to have not changed.
The table reveals interesting facts. The first is that rice and wheat are the most-remunerative crops and there is no incentive for farmers to move to pulses as the returns are lower. The high MSP being provided with the assurance of procurement has set benchmarks in the market for these commodities . Secondly, urad and moong are the least remunerative crops, so it is not surprising that their share in total pulses production is just 13%.
Thirdly, tur provides better returns than even chana. However, the two do not compete as one is kharif and the other is rabi. Fourth, there is scope for migrating more farmers to chana in Uttar Pradesh where its return is better than wheat (at least for this year). However, it must be mentioned here that, typically, chana has not been a problem for the country and it is the other three that have had to be imported in the past. At times, we have exported chana.
Now, what are the lessons to be drawn from these numbers? The government evidently has to focus on improving the yield of pulses as this would be the only way to enhance production . We need to revisit the Green revolution concept of providing better seeds, fertiliser, irrigation and pesticides to farmers if we have to get out of this trap. Simultaneously, the cost has to be brought down through subsidies across states. This is so because market prices are higher than the MSPs — which makes MSPs irrelevant — and they are not within the purview of the procurement and distribution system of the government.
Further, a critical decision has to be taken on whether to migrate cultivation to pulses from cereals. Also, the inter-state variations in income have to narrow down. For example, in the case of urad, prices have ranged from Rs 1,700 in Chhattisgarh to Rs 3,139 in Tamil Nadu. Moong prices have varied from Rs 2,647 in Andhra Pradesh to Rs 3,673 in Orissa. The difference is not just on account of quality and transportation costs. Quite clearly, spot market reforms are needed to even out prices so that farmers are able to get a better deal. The operation of electronic spot markets would take one closer towards these goals with price knowledge being made available to all.
The takeaway is that the issue of being on the edge in case of pulses is a deep-rooted problem that can’t be resolved by piecemeal measures. Only an intensive campaign can provide a solution.
Saturday, February 6, 2010
What Parikh Can't do for the government" Financial Express: Feb 6 2010
It may sound uncharitable to say that the Kirit Parikh Committee Report on Pricing of Petroleum Products is quite banal and lacks novelty. But we have had the Rangarajan and Chaturvedi Committee Reports in the past that spoke on similar lines. Hence, we already know that petroleum prices should be freed and there should be competition. The problem is on the implementation side, which is always outside the purview of government-appointed committees. Therefore, while this report does not really add to the literature on the subject, or at best, is an update, it can be considered to be another reminder to the government to act fast.
At the moment the government supports fuel prices at levels lower than the market price, leading to losses of around Rs 40,000 crore for the oil companies this fiscal year. The suggestions, to begin with, are to increase the price of petrol by Rs 3 per litre, of diesel by Rs 3-4 per litre, of LPG by Rs 100 and of kerosene by Rs 6 per litre. Further, better distribution of kerosene and LPG is recommended.
The focus here again is on implementation. Two different kinds of analogies may be drawn that provide a view on government action when moving from a controlled to an open system. The first is the telecom sector, where BSNL/MTNL had a monopoly and could charge high prices. Competition and opening of the market helped to lower prices. This was welcome but the two parties involved were a government company and the common man. The common man benefited finally and the government companies were forced to become efficient.
The farm sector is the second area where there is considerable regulation in terms of prices. Here the minimum support prices fixed by the government are often biased upwards to help the farmer. However, higher prices emanating from free market operations are viewed with suspicion. One can recollect that futures trading in wheat, sugar, etc, have been banned at times based on this argument.
This is so because the government gets caught in a quandary whether to favour the farmer or the consumer. Higher farm prices, while helping the farmer, also mean higher inflation for the consumer and that is not exactly palatable. Therefore, inflation caused by higher MSPs is acceptable, while the same for non-MSP products is not. The argument is that when the market arrives at a higher price, it is the middlemanwho gains and not the farmer, while when it is due to the MSP, it is the farmer who is gaining and not the middleman.
The farm analogy is pertinent to oil prices because the two counter-parties concerned are the common man and the oil company—that is the government at present. Keeping this in mind, the freeing of fuel prices raises some questions.
Let us assume that these recommendations are implemented and the prices are market- determined. Prices will move in line with world prices. Higher volatility currently has been eschewed by having prices fixed by the government. A deviation will lead to greater volatility. Another scenario is when global prices fall to, say, $40 a barrel and retail prices are rolled back commensurately, then both the government (excise collections) and oil companies will have a problem on their P&L. This is why prices remain sticky downwards. Are we prepared for this situation?
Higher fuel prices would automatically mean that transport costs will increase and feed into commodity prices. Therefore, even a good harvest could mean higher prices if fuel prices move up. Are we willing to accept these price changes?
Free pricing in the market that has, say, four to six companies will create an oligopolistic situation where prices can be driven higher to enhance profits. This happens in all markets where initial competition can lead to lower prices to keep others out, but that gets reversed subsequently. In this case it is more likely that prices will gravitate upwards. Is this okay with us?
Further, an oligopolistic situation can lead to shortages as companies will take bets on future price movements and it may make sense to supply less today and more in the future when prices increase. Will petrol and diesel then be classified as essential commodities and stock limits placed by the government as they have done for foodgrains?
Assuming that such situations come up, will the sugar model (or muddle) be applicable here where the government suddenly starts imposing quota releases and price bands for oil products?
While some of the doubts raised here may sound far-fetched, we have seen that the government isn’t politically prepared to have open markets and free pricing for essential commodities. Freeing markets is easy, but we need to show character by sticking to the consequences. Otherwise, the present approach where the referee (government) increases or decreases theprice is adequate. But, then this is not analogous to free pricing and competition.
At the moment the government supports fuel prices at levels lower than the market price, leading to losses of around Rs 40,000 crore for the oil companies this fiscal year. The suggestions, to begin with, are to increase the price of petrol by Rs 3 per litre, of diesel by Rs 3-4 per litre, of LPG by Rs 100 and of kerosene by Rs 6 per litre. Further, better distribution of kerosene and LPG is recommended.
The focus here again is on implementation. Two different kinds of analogies may be drawn that provide a view on government action when moving from a controlled to an open system. The first is the telecom sector, where BSNL/MTNL had a monopoly and could charge high prices. Competition and opening of the market helped to lower prices. This was welcome but the two parties involved were a government company and the common man. The common man benefited finally and the government companies were forced to become efficient.
The farm sector is the second area where there is considerable regulation in terms of prices. Here the minimum support prices fixed by the government are often biased upwards to help the farmer. However, higher prices emanating from free market operations are viewed with suspicion. One can recollect that futures trading in wheat, sugar, etc, have been banned at times based on this argument.
This is so because the government gets caught in a quandary whether to favour the farmer or the consumer. Higher farm prices, while helping the farmer, also mean higher inflation for the consumer and that is not exactly palatable. Therefore, inflation caused by higher MSPs is acceptable, while the same for non-MSP products is not. The argument is that when the market arrives at a higher price, it is the middlemanwho gains and not the farmer, while when it is due to the MSP, it is the farmer who is gaining and not the middleman.
The farm analogy is pertinent to oil prices because the two counter-parties concerned are the common man and the oil company—that is the government at present. Keeping this in mind, the freeing of fuel prices raises some questions.
Let us assume that these recommendations are implemented and the prices are market- determined. Prices will move in line with world prices. Higher volatility currently has been eschewed by having prices fixed by the government. A deviation will lead to greater volatility. Another scenario is when global prices fall to, say, $40 a barrel and retail prices are rolled back commensurately, then both the government (excise collections) and oil companies will have a problem on their P&L. This is why prices remain sticky downwards. Are we prepared for this situation?
Higher fuel prices would automatically mean that transport costs will increase and feed into commodity prices. Therefore, even a good harvest could mean higher prices if fuel prices move up. Are we willing to accept these price changes?
Free pricing in the market that has, say, four to six companies will create an oligopolistic situation where prices can be driven higher to enhance profits. This happens in all markets where initial competition can lead to lower prices to keep others out, but that gets reversed subsequently. In this case it is more likely that prices will gravitate upwards. Is this okay with us?
Further, an oligopolistic situation can lead to shortages as companies will take bets on future price movements and it may make sense to supply less today and more in the future when prices increase. Will petrol and diesel then be classified as essential commodities and stock limits placed by the government as they have done for foodgrains?
Assuming that such situations come up, will the sugar model (or muddle) be applicable here where the government suddenly starts imposing quota releases and price bands for oil products?
While some of the doubts raised here may sound far-fetched, we have seen that the government isn’t politically prepared to have open markets and free pricing for essential commodities. Freeing markets is easy, but we need to show character by sticking to the consequences. Otherwise, the present approach where the referee (government) increases or decreases theprice is adequate. But, then this is not analogous to free pricing and competition.
Subbarao’s monetary policy muddle: Financial Express: 30th January 2010
A couple of days before the credit policy was announced, it was interesting to hear some of the chiefs of large banks, including those in the public sector, actually stating that they would not increase interest rates even if RBI hiked them. This is significant not because it is a view of bankers, but because it may also mean that the credit policy per se may be becoming a little less relevant in terms of drawing the desired response from the banks. On the lighter side, this may be the reason why the policy document is just 13 pages. Two issues in the policy document stand out that leave ample scope for debate, as there is a certain degree of ambivalence in them. The first is with respect to GDP growth. RBI has, quite uncharacteristically, upped its projection of growth in GDP for the year from 6% to 7.5%. Such a sudden increase actually means adding something like Rs 50,000 crore of real GDP to the original estimate. Is this achievable? Growth in GDP during the first half of the year has been around 7% and in order to average 7.5% for the full year the economy will have to grow by around 8% during the second half of the year. Agricultural production would play an important role in these two quarters with its weight of around 17-18% in GDP. The kharif crop has been suboptimal with a fall in output of rice, soybean, groundnut, maize, sugarcane, etc. The double-digit decline in output can only partly be addressed by the expected good performance of the rabi crop. This is so because we have already attained peaks in production of wheat, chana and mustard in FY09, which are the major rabi crops. Hence, scoring over these numbers would be a bit difficult. Even at the most optimistic level, there would still be a decline in farm output by at least 5%. Now, even if industry grows by 10% (it has been 7.6% for the first eight months), finance sector by 9% and the social sector (fiscal stimulus sector) by 10% during the second half of the year (which will come over an increase of 17% in FY09), GDP growth would come to at best 6.5%. This is assuming buoyant growth in other areas like construction (8%), transport and trade (9%) and mining (9%).
The second issue pertains to monetary policy per se. The basic objectives of monetary policy are growth and inflation. Is RBI targeting inflation or growth? The answer is not clear based on the actions of RBI. The central bank has highlighted the downside risk of inflation becoming even higher than it is perceived today since even cost-push-inflation on the supply side feeds into inflationary expectations. In fact, if RBI’s projection of 7.5% growth in GDP is to work out, then the economy will be getting overheated, in which case inflation on the demand side would also emanate. Prices of manufactured goods have already started increasing in the last two months, which means that we cannot brush aside inflation as being only a supply-side phenomenon. In such a situation, RBI should have been raising rates, which it has chosen not to do. The reason is ostensibly to not do anything that impedes growth. But, is the policy supportive of growth? The answer is not clear since RBI will absorb Rs 36,000 crore from the system to send signals that it means business. However, with surplus funds of Rs 70,000 crore being invested in the reverse repo auctions on a daily basis by banks, this amount is evidently not significant from the point of view of liquidity as there will still be surpluses with the banking system. But, given that RBI expects the economy to grow rapidly in the second half, especially industry, there should logically be an increase in demand for credit. But, if this happens, then the move to absorb liquidity through the 75 bps increase in CRR will be counter-productive. Absorbing surplus liquidity cannot control inflation just as the SLR increase earlier did not matter when banks had an investment-deposit ratio of 30%. The move is also not supportive of growth as it withdraws money from the system. Besides, the banks too would be bearing a loss of above Rs 1,000 crore as interest income forgone as this was being invested in the reverse repo auctions at 3.25%. The credit policy, while clear on its numbers for growth and inflation, blows hot and cold on how its monetary measures would actually help in achieving them.
The second issue pertains to monetary policy per se. The basic objectives of monetary policy are growth and inflation. Is RBI targeting inflation or growth? The answer is not clear based on the actions of RBI. The central bank has highlighted the downside risk of inflation becoming even higher than it is perceived today since even cost-push-inflation on the supply side feeds into inflationary expectations. In fact, if RBI’s projection of 7.5% growth in GDP is to work out, then the economy will be getting overheated, in which case inflation on the demand side would also emanate. Prices of manufactured goods have already started increasing in the last two months, which means that we cannot brush aside inflation as being only a supply-side phenomenon. In such a situation, RBI should have been raising rates, which it has chosen not to do. The reason is ostensibly to not do anything that impedes growth. But, is the policy supportive of growth? The answer is not clear since RBI will absorb Rs 36,000 crore from the system to send signals that it means business. However, with surplus funds of Rs 70,000 crore being invested in the reverse repo auctions on a daily basis by banks, this amount is evidently not significant from the point of view of liquidity as there will still be surpluses with the banking system. But, given that RBI expects the economy to grow rapidly in the second half, especially industry, there should logically be an increase in demand for credit. But, if this happens, then the move to absorb liquidity through the 75 bps increase in CRR will be counter-productive. Absorbing surplus liquidity cannot control inflation just as the SLR increase earlier did not matter when banks had an investment-deposit ratio of 30%. The move is also not supportive of growth as it withdraws money from the system. Besides, the banks too would be bearing a loss of above Rs 1,000 crore as interest income forgone as this was being invested in the reverse repo auctions at 3.25%. The credit policy, while clear on its numbers for growth and inflation, blows hot and cold on how its monetary measures would actually help in achieving them.
Industry is growing, but not speeding, Financial Express 28th January 2010
The economic indicators announced in the last month or so have been very encouraging. The IIP growth number for the first eight months of the year was 7.6% with growth in November being 11.7%. In fact, in the last six months, the month-on-month rate has exceeded 7% and crossed the double-digit mark thrice. Exports have started showing an about-turn, though just for one month. But, given that the world economy is improving, there is reason to believe that all may be well. However, the industrial picture begs certain questions that need to be answered. The first is that the closest indicator of industrial growth, bank credit, has not exhibited a parallel picture. Growth in bank credit is sluggish at 8.8% for the first nine months of the year as against 12.5% last year. Either industry does not demand the funds or banks are not lending easily—either way the result is that growth is low. This quick indicator of industrial activity does not quite gel with the numbers witnessed in the real sector. The second is that growth in bank deposits, which still constitute around 45-50% of domestic household savings, is down at 9.8% as against 11.7% last year. This is a proxy indicator for investment taking place as savings get translated into investment. As this number is low, there is some concern here, even though in terms of equity raised in the market, the picture is more sanguine at Rs 87,146 crore in the first nine months of the year as against Rs 30,517 crore last year. The third concern here on the industrial front is that the corporate performance is not what it should be. Detailed information on corporate performance for the third quarter, and hence the first nine months, would be available only after February. But, if one looks at the first six months’ performance of industry and the corporate performance, there is a disconnect. Industrial growth has been moderately high at 6.3%; but according to RBI’s latest study on financial performance of companies for the first half of FY10, sales for a sample of 1,752 manufacturing companies had declined by -1.6% while net profits were up by 9.6%. Curiously, profits increased mainly due to the sharp cuts in raw material costs by 9.3%. Stocks, too, had registered a sharp decline during this period. Hence, it is difficult to reconcile declining sales and stocks with growing production. A similar picture is witnessed at.the disaggregated industry level, where sales growth in industries such as chemicals, paper, rubber and machinery was lower than the equivalent IIP growth numbers. This is really a conundrum for interpretation because the IIP numbers that show production growth are not getting reflected in the sales performance. Another related factor that provides important support to industrial growth is the electricity sector. This number has been relatively low at 6.1% in the first eight months and at 3.3% as of November. Typically, the power sector output should be rising dynamically with that in manufacturing. The fourth anomaly in the industrial performance can be viewed from the sharp decline in non-oil imports. This is again significant because normally any growth recovery in the economy must get reflected in higher imports. Normally one would expect imports of raw materials and capital goods to increase to support industrial growth. This is not yet visible and the growth rate as late as November has been negative. The consolation here is that the decline in imports has been low at 6% as against double-digit rates during the year. The fifth indicator of state of industry is the movement in prices. Growth of manufactured segment prices is still low at around 5%, which comes down further to around less than half per cent if food products are excluded. Normally when industrial growth picks up, prices also increase for two reasons. The first is the demand factor that pulls up prices. The other is high manufactured goods inflation is a precondition for industrial growth to take place. The absence of such price increases is again not supportive of the growth hypothesis. The last anomaly that cannot be fully reconciled is tax collections. For the first eight months of the year, corporate tax collections increased by 6.6%. However, customs & excise collections were down at 31.2% and 20%, respectively. Quite clearly, the tax payments have not been coming in at the same pace of production. While lower tax rates could be part of the explanation, even in the last two months the drop in excise collections is significant—this was the time when rates were relaxed by the government in 2008. Given these anomalies in related scenarios, it may be prudent to wait and watch before being convinced that industry is really back on its feet.
Pragmatic approach, DNA , January 18, 2010
There is a feeling of economic euphoria in the country today with even economists talking of 8 per cent growth in GDP, double digit industrial growth rate, soaring Sensex, and a revival in exports. The gushing in of foreign investment has added to this optimism. Inflation surely is spoiling the party but then after a point it is beyond our control when there is crop failure.Against this backdrop, there is talk about whether the government is going to pursue an exit policy. What exactly are we talking of?It may be recollected that when there was an economic slump in the last quarter of 2008 following Lehman, the entire world went into a stimulus mode. What governments essentially did was to pump-prime their economies.Central banks lowered interest rates while the Fed and US Treasury provided capital and guarantees to various financial institutions to restore confidence.Governments went soft on their deficits and began cutting tax rates and increasing their spending so that their economies were on their feet. They supported financial institutions through recapitalisation and direct funding measures. In fact, UK, USA, Japan and the Euro zone all have fiscal deficit ratios that are higher than that of India. The basic idea was to eschew the possibility of a full-scale recession as was the case in 1930 when the Depression ostensibly was aggrandised because governments did nothing.
Therefore, the booster shots were all encompassing. The significance of this approach is that it was pursued by all leading economies almost in cohesion; and more importantly they worked. Almost all countries are showing positive growth, and have come out of the low phase and are seriously thinking about rolling back some of these measures.For us in India, it is necessary to debate this issue because we have two critical policies coming up — the RBI credit policy towards the end of January and the Budget towards the end of February. While the first will give us an idea of the official view of the state of affairs, the second will provide a definite direction. So, we can see these two statements actually putting in perspective the confidence that we have in our economy. Now, the high growth witnessed in the country has come mainly from the services sector, where the social and community services segment, which means the government, has played a critical part. The sharp duty cuts reckoned in 2008 have also helped to stabilise industry which is displaying a steady growth rate for the period September-November 2009.A reduction in such expenditure would be justified provided we are sure that the other sectors would be able to provide the necessary bulk to keep the economy on the upswing.For the current financial year, agriculture has been a failure and a negative growth rate is expected, which means that unless we are sure of this growth in future, any withdrawal of the fiscal stimulus would affect overall growth.Or there has to be compensation from some other sector. Assuming high industrial growth this year of say 8-9 per cent, sustaining the same over a high base could be a challenge.As far as tax rates go, while we have accepted a Goods and Services Tax (GST), its implementation is still a distance away and presently we will have to toss whether or not we go back to the pre-2008 duty structure. While industrial growth has been steady, are we prepared to disturb the applecart at this stage? Probably not, because industrial growth has been supported substantially by fiscal action in the last nine months or so and it may be prudent to persevere with the same until we are certain the growth is self sustaining. Industries like capital goods, cement, construction, intermediates and so on have definitely benefited from such action. A roll-backtoday could be counter-productive. How about inflation? Inflation is a grave concern here and should provoke affirmative action from the RBI on January 29. The value of growth is eroded substantially when inflation, especially food inflation is of the order of 15 per cent or so. This has been caused by compression in supplies on the agriculture side and rising demand as evidenced by rapid growth in industry, which has pushed up prices. In fact, if we believe the high growth story, which most do, then there is reason to curb the demand forces and hence tighten the belt. Also it is said that monetary policy has to be forward looking as central banks have to target potential inflation rather than current inflation.There is hence strong economic rationale for monetary action to control inflation while keeping the fiscal window still open for some more time. We should hopefully be within the 6.8 per cent fiscal deficit targeted for this year and there is no hurry to improve on it presently until growth stabilises. Monetary tightening is certainly needed more through rate hikes than reserves pre-emption to control potential inflation. This would be a pragmatic approach.
Therefore, the booster shots were all encompassing. The significance of this approach is that it was pursued by all leading economies almost in cohesion; and more importantly they worked. Almost all countries are showing positive growth, and have come out of the low phase and are seriously thinking about rolling back some of these measures.For us in India, it is necessary to debate this issue because we have two critical policies coming up — the RBI credit policy towards the end of January and the Budget towards the end of February. While the first will give us an idea of the official view of the state of affairs, the second will provide a definite direction. So, we can see these two statements actually putting in perspective the confidence that we have in our economy. Now, the high growth witnessed in the country has come mainly from the services sector, where the social and community services segment, which means the government, has played a critical part. The sharp duty cuts reckoned in 2008 have also helped to stabilise industry which is displaying a steady growth rate for the period September-November 2009.A reduction in such expenditure would be justified provided we are sure that the other sectors would be able to provide the necessary bulk to keep the economy on the upswing.For the current financial year, agriculture has been a failure and a negative growth rate is expected, which means that unless we are sure of this growth in future, any withdrawal of the fiscal stimulus would affect overall growth.Or there has to be compensation from some other sector. Assuming high industrial growth this year of say 8-9 per cent, sustaining the same over a high base could be a challenge.As far as tax rates go, while we have accepted a Goods and Services Tax (GST), its implementation is still a distance away and presently we will have to toss whether or not we go back to the pre-2008 duty structure. While industrial growth has been steady, are we prepared to disturb the applecart at this stage? Probably not, because industrial growth has been supported substantially by fiscal action in the last nine months or so and it may be prudent to persevere with the same until we are certain the growth is self sustaining. Industries like capital goods, cement, construction, intermediates and so on have definitely benefited from such action. A roll-backtoday could be counter-productive. How about inflation? Inflation is a grave concern here and should provoke affirmative action from the RBI on January 29. The value of growth is eroded substantially when inflation, especially food inflation is of the order of 15 per cent or so. This has been caused by compression in supplies on the agriculture side and rising demand as evidenced by rapid growth in industry, which has pushed up prices. In fact, if we believe the high growth story, which most do, then there is reason to curb the demand forces and hence tighten the belt. Also it is said that monetary policy has to be forward looking as central banks have to target potential inflation rather than current inflation.There is hence strong economic rationale for monetary action to control inflation while keeping the fiscal window still open for some more time. We should hopefully be within the 6.8 per cent fiscal deficit targeted for this year and there is no hurry to improve on it presently until growth stabilises. Monetary tightening is certainly needed more through rate hikes than reserves pre-emption to control potential inflation. This would be a pragmatic approach.
Subscribe to:
Posts (Atom)
