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Downside risks to growth are actually receding Posted: 22 May 2012 10:42 PM PDT
Amongst a feeling of all gloom
and doom, especially in the domestic side of the economy where most people
believe that India has thrown away an excellent opportunity to attract capital
and grow strongly at a time when global liquidity is ample and there are enough
opportunities to invest in India be it the infrastructure, housing, capacity
creation across industries etc. High fiscal slippages (which are happening in
countries across the world) and a high current account deficit are the major
concerns.
I have been a firm believer of
the fact that the way in which the fiscal discipline can come back into India will be
more by boosting growth and revenues rather than cutting expenditure. Even on
the subsidies, ex of oil subsidy reducing the other components like fertilizer,
food etc. is going to be very difficult. Growth can be boosted in two ways; the
first is by monetary policy where lower interest rates and improved liquidity
will boost the growth cycle. The other obviously has to be via reviving the
investment cycle which has got totally stalled more due to government inaction
in granting approvals across the board and taking proactive policy measures.
Consumption has continued to remain strong in the economy despite high
inflation and interest rates.
The current account has suffered
due to rising prices of commodities, among which the main are gold and oil.
Additional expenditure on both of these commodities essentially added nearly $
70 bn to India’s
incremental import bill last year. On the other hand export growth slowed down
due to the global growth scenario.
Let’s try to evaluate various
factors and the direction going forward
Government policy making and the
fiscal deficit – I guess on the fiscal front we need to face the reality and so
does the government. Despite making noises over the last few days on
controlling expenditure it is very clear to anyone who goes through the
governments accounts that it is very difficult to do so. Given that 80% of the
fiscal deficit is in any case revenue deficit there are no quick fixes. On top
of that we have a risk on the denominator in the calculation i.e. the GDP. The
assumptions on GDP growth look quite aggressive in the scenario in which we
operate today. The redeeming feature for the government on this front is likely
to come from the fuel subsidy side where higher supplies and demands
destruction due to higher prices has lead to a 15% correction in global oil
prices. Along with this other commodities have also corrected and with a lag we
should also see fertilizer prices correcting. Although the fall in the value of
the INR nullifies some of these gains, still the incremental gains are
substantial.
Another significant development
that was seen on the 3rd anniversary celebrations of UPA II
yesterday was the participation of Samajwadi Party in the celebrations. This
raises some hope that the government will eventually move ahead and take some
policy decisions that are good for the economy and for growth. The net revenue
collections for the government for the first month of the current financial
year have been strong in the midst of the severe stress that the economy is
going through. If growth actually revives going forward we might see more
improvements coming through on that front. However the government needs to show
some intent on moving forward by bringing about incremental price increases in
fuel and controlled fertilizer prices. This move could be seen as the first
move towards a more economy friendly agenda. Given the higher yields of Indian
assets as compared to global assets at this stage we can easily attract FDI if
we want to. For this the policy environment has to be friendlier both on the
front of making foreign investors feel welcome as well as reducing the uncertainties
that issues like GAAR brought out. Project clearances also need to pick up as a
first step towards reviving the investment cycle. Clearly at this stage the expectations
from the government are running so low that small incremental steps might be
greeted positively. Overall ex of the subsidy part which is more dependant on
global commodity prices as well as the value of the INR, the fiscal deficit
should be ok this year.
The current account – The current account has actually been of a
greater concern in the short run and has caused a mini run on the rupee. In
reality the outlook for trade deficit has improved significantly due to the
fall in the price of crude oil as well as gold and also the drastic fall in
gold consumption. On top of this the fall in the value of the INR is improving
the terms of trade which will eventually contribute to greater export buoyancy.
Competing currencies have fallen much lesser than the INR. Infact the Yuan has
actually been quite stable at the time when the INR has fallen nearly 22%. An
example of this is evident in a meeting that I had with an auto part
manufacturer in Pune. He mentioned that till couple of years back a large auto
company has asked this company to set up a plant in China to source wheel rims as it
was 15% cheaper to do so. However high wage inflation and relative currency
movements have made the entire economies very different today where it is
10-15% cheaper to manufacture in India today. The INR has taken the
hit due to the higher trade deficit, as it ideally should also be. Contrary to
general views I believe that the outlook for the CAD for this year is much
better than last year and we should see it settling at 2.6-2.7% in 2012-13. The
key then will be capital flows where FDI reforms (if they take place) will go a
long way in brining confidence back. The fall in the INR over the last few days
has been more a game of low confidence rather than an actual deterioration in
outlook or huge capital outflows. Infact investments and commitments by PE
funds continue to be strong. From the current levels ex of an actual Greek exit
from Euro zone which can cause a short term knee jerk reaction the bias for the
rupee should be for a higher level rather than a lower level over the remaining
part of the current financial year.
Overall lower commodity prices, a
more growth oriented RBI policy environment combined extremely low expectations
from the government have reduced the downside risks for the economy &
markets in the domestic context. Most technical indicators on the charts as
well as the Futures & Options segment also indicate an oversold market. Globally
too the investors are running scared which is reflected in the yields of US
Treasuries, UK Gilts & German Bunds. Unless and until the bet is on a long
term deflationary cycle the risk of a capital loss by investing in US 10 yr
bonds @ 1.75% & Bunds at 1.45% seem to be quite high. My bet would be on an
eventual long term shift from global bonds to equities as equities are much
cheaper relative to bonds. The key risk continues to be that of a Greek exit
whose repercussions are difficult to evaluate at this stage.
However I do believe that we are
at a stage where an improvement in domestic policy environment can move India from an
underperforming to an outperforming market. I guess we will have to wait for
the Presidential elections to be over before we see moves on that front. (Earlier we thought that we will see moves post the parliament session that ended yesterday)
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India’s Balance of Payment Crisis fears are vastly exaggerated Posted: 28 May 2012 09:18 PM PDT
Over the last few months the
fears of a new balance of payments crisis in India has gripped headlines and is
being propounded by a vast majority of analysts and economists. Although the
continuously rising trade deficit is of concern due to the growing domestic
demand and a reduction in exports growth momentum due to the economic crisis
worldwide the years of an actual BOP crisis are vastly exaggerated.
In the last financial year the
trade deficit went up to a record level of $ 185 bn and the current account
deficit went upto an estimated $ 65 bn amounting to around 4% of GDP. At the
same time the total forex reserves stand at around $ 295 bn. The run rate of
imports financial year was around $ 480 billion for the year. Out of this the
net import of crude and petroleum products amounted to $ 150 bn, after taking
into account refined product exports and total gold imports amounted to $ 65
bn. The total funding gap last year thus amounted to $ 65 bn i.e. the Current
Account deficit. For the first month of the current fiscal the Trade Deficit
has been $ 13.2 bn and gold imports have fallen from $ 4.7 bn to $ 3.1 bn. The
fall in the value of gold imports has also been despite the average price of
gold being $ 1650 per ounce as against $ 1150 per ounce at the same time last
year. As such it is important to see how the scenario will play out this year
and whether the BOP fears are real or now.
The run rate of deficit – As per the April deficit figures the
Trade deficit has been $ 13.2 bn. This run rate includes gold imports at prices
that are 5-7% higher than the current levels and crude oil imports that were
booked in the month of February 2012 when prices were higher by 10% from the
current levels. Under the circumstances when we evaluate the performance of
trade deficit for the full year this year given that commodity prices in
general are down by nearly 15-20% versus the same time last year. A big part of the increase in crude oil imports
last year was more due to the increase in crude oil prices rather than an
increase in volumes. For example the average price of Brent in 2010-11 was $ 86
per barrel which jumped to $ 114 per barrel last year. In the current financial
year given the demand supply dynamics and the fact that crude oil stocks are
continuously growing worldwide the average price of crude in all probability
will be at least 5-10% below that of last year. Taking into account the
increase in volumes the total value of oil imports in dollar terms should be
the same as last years. Now the other major component of imports i.e. gold
where prices have been coming down in USD terms due to falling consumption and
reducing luster of gold as an investment. Specifically in the Indian context
gold consumption has fallen drastically due to two factors. The first has been
the decline in the value of the INR by nearly 20% which has totally offset the
decline in gold prices by 20% from its peak levels last year. The second factor
also has been the imposition of a 4% import duty on gold which has increase the
average per 10 grams of gold by nearly Rs 1000. This has further added to the
price of gold in rupees and has impacted consumption further. As such my
estimate is that the total value of gold imports in the current financial year
should fall by nearly 40%. As such total gold imports should fall to $ 40 bn
from $ 65 bn last year. Due to various environmental and legal issues Iron ore
imports are estimated to have fallen by $ 6 bn last year. These two factors by themselves
could result in a fall in trade deficit by $ 25-30 bn in the current financial
year.
Exports Outlook – The rate of growth of exports from India have been
falling over the last several months. In the month of April the growth was
around 3%. However it is also important to see that the increase of 3% came on
a 32% increase in exports in the same month last year. Similarly the growth in
imports has slowed down to around 4%. I expect that the value of imports will
trend down further over the next few months as the dollar value of most
commodities has corrected significantly. The lagged impact of the fall in the
value of the rupee in boosting export competitiveness should be felt at some
stage. I believe that a bigger factor which has prevented most Indian companies
in taking advantage of the exchange rate differential that has built up has
been largely due to the unavailability of both, adequate credit as well as the
extremely high cost of credit due to the excessively tight monetary policy.
Since the tight monetary policy is largely targeted at domestic inflation and
demand RBI needs to find a way to provide adequate and cheap export credit. The
impact of high interest rates has also got exaggerated due to increasing debtor
cycle due to a general slowdown. Going forward as interest rates ease off and
the global economic cycle stabilizes there is an increased probability that the
currency differential export competitiveness will play out. The restrictions
put on farm product exports as well as the fall in iron ore exports last year
added nearly $ 10 bn additionally to lower exports last year. Farm exports are
now being increasingly liberalized and Iron
Ore exports should also start
coming back over the next few months. If the government incentivizes labor
intensive export industries in the short run it can provide a significant
fillip to exports. As RBI eases monetary policy going forward it will also
provide some support to the exports. As
such the overall outlook for exports does not look very bad except for the
uncertain global economic scenario.
Is import cover the right way to evaluate external vulnerability – The
way in which the external sector vulnerability has been traditionally measured
has been by calculating the import cover based on foreign exchange reserves.
This analysis is flawed in its basis thesis. Given that India has 60%
plus of its GDP coming from services and services/invisibles exports constitute
a significant part of exports currently just evaluating the merchandize trade
gap does not have much relevance. Invisibles and remittances amounted to around
$ 110-120 bn last year. Out of this software and BPO exports are estimated to
have been $ 70 bn last year. As per NASSCOM these are likely to grow by 11-14%
in the current year and as such should reach a level of around $ 80 bn in the
current financial year. Secondly let’s
come to remittances. Remittances into India last year went up to a record
$ 63.5 bn. Now, mostly remittances are a stable form of funding and if we take
into account the liberalization in the interest rates that banks can offer to
NRI’s both for rupee and Foreign currency deposits to a levels which is much
higher than the levels at which it was till last year should significantly
boost capital inflows due to NRI deposits. Well placed and financially sound
NRI’s can have a huge carry trade by borrowing extremely cheap in western
economies and pumping that into India. Given that the US Fed has indicated that
it will keep policy rates low for at least the next 2-3 years this carry trade should
continue strongly in the near term.
Now let’s come to FDI. It is
estimated that the cumulative FDI into India in 2011-12 was to the
magnitude of $ 36.5 bn. However there has also been significant outbound FDI in
recent times. As such the net figure is more important which should be to the
tune of $ 28 bn. In a scenario where key reform bills have been on hold and FDI
liberalization has not happened this is still a very strong flow. Given
negative sentiments this can reduce somewhat but should still continue to be
strong given India’s
long term growth prospects.
The other component of foreign
exchange flows i.e. FII flows has been erratic in recent times. After a sharp
outflow cycle in 2008 it reversed very strongly in 2009 and 2010. Last year was
slow where there was hardly any net inflow from FII’s. In the first four months
of the current year net flows have been nearly $ 8 bn. My long term outlook in
terms of flows continues to be that globally bonds are much more overpriced as compared
to equities. The 1.8% yield on 10yr UST’s and 1.5% on German Bunds is clearly
unsustainable. Equity yields worldwide look much more attractive and a long
term shift towards equities is imminent over the next few years as the
currently unstable European situation stabilizes.
Overall as large part of the gap
in the trade deficit is made up with flows that are largely stable in nature
Synopsis
On an overall analysis, taking
into account the fact that India’s GDP on a nominal basis should grow by around
13-14% in the current year and the trade deficit will decline by 15-20% (unless
and until there is a spike in oil prices) the overall current account deficit
is likely to come down to 2.6-2.7% in the current financial year which is
easily fundable from even the reduced levels of capital inflows. Also as we
have seen that the FDI flows have continued to be strong in uncertain times and
both invisibles as well as remittances are a stable source of foreign exchange
flows. As such the probability of a balance of payment shock at this stage
looks extremely low and improbable. Under the circumstances the outlook for the
Indian Rupee as well as external sector macroeconomic stability in India should be
sanguine going forward.
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