The Reserve Bank of India (RBI) published its annual report in late August. Its accounting year runs from July to June. Hence, the annual report is released. The good thing about this report is that it is updated with the most recent macro data. In this particular report, even the Standard and Poor’s downgrade of the US finds a mention.
RBI is worried about federal fiscal consolidation, or the lack of it. They do not mince too many words on it. The need to balance government consumption and investment is stressed. The government fiscal multiplier is higher for capital expenditure than for government consumption expenditure. Not surprising.
India’s inflation threshold is around 4-6%. RBI is preparing for global growth slowdown, but not a crisis. It hopes for a sustained correction in commodities. Otherwise, it is concerned about monetary accommodation in advanced economies and its implication for commodities prices, India’s fiscal deficit and inflation.
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The Incremental Capital-Output Ratio in the 11th Plan period was 4.5, while the target was 4.1. We doubt if this would be bettered in the 12th Plan. So, to get to 9% growth, the savings rate has to go up to 38%. It is around 33% now. If we assume a current account deficit of 2%, the savings rate needs to go up by another 3% at least. Hence, if India achieves 8% real gross domestic product (GDP) growth in the 12th Plan period, that would be a good achievement. Real GDP would double in nine years and nominal in five years, assuming 6% GDP deflator.
This is the last fiscal year of the 11th Five-year Plan. The economic growth rate in the fiscal first quarter (April– June) slipped to below 8% (year-on-year). There may be an upward revision later but, taken at face value, the slowdown is neither a surprise nor is it unwarranted. India’s demand side still needs to slow.
In fact, RBI in its annual report noted with satisfaction that India’s private consumption and investment were balanced during 2002-07 (10th Plan period). But, lately, consumption has accelerated while investment has slowed. For instance, despite the recent steep drop in car sales, it is running at 12% higher than last year’s vehicle sales year-to-date up to July. That is one of the reasons why the central bank has not hesitated to tighten monetary policy in the last one year, despite many calls for an end to the tightening cycle.
At some stage, as the Indian democracy helps to settle issues over governance and corruption, confidence would return and investment would pick up. In any case, it is an empirical fact that abnormally low interest rates never aid investment, but only speculation. Indian companies became “lean and mean” in the 1990s when real interest rates were kept high.
Of course, no one is suggesting that the higher the interest rate, the higher the investment spending. There is a golden mean and it certainly is not a real interest rate of zero or a negative real rate of interest.
Now, high nominal rates would encourage household financial savings to rise and thus help investment spending to pick up in the second half of the current fiscal and in the next fiscal year, especially if there is an improvement in the policy and political climate. That would see portfolio flows return, which has lagged the foreign direct investment flows this year. The latter has improved considerably over last year’s trickle.
Nonetheless, Bare Talk is of the view that the tightening cycle is not over yet. Given the concerns of RBI over the easy (and likely easier) monetary policy in the developed world, it is unlikely to signal a pause (let alone end) to the tightening cycle, at least until the Federal Reserve Monetary Policy meeting in September. Should the Fed embark on another round of monetary easing this month, it is bound to keep the Indian central bank on high inflation alert. Additional tightening of 50 basis points is still a possibility.
Therefore, Bare Talk expects the rupee to perform better against global currencies in 2012 in contrast to its relatively weak performances of 2010 and 2011. That has helped in one area though. India’s export performance has been stellar due to its diversification of product lines and export markets.
In sum, if India is able to maintain a decent export growth rate and if private investment picks up (that is a big IF), India might weather the upcoming global storm in 2012 better than other Asian economies.
Yours Truly recognizes that he has made it sound a lot easier than it would be, particularly given the record of governance at the Centre and record of compliance in the nation that includes behaviour on the road and illegal mining and everything in between. As a nation, we retain considerable potential to screw up things in 2012 as we have been doing for the last several years now.
V. Anantha Nageswaran is an independent macroeconomic and investment strategy consultant, based in Singapore. Your comments are welcome at email@example.com