Downside risks to growth are actually receding

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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