April has been a month of rapid change. Fortune has unexpectedly smiled on the Indian economy. Pessimists might argue that the lucky drop in gold, oil and commodity prices in recent weeks may not meaningfully help contain inflation and current account risks. They could yet be proven wrong.
Consider how the recent trends alter the economic outlook. What the drop in prices of gold, oil and commodities means for a commodity importer such as India is well understood, even though it comes because of lower global growth and matters somewhat less for an economy based on domestic demand. Savings from cheaper gold, oil and commodity imports are unlikely to be offset by domestic production substituting imports of steel scrap and coal. Coal prices have dropped by 10-12%, while long-term prices are being contracted at 15-20% discounts, according to Nilesh Shah of Axis Bank Ltd. There is a step-shift in the global energy scenario due to fundamental changes in the drivers. And, with lifting of the ban on iron ore mining in Karnataka and Goa, iron ore production could resume a few months hence.
By far the most important change is in the outlook for inflation where a predicted above-average monsoon may play a not-inconsiderable role in accelerating the decline triggered by global factors. Consumer price inflation, still in double digits, will likely ease ahead from better food supplies and lagged transmission of lower core wholesale prices. Easing retail prices, which informally figure in the central bank’s monetary policy decisions, open up more space for the Reserve Bank of India than assessments one month ago. A good monsoon augurs well for growth too. Private consumer spending, which slowed to an average 2.9% over April-December 2012, or half the post-crisis average, can be expected to revive, besides providing multiplier effects for the industrial sector.
An important aspect of lower inflation and costs of capital for firms is the opportunity to recoup some of their lost competitiveness, which is a forceful incentive for investment; it also offers considerable relief to stressed balance sheets, including those of banks. With major firms like Reliance and GMR planning fresh investments, the stimulating effects of project clearances by the cabinet committee on investments could gain strength in such a setting.
The most positive fallout is that real interest rates have turned positive. What can that do for the current account in terms of shifting investors away from gold to alternate assets? And when bond markets in the US, Europe and Japan are yielding near-zero, even negative returns, why should foreign investors ignore the positive real returns to be had from investing in India?
Put together, lower inflation, more-than-expected rate cuts, a contracting current account deficit and relatively better financial returns and it is not surprising the pressure is off the rupee. Indeed, expectations of its potential appreciation in the near term are building up. Has the tide turned?
Renu Kohli is a New Delhi-based macroeconomist; she is currently lead economist, DEA-Icrier G-20 research programme and a former staff member of the International Monetary Fund and Reserve Bank of India.