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Saturday, August 31, 2013

India’s Faltering Economy Could Get Worse and worse day by day

Few economic experts in recent months have been as critical of India’s fiscal policy and governance and as bearish about the country’s economic future if reform does not happen as Rajeev Malik, senior economist with CLSA Asia-Pacific Markets, an independent research and brokerage firm.

Several recent indicators suggest that his bearishness is not misplaced. In November, Mr. Malik warned that India’s currency could fall to 57 rupees to the United States dollar (at the time it was trading at about 52 rupees to the dollar). On Friday afternoon, the rupee was trading dangerously close, at 68.2 to the dollar. In December, he cut India’s economic growth forecast for the fiscal year that began April 1 to 6.3 percent, a forecast that has just recently been echoed by other economists.
Courtesy of CLSA Asia-Pacific MarketsRajeev Malik, senior economist at CLSA Asia-Pacific Markets.
In an interview with India Ink, Mr. Malik discussed Wednesday’s petrol price increase, what the government should do next and what role he thinks  Sonia Gandhi, president of the Congress Party, plays in stifling economic reform in the country.
Q: What are the options available to the central government and the Reserve Bank of India to slow the rupee’s free fall?
A: The ball is very much in the government’s court and with Sonia Gandhi. The R.B.I. is doing whatever it can, and is taking a sensible approach. The last thing it should do is effect a particular level [for the currency] and then defend it at the cost of losing a large amount of foreign reserves. There could be greater pressure in the future on the currency from heightened global aversion, so it would be suicidal to squander reserves.
In all of this, the R.B.I. cannot be the savior. No central bank can be the savior. The Indian government creates the mess and the R.B.I. is the vacuum cleaner, but even a vacuum cleaner can’t do a good job in a garbage dump.
The first thing the government needs to do is wake up and acknowledge there is a problem. Just saying that there are external problems, when almost all of India’s problems are home grown, is not enough. The external issues amplify the domestic imbalances but government’s policies in recent years have significantly worsened those imbalances.
There are many Band-Aid fixes that can be done, but relevant long-lasting benefits require significant hikes in fuel prices to cut subsidies, getting the fiscal and current account deficits under control, improving the local investment climate, squeezing out inflation, attracting foreign direct investment and moving forward with reforms.
Growth is going to be trapped around the 6 percent mark and downside could still be there – it could clearly be lower if nothing is done by the government.
There are no painless options. The can has been kicked down the road so often and for so long, there will be unpopular moves but they have to be undertaken.
Q: Is Wednesday’s steep petrol price increase a sign the government has finally woken up and is ready to make the reforms needed?
A: It is a start, but it only shows a government trying to marginally make up the distance it has fallen behind. It is still wedded to doing the least possible needed to avoid a major systematic problem rather than being pragmatic enough to undertake reforms so that India can do much better. It is merely doing enough for the economy to survive, not thrive.
Q: What’s the next move the government should make after the fuel price increase?
A: We have to see significant increases in diesel and cooking gas prices. The prices of other things, like electricity and coal, have to be closer to market-clearing levels.
The government needs to jump-start investment and create a more enabling environment for growth.
What makes the Indian situation so very unique is that it is not as if the problems are not known or the solutions; it is the implementation that doesn’t happen because of political myopia.
The current dual political structure doesn’t work. It is ironic that the world’s largest democracy has a selected, not popularly elected, prime minister. The people who do understand economics don’t have the political strength to make decisions. Those who have political power either don’t understand economics or are too fixated on populism.
Q: What does a weak rupee actually mean? If it doesn’t have a big impact on most Indian citizens, why should politicians address it?
A: A weak rupee is a symptom of the underlying problem, it is not the problem; it is the messenger rather than the message. It is the outcome of chronically high inflation, policy incoherence and self-inflicted injuries.
Consumer price inflation is over 10 percent, the rupee is in free fall, growth has been crippled and reforms have become a figment of people’s imagination.
The rupee has weakened more since the end of July 2011 than it did during the 1991 devaluation. The significant depreciation now will have a much smaller positive impact than in 1991 because it is not accompanied by a reform agenda. In 1991, the Indian government didn’t have a choice; the International Monetary Fund forced it to put in path-breaking reforms.
Q: What is our worst-case scenario? How low could the rupee go?
A: We don’t know. No one can really forecast currencies very accurately, in the near term and given global uncertainty.
The rupee could easily fall between 57 and 60 to the dollar depending on how the European Union situation plays out. We just have to see what the government ends up doing.
Q: You must speak with government and political advisers. Do you get the sense the central government appreciates the necessity of doing something now?
A: There seems to be a disconnect. The people who understand the gravity of the situation and know what needs to be done don’t have the political capital to push through things. A lot of the relevant people get it; one doesn’t need to be a whiz kid in economics to appreciate what India is going through.
Q: You mentioned Sonia Gandhi earlier – is she the major roadblock standing in the way of the economic reforms that need to happen?
A: It is understandable that she has a political agenda. But strong and well-balanced economic growth will offer more, not less, opportunities for her well-intentioned redistributive agenda. Not undertaking reforms that will boost growth needed to meet the rising aspirations is a one-way path for the government to be out of a job.
I don’t think people are opposed to helping the poor. But the popularity of handouts needs to change. Growth is the best answer to poverty.
We require political will to do something. The more the government waits, the stronger and more unpopular these corrective measures will have to be.

Reason for Indian Rupee Depreciation

Why is the Indian Rupee Depreciating?

The Indian Rupee has depreciated to an all time low with respect to the US Dollar. On 28th August 2013, the Indian rupee had gone down to 68.825 against the Dollar but the situation was somewhat revived by the Reserve Bank of India that decided to open a special window for helping state owned oil companies – Indian Oil Corp Ltd., Bharat Petroleum Corp and Hindustan Petroleum Corp.

The beneficiaries will be able to buy dollars through this window till further notice is provided. These companies, together, require about 8.5 billion dollars every month to import oil and it is expected that this will help them meet the requirements. This has had an immediate effect as is evident from the fact that the INR has started at 67 against the USD at the early proceedings in the Interbank Foreign Exchange Market. The question, however, is why this is happening. There are several reasons that can be enumerated in such a scenario:

Basic law of economics

As per the rudimentary laws of economics if the demand for USD in India exceeds its supply then its worth will go up and that of the INR will come down in that respect. It may be that importers are the major entities who are in need of the dollar for making their payments. Another possibility here could be that the Foreign Institutional Investors are withdrawing their investments in the country and taking them elsewhere.
This can create a shortfall in supply of the dollar in India. In fact, of late, the FIIs have been heading to greener pastures like Singapore owing to the greater operational efficiency and lesser bureaucratic problems that have unsettled the Indian business fraternity and hampered its overall economic growth.
This situation can only be addressed by exporters who can bring in dollars in the system. If somehow the FIIs can be wooed back, then this imbalance can also be addressed to a certain extent.

Price of crude oil

The worth of crude oil has been a major bane for India since it has to bring in the majority of its requirement from outside the country. The demand for oil in India has been going up every year and this has led to the present situation. All over the world, the price of oil is given in dollars. This implies that as and when the demand for oil increases in India or there is an increase in oil prices in the global market, there also arises a need for more dollars to pay the suppliers. This also results in a situation where the worth of the INR decreases significantly in comparison to the dollar.

Performance of dollar with respect to other currencies

The central banks across Japan and countries in the Eurozone have been bringing out a lot of money and this has meant that both Yen and Euro have lost their value. Compared to this the US Federal Reserve is giving hints that it will end the fiscal stimulus so that the dollar becomes stronger with respect to other currencies such as the Indian Rupee at least for the time being. Till now in 2013, the US dollar index has become stronger by 1.91%.
In an interview with the Economic Times, the CO-CIO of Birla SunLife Mutual Fund, Mahesh Patil has stated that the increase in worth of USD is the major reason behind the depreciation of the INR. The Federal Reserve’s decision to reduce its Quantitative Easing has also contributed to the present situation as every asset class has been affected by the decision.

Volatility in the equity market

The equity markets in India have been volatile for a certain period of time. This has put the FIIs into a dilemma as to whether they should be investing in India or not. In recent times their investments have touched an unprecedented level and so if they pull out then the inflow will go down as well.
As per a report in Business Today, the international investors in India have withdrawn to the tune of INR 44,162 crore during June 2013 and this is a record amount. This has also created a current account deficit (CAD) that is only increasing, thus contributing significantly to the depreciation of the INR.

Effects of equity market problems on investors

Now if the INR becomes weak then it will affect the investors who are putting their money in India. For the first time ever since 2012 the FIIs have been reduced to net sellers of debt based securities. The main reason behind this is the present state of the INR. The expenses incurred in hedging the unpredictable INR are reducing the yield differential that is the main area of profit for these investors.
India, in fact, is not the only emerging market where the currency has taken a hit. The situation is similar in countries like Indonesia, Brazil and Thailand. The bond markets in several countries like India are also taking a hit as the FIIs are withdrawing en masse. The exchange traded funds are also being redeemed as the global business fraternity is looking to cut down on risks.

Poor current account deficit

One of the main reasons behind the Indian government’s inability to arrest the fall of the national currency is the critical current account deficit. In the 2012-13 fiscal India’s CAD was measured at 4.8 per cent of the GDP. The government has been unable to come up with any new destinations for exporting its products and this has also hampered the growth in this sector. There are other crucial reasons here like the lack of one window for clearance purposes and procedural delays. Even areas where India has traditionally done well on this front have fared badly this time around.

Withdrawal of investors

Recently ArcelorMittal and Posco decided to pull out from their projects in India. Posco did not go ahead with a steel plant worth INR 30,000 crore that was supposed to be built in Karnataka and ArcelorMittal withdrew from setting up a steel plant in Odisha that was supposed to cost around 52,000 crore. There were lot of delays and problems related to acquiring land for the project. In fact in 2012-13 the Indian companies have spent more outside India compared to FIIs in India.

Downgrading of Indian stocks

Goldman Sachs, one of the leading banks in the world, has rated Indian stocks as being underweight. It has also asked investors to be careful given the concerns surrounding the recovery of the growth of Indian economy.

Condition of import bill

India’s import bill has been going up of late and most of this can be attributed to gold. This has also hampered India’s efforts to arrest the slide of the INR. Gold alone takes up more than 10 per cent of India’s import bill – in April 2013, 141 tons of gold were imported and it went up to 162 during May. The government took some measures that restricted gold imports to 31 tons during June but once again in the first 25 days in July the imports went up to 45 tons.

Contraction of Indian economy

The various important sectors of Indian economy such as manufacturing, mining and agriculture have seen poor growth in 2013 and this has made them less appealing propositions for the investors. During June 2013, the aggregate industrial production in India reduced by 2.2 per cent and in July 2013 the RBI predicted that in the present fiscal there would be a growth of 5.5% which was lesser than its previous prediction of 5.7%.

Future prospects of INR

In spite of all that has been said above it will be foolish to write off the INR completely and say it shall not rise from the mire. Experts are saying that the government needs to take some short and medium term steps that will help the economy get back on its feet yet again. It is only through continued efforts that the Indian government will be able to retrieve the situation. However, it will take a Herculean effort to help the INR get back to the 55 mark.

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