Indian Economy, 5th edition (137 page)

From the government’s perspective, a major contribution to the fight against inflation will be to reduce the fiscal impetus to demand. Also a focus on incentivising food production through measures other than price supports, while facilitating storage and distribution, can help contain food inflation, which is hard for the RBI to control. Policy on price and procurement supports should be calibrated so as to not encourage more production of crops that are already abundantly supplied. Other measures to increase investment more broadly, and therefore supply, can also help over the medium term.

The BoP and External Position

The CAD in the first half of 2012-13 has been 4.6 per cent of GDP. Available indications do not seem to suggest any improvement in the current account balance in the second half. There is a case for discouraging imports of commodities like
gold
and making efforts to
raise exports
. While the government has ‘thrown sand in the wheels’ by raising the tariff on gold from 4 per cent to 6 per cent in order to discourage imports and tried to unlock passive gold holdings through gold loans, gold purchases are likely to come down primarily when households see
attractive alternative investment avenues
. Lower inflation will be the key. In the meantime, increasing exports at the present juncture is proving to be a more difficult task, given the slow global recovery. Greater competitiveness of exports through greater corporate productivity as well as better logistics infrastructure will help, as will diversification towards fast growing emerging and frontier markets—which is under way. But a return to strong export growth will depend on the revival of growth in industrial countries.

With net exports declining, India’s
balance of payments
(BoP) has come
under pressure
. So far the CAD has been financed without drawing on reserves. Net capital flows declined to US$ 40.0 billion (4.8 per cent of GDP) in H1 of 2012-13 as against US$ 43.5 billion (4.8 per cent of GDP) in H1 of 2011-12 (Table 1.9). Net foreign direct investment (FDI) to India decreased but net portfolio flows including foreign institutional investments (FII) increased, with early estimates suggesting an even larger inflow of US$ 9.9 billion in the third quarter as compared to US$ 5.8 billion in the second quarter. Non-resident Indian (NRI) deposits remained robust as did net flows of trade credit. Despite the large CAD, therefore, there was net accretion to reserves (on BoP basis) during H1 of 2012-13 at US$ 0.4 billion. This was, however, lower than the US$ 5.7 billion accretion in H1 of the previous year.

In the current fiscal,
foreign exchange reserves
have fluctuated between US$ 286.0 billion and US$ 295.6 billion. At end January 2013, reserves stood at US$ 295.5 billion, indicating a marginal increase from US$ 294.4 billion at end March 2012. The rupee, however, has been more volatile. Between April 2012 and
January 2013
, the monthly average value of the rupee per US dollar fluctuated significantly, touching an all-time low of Rs. 57.22 per US dollar on 27 June 2012, thus depreciating by 10.6 per cent from Rs. 51.16 per US dollar on 30 March 2012. In the subsequent months of July to September 2012, the rupee appreciated, touching Rs. 51.62 per US dollar on 5 October 2012. It began depreciating again thereafter and the monthly average exchange rate has since been in the range of Rs. 53.02 to Rs. 54.78 per US dollar during October 2012 to January 2013.

The
REER
(real effective exchange rate), which takes into account domestic inflation in India, and is an important determinant of the competitiveness of Indian exports, has depreciated by about 11 per cent since mid-2011.

India’s
external debt
stock stood at US$ 365.3 billion at end-September 2012, recording an increase of about US$ 20.0 billion (5.8 per cent) over the end-March 2012 level. This increase has been
primarily on account
of higher NRI deposits, short-term debt, and ECBs. These three components together contributed 94.7 per cent of the total increase in the country’s external debt.

The
maturity profile
of India’s external debt continues to be dominated by long-term loans. At end-September 2012, long-term external debt at US$ 280.8 billion, accounted for 76.9 per cent of total external debt, while the remaining 23.1 per cent was short-term debt.
Government (sovereign) external debt
stood at US$ 81.5 billion, while non-government debt amounted to US$ 283.9 billion at end-September 2012.

India’s external debt has remained within manageable limits as indicated by the
external debt-GDP ratio
of 19.7 per cent and debt service ratio of 6.0 per cent in 2011-12. But the trends in size, source, maturity, and hedging of external debt bear careful monitoring. In particular, regulators will have to be careful about the tendency of some Indian corporations or entities without substantial foreign exchange earnings to leave foreign exchange borrowings un-hedged so as to get ‘cheap’ foreign financing. Low un-hedged foreign interest rates can be deceptively enticing, leaving the borrower exposed to significantly higher repayments if the rupee depreciates unexpectedly.

In this context,
regulators have to maintain a balance
between what is of public importance and what is prudential these are –

i.
Areas of public importance, such as infrastructure deserve substantial support. However, these areas of activity may also be risky.

ii.
Support should be given by de-risking the areas (policy to speed up infrastructure projects and ease their completion), through financial development (creating new financing institutions, attracting new investors), or fiscal means (interest subventions, tax breaks) but not by relaxing prudential norms (lower capital requirements, allowing un-hedged foreign borrowing) or riskier capital structures (allowing greater debt ratios).

iii.
Ultimately, riskier financing for projects of public importance builds up greater risk for the country because if these projects fail to take off, they impinge on both growth and the financial system at the same time, at a time when the government has fewer resources to cope.

Assessment and Policy Measures

The strong post-financial-crisis fiscal and monetary stimulus in India led to spectacular growth in the immediate aftermath of the crisis. But with corporate and infrastructural investment not keeping pace, and food production constrained, the boost to consumption eventually led to higher inflation. And falling savings, partly as a result of government spending and partly as a result of high inflation, have led to a widening CAD. Monetary policy has been tightened, even as global headwinds to growth have increased. India has been caught in a vicious circle of falling growth and stimulus withdrawal that could well exacerbate the decline. Of some concern is India’s increased dependence on foreign borrowing even as growth has slowed.

Because of the slowdown and high levels of leverage, some industry and infrastructure sectors are experiencing an increase in non-performing assets (NPAs). Overall gross
NPAs
of the banking sector increased from 2.36 per cent of total credit advanced in March 2011 to 3.57 per cent of total credit advanced in September 2012. The increase is particularly sharp for the industry and infrastructure sectors. Sub-sectors particularly under stress include textiles, chemicals, iron and steel, food processing, construction, and telecommunications. The increase in gross NPAs is also significantly higher for public sector banks, which are typically more exposed to the distressed sectors.

Some of the reasons for the increase in NPAs are technical (a switch to system-based identification by public-sector banks), but stress also stems from slow growth and project delays. A revival of growth will help contain NPAs, but going forward, more attention will have to be paid to whether projects are adequately capitalised up front given the risks, and to whether distress resolution systems work effectively in recapitalising distressed assets and putting them back to work, while excising ineffective promoters from management and imposing losses on those who contracted to take the risk.

The way out, and the hope for starting a virtuous circle, lies in shifting national spending from consumption to investment, removing the bottlenecks to investment, growth, and job creation, in part through structural reforms, combating inflation both through monetary and supply-side measures, reducing the costs for borrowers of raising financing, and increasing the opportunities for savers to get strong real investment returns.

In practical terms for government policy, this translates into containing the fiscal deficit especially by shrinking wasteful and distortionary subsidies. It means working on reducing the impediments to investment such as delays in getting permissions, clarifying difficult and non-transparent processes for land acquisition, and increasing access to good infrastructure such as power and roads. It warrants reworking the regulatory and incentive structure that keeps small businesses tiny and prevents them from creating good productive jobs. It calls for reducing the barriers to entry in various areas of business and allowing FDI, even while ensuring domestic companies are not disadvantaged. It entails providing the incentives and means for the farmer to increase production, even while improving the management and the logistics of food procurement and distribution. And it necessitates continuing financial sector reform to increase the entry of new institutions, reduce transactions costs for investors, increase access for borrowers and savers to one another, and improve the quality of regulation.

The government has already taken some important steps in this direction, some of which we have already alluded to. In addition, two helpful potential developments are in sight, one on the revenue side and the other on the expenditure side. The
goods and services tax
(GST), if approved, would replace a number of state and central taxes, make India more of a national integrated market, and bring more producers into the tax net. By improving efficiency as well as revenues, it can add substantially to growth as well as helping government finances. On the expenditure side, the direct benefit transfer scheme that will allow the transfer of government benefits directly to targeted recipient bank accounts can help reduce transactions costs, prevent duplication, leakage, and fraud, and improve choices for the poor. By translating a number of subsidies into equivalent cash transfers, it can avoid price distortions and can target subsidies better to the truly deserving. This will help contain expenditure.

The
government has also taken a number of steps
to
revive investment and growth
which comprise –

a.
Setting up the CCI (Cabinet Committee on Investment) headed by the Prime Minister to fast-track mega projects of over Rs. 1,000 crore;

b.
A scheme for restructuring the debts of state power distribution companies, which includes incentives for them to charge reasonable tariffs so that they do not get over-indebted again;

c.
Movement towards a land acquisition bill that will clarify and make the process of land acquisition fairer;

d.
Permitting FDI in a number of areas including multibrand retail, power exchanges, and civil aviation;

e.
Increasing investment in irrigation, storage and cold storage networks;

f.
Undertaking programmes to improve the production of protein foods;

g.
Steps have also been taken on financial-sector reform;

h.
The Banking Laws (Amendment) Act 2012 strengthens the regulatory powers of the RBI and paves the way for grant of new bank licences by the RBI;

i.
The Financial Sector Legislative Reforms Commission is examining the laws governing the financial sector with a remit to suggest ways of modernising them; and

j.
A number of steps have been taken by the government, together with the financial sector regulators, for easing savings and investment in the country, both for domestic and foreign investors.

More generally, India’s
situation is difficult
but steps have been taken to bring the macroeconomy back into balance and growth on track. What is important is to recognize that a lot needs to be done and the slowdown is a wake-up call for increasing the pace of actions and reforms.

Prospects, Short Term and Medium Term

The revival of
growth in the advanced countries
is expected to be slow and uncertain at least in the near future, despite the measures being taken on monetary and fiscal fronts. In
Europe
, in particular, this is also being accompanied by changes in the institutional framework. With the ongoing private sector deleveraging and government fiscal consolidation, most analysts have projected only a very moderate global recovery in 2013, which could gather steam in 2014. At the same time, if the
United States
can deal with its fiscal overhang, the potential upside to global growth could be substantial, given the health of US corporations, continuing innovation, low energy costs, and the improving finances of households. Emerging markets can also compensate a little for tepid growth in industrial economies, and the changing direction of Indian exports towards emerging markets can help their revival.

Nevertheless, it is
unlikely
that the support to Indian growth from the global economy will be significant. Indeed, there are two sources of downside risk. First, India is exposed to shifts in the risk tolerance of international investors. Second, India’s import bill is strongly tied to the price of oil. Of course, one reason for rising oil prices would be improvements in the global economy, which would mean stronger exports. The more worrisome situation would be if the oil prices rise because of geo-political risks, which would mean increasing investor anxiety and slow world growth.