Let us interpret data the right way: MInt 5th May 2012

The way we look at data is quite different from what happens globally, which should make us pause and reflect There has been considerable debate on the fallacy of our data systems. While this is important, another issue which is not talked of is how data should be interpreted. Do we look at month-over-month or average annual or cumulative or daily changes in economic variables? This is important because policy decisions are taken based on growth rates where often we may not really have an explanation and fall back on the “base-year effect” —one where present growth rates appear high or low on account of the low or high base on which these rates are reckoned. Also the way we look at data is quite different from what happens globally, which should make us pause and reflect. Let us look at inflation. The Reserve Bank of India (RBI) looks at annual growth rates and hence reckons March 2012 over March 2011 or February 2012 over February 2011 to gauge inflation. Globally, however, inflation indices are tracked across immediate months to conclude whether prices are coming down or going up. From the policy perspective, we ideally should look at average inflation rate as several components, especially food products are susceptible to seasonal fluctuations, which create spikes as removing seasonal effects is not easy to comprehend for the lay man. Households rarely relate with our inflation numbers. Inflation peaked at 10% in September and started coming down, but the index numbers kept increasing right up to March, which means prices were rising and not falling as the inflation numbers implied. The conundrum is stark when there is linkage of policy with this phenomenon. When RBI had its policy last month, it spoke of inflation at 6.9%, which was March 2012 over March 2011. Yet, average inflation was 8.8%. Different prescriptions could have been invoked if the latter was considered. In case of say industrial production, conclusions drawn become bizarre at times, when there are negative or low growth rates in a month followed by opposite extremes in the next. Industrial production typically builds up during the year and there are issues of reporting as well as demand conditions. Orders received could be executed any time, while demand has its own cycles. Consumer goods are in demand during festival time or in the post-harvest season. Capital goods growth is based on existing inventory, demand conditions as well as interest rates and could spread out during the year. This being the case, we should look at a cumulative build-up of production during the year, and an average concept of indices is more realistic. Therefore, while we could be distraught in December and January with low growth rates of 2.5% and 1.1%, respectively, February looked impressive at 4.1%. However, the average for 11 months was 3.5%. Export data, too, is a function of demand conditions from overseas customers and there are time lags between orders being placed and executed. Month-on-month growth rates could be puzzling and we need to cumulate exports during the year to draw comparisons. In the last six months there were extreme variations: Two negative growth rates, two at 4-5%, one above 10% and the last over 20%. Every time the analyst would squeeze in an explanation, only to be contradicted subsequently. Cumulative build-up would be more pragmatic. The same holds for imports. When we look at the capital market, it is even more intriguing. We always tend to look at the Sensex at a point of time and then conclude that market capitalization or the Sensex was up or down. Mutual funds present their net asset values at two points of time, influenced by the points chosen. Ideally, one should be looking at either monthly averages or annual total daily returns. This way the number is unbiased. Using such end points according to convenience may not be right as often there could be high levels of activity at these end points. Interpreting bank activity is also interesting as both credit and deposits jump up in the last week of March as targets are set to be met. Loans are disbursed for short terms—often inter-bank, while deposits move through the certificates of deposits route, only to decline in the first fortnight of April. Here, a better way is to stop at the mid-month level to gauge growth. For the reporting fortnight of 23 March, growth in deposits and credit were 13.4% and 17%, respectively, while after seven days the growth rates shifted to 17.4% and 19.3%, respectively. How does one judge their growth? Exchange rates and interest rates are different kinds of variables. Daily variations are useful when doing statistical analysis. But ideally for policy action, trends need to be studied and if aggregation is required, then monthly averages are more useful. Like the stock market, looking into daily reasons for movements, though enchanting, does not really add value to the policy approach. Clearly, we should interpret data in a more meaningful manner. Just like getting in high frequency data has not quite improved the accuracy levels, more real time interpretation is not only myopic, but could also lead to erroneous conclusions. Periodic reviews over a broader horizon are what may be recommended.

Indian fundamentals stable: Financial Express, 26th April 2012

The revision in the rating outlook for India by an international rating agency to negative from stable provokes discussion. There are two issues to be debated. The first is whether there are compelling arguments for such a view and the second is about its broader impact on the economy. The major concerns of the rating agency appear to be growth prospects and the state of the external and fiscal accounts, which is quite normal for any country rating. The first question to be asked is whether conditions have changed drastically or even marginally in the recent past. The answer is no. The economy appears to be on the growth path of 7-7.5%, which, though lower by our own past standards, is definitely impressive compared with that of other nations. Can this growth rate be sustained in the coming year? The answer appears to be yes, as monetary policy has already taken a marginally positive turn and inflation appears to have come down, though there could be pressure from oil prices, which is a global phenomenon. One must remember that growth has come about through strong performance of the service sector supported by farm output. This has made up for the lower industrial output. Even the IMF, in its World Economic Outlook, looks at stable growth in 2012 with a marginal improvement in 2013. The external account is a concern, given that the current account deficit has been widening. However, it must be pointed out that the main reason for this has been the high growth in the import bill on account of fuel and gold. The latter has slowed down, while crude oil would remain an unknown quantity. Quite heartening has been the strong growth in exports of $300 billion in FY12 through country-diversification. Remittances and software have continued to provide strength even at a time when the euro region has been on a downward path. Hence, while the current account deficit would still be under pressure in the range of 3-3.5% of GDP, it is certainly not in a crisis-like situation. More importantly, the strong FDI inflows and liberalisation of ECB norms has provided strong capital account support even when FII flows have slowed down. The fiscal issues must be bifurcated. The first is that these pressures are existing ones and not new developments. While controlling subsides and attaining the fiscal deficit targets would be a challenge, the government has targeted a more realistic number this year, which could be achieved, given the steps that are being taken to garner revenue. The subsidy bill would, however, be something to be monitored, though the cooling of oil prices could provide comfort. The second is that while fiscal deficits need to be controlled, the ultimate test for their impact is on debt and liquidity. Here, it can be positively stated that our debt-to-GDP ratio is very low, at around 45%, unlike the western nations in difficulty, where it ranges from 80-120%. Further, debt is in local currency and poses no systemic risk to the global economy. The impact on liquidity has been perceptible, but to the credit of RBI, it has handled it adeptly throughout the year through OMOs and CRR reduction to ensure that liquidity did not come in the way of private sector being crowded out. Therefore, once again while the situation is serious, it has not exactly had a deleterious impact to generate panic. More importantly, the banking system is very well capitalised and while NPAs may have increased in FY12, they are within the global norms of 1-1.5%. The concerns on certain policies like GAAR and retrospective taxation are issues that are still at the discussion stage with the government. While they could impact investment decisions at the margin, it should be remembered that investment to any nation moves on the promise of long-term growth. Improper implementation of such policies could be a deterrent but the government has assured investors that there would be selective use of GAAR. The response of foreign investors since the proposal was mooted appears to be cautious but we have not observed withdrawal from the market. Other reforms or policy changes, while being possible stimulants, cannot really be used as a reason for change of outlook, considering that we never had these reforms in place all these years. What would be the impact of such a change in outlook? Practically speaking, any lower rating or outlook affects companies that are borrowing in the euro markets. This will become an issue in case the rating is actually altered. However, at the broader level, the impact on investment would be mixed. The present concern on GAAR has slowed down FII flows. However, they will be guided more by long-term prospects, which even the rating agency admits are favourable. If investors see the growth story to be interesting, then funds will flow in. We probably should leverage this situation, get our act together and bring clarity to these new proposals with some urgency, and also hasten the pace of reforms. Therefore, on the whole, the change of rating outlook should be viewed against the background of strong fundamentals and relative performance vis-à-vis other nations. The macro impact should not be too serious as we have seen this happen to several nations in the last year, which has not really significantly changed global capital flows or reputations.