Indianomics – the worst it can get!!!!

To me, the launch of Food Security Bill is only a ploy to earn votes. This bill will undoubtedly have a further drag on the fiscal deficit and it is a cost which the government will not mind paying for gaining votes. They say, political necessities sometimes turn out to be political mistakes. Hopefully the implementation of this bill doesn’t prove this thought yet again.

Well, that’s not the only issue here. Given the situation of the economy today, where many inter-dependent issues such as rising current account deficit, continued rupee depreciation, falling foreign capital inflows, high real interest rates, poor investment sentiments and stalled reforms process, the economy will continue to struggle. And therefore, it needs to taken way more seriously.

The recent continuous slide in rupee against dollars is the biggest concern, today. What is more worrying is that the reason for this fall in rupee is largely external, thus uncontrollable. Owing to the rising current account deficit and the plans of the US Fed to slowdown or ease the US bond buying program, investors have become way too conscious in terms of making investments. They have become risk-averse as tapering plans of the US bond buying program simply indicates that the US economy is recovering. With that, investors prefer to invest in the US markets, being the least risky market and therefore are exiting from other risky developing markets (such as India). With only negativity all over, whether you accept it or not, the Indian economy is very uncertain and risky, today.

Falling rupee puts pressure on the economy as a whole. The biggest concern is that imports become costlier leading to a rise in inflation. This forces the central bank to keep the interest rates high. In the current situation, India is at a stage where raising interest rates are not feasible as further rise in interest rates will directly impact the economic growth of the country, which already recorded a decade low growth in the last year.

Today, India needs foreign capital inflows in the form of foreign investments as well as investments by industries within the country. But, the irony is that for attracting foreign capital inflows, India needs to keep interest rates high (remind you, interest rates in India currently are at highest levels as compared to any other developing country) and for promoting domestic investments, it needs to keep interest rates low. Confusion!!!!! Although India has high interest rates, foreign capital flows are not flowing in and at the same time, companies are either postponing their domestic investment plans in anticipation of lower interest rates in the future or investing in other countries. Recent data published by Firstpost, reported that for the first 3 months of the current FY the country saw an outward FDI from India worth $11.2b flowing out of the country as compared to inward FDI into India to the tune of $7.6b in the same period. 

Can you see the impact on the economic growth? Here, the task of the RBI is to find that level of interest rates which attracts both, foreign as well as domestic investments.

The second biggest concern is the forever rising current account deficit. The inability of the government to control imports has been the major reason here. Rising imports more than exports along with the fall in rupee and foreign capital inflows, a high CAD shouldn’t surprise us. I wonder if only raising import duty on gold or such items will help contain the CAD. 

There is more to worry about. The June IIP number continued the decline trend by reporting -2.2% growth, whereas the retail inflation rate for the month of July showed a marginal fall to 9.64% (from 9.87% in June). With the July PMI reporting 47.9 (from 51.7 in the previous month), it is certain that the Indian economy is contracting.

There are these problems but where is the solution? 

At this moment, there is only one solution and that is to better and ease up the Foreign Investment policies. This will have two sided impact on the economy: One, the rupee depreciation will stop or recover and two, the current account deficit will look better as it is majorly financed by foreign investments.

The retail inflation will not fall to or below the desired levels considering the implementation of the FSB. And with this, Raghuram Rajan, the new RBI Governor, will have a challenging task to control inflation with the help of policy rates changes. At the same time, his job will be to stabilize the movement of the rupee value by taking some bold and effective decisions.

We are in such a situation that one can’t really predict the future of the economy but one thing is certain, in FY14 the GDP growth will remain low and the CAD will be high. It remains to be seen if the FM is able to contain the fiscal deficit to below 4.8%. Actually, he can!! He can simply reduce government expenditure this year again, and the fiscal deficit number will look better. Isn’t that the best solution??

The Japan-ease ‘Abe’nomics

Not an old story that Japan has been a deflationary economy for over 15 years, but markets were taken aback last week after the Bank of Japan’s new governor Haruhiko Kuroda announced an unexpected measure to pull the country out of deflation. Following the principles and policies of the Prime Minister Shinzo Abe, Kuroda announced a massive quantitative easing program that will double the country’s money supply in two years, from US $1.43 trillion to US $2.86 trillion. Shinzo Abe’s economics – also called as ‘Abenomics’ – is to increase money supply in the economy to elevate inflation.

This decision of infusing money supply comes alongside tax breaks from the government aimed at encouraging firms to raise wages, in the hope that consumers will respond by increasing spending, and allow prices to rise, too. At the same time, in a bid to make exports more competitive, the government is looking to depreciate its currency. By doing so, imports will become costlier which will help in bringing about inflation and also reduce the trade and current account deficit of the country.

Under the announced plan, Bank of Japan has decided to buy long term government bonds worth $70 billion every month for the remaining part of this year and the whole of next year.

Given that the US Fed Reserve is infusing $85 billion every month by buying government bonds and Japan being only 1/3^rd of the size of the US economy, spending $70 billion every month looks very huge and unsustainable. Plus, it is said that BoJ’s balance sheet will increase by around 1% per year whereas the Fed’s balance sheet is growing by about 0.54% per year. This raises a question whether the Japanese economy will be able to absorb such massive levels of liquidity infusion.

The backdrop is that inflation in Japan has remained either flat or negative since the collapse of the country’s stock market and real estate bubble at the beginning of the 1990s.

Theoretically, when an economy is in deflation, it simply means that prices are falling y-o-y. Needless to say, falling prices make people happy but in anticipation of prices falling in the future, they postpone their consumption decisions. This impacts businesses and their earnings remain flat or fall. This affects the economic growth of the country as a whole. Thus, it is proved and well received, that inflation, at comfortable levels, should persist in an economy.

Was this announcement less in itself to excite the market that Mr. Kuroda has gone to the extent of saying that if prices did not rise as expected, the bank ‘would not hesitate’ to increase its easing program?

Well, we must, with open arms, appreciate the bold decision taken by Mr. Kuroda but we should also not sideline and ignore the issues which may become a hurdle in achieving the objectives outlined.

One issue is that regardless of the increasing liquidity in the economy, money is not trickling down to all levels in the economy, more specifically to the bottom of the pyramid. This does not support the success of the quantitative easing program. Secondly, majority of the population of the country is in the age range 60-65 years. With this proportion expected to rise in the future, it continues to remain a deterrent even going ahead. At this stage the country wants its people to borrow and spend but the ageing population, out of its tendency to save, may not spend. Economic instability along with fiscal deficit remaining at above 9% levels, government debt remaining at above 200% of GDP and trade balance moving into deficit will also remain a concern going forward.

These structural issues, I assume, are enough to convince investors to keep their sums of money out of Japan, thus defying the basic purpose of introducing the quantitative easing program. 

Simple Economics: the US way

On the last once-in-a-lifetime date of this century, the US Federal Reserve chairman Ben Bernanke (BB) announced a decision to buy additional $45 billion a month of long-term securities along with $40 billion a month of mortgage backed securities – widely referred to as QE4. Yes, its $85 billion a month of buying securities that BB was talking about!!

The trigger point: Post the economic crisis in 2008-09, the Fed, to support a stronger economic recovery, took some bold steps to loosen monetary policy and increase demand. It decided to keep interest rates at ultra low levels and begin a program of bond buying to inject money into the economy to boost nominal spending. This helps because buying long-term securities pushes up the asset prices and lowers yields, thus lowering the borrowing costs for the firms.

In order to stimulate borrowings and create jobs in the economy, BB promised himself and to the world to keep the rates low and continue spending until the unemployment rate falls below 6.5%.

But looks like BB totally ignored the impact of this program on other important economic factors!!! Won’t keeping interest rates low and infusing $85 billion every month push up the inflation in the medium to long term? It’s a concern because, after all, high inflation rate doesn’t support economic growth.

Now, let’s go back to 2011 when the US Congress agreed to the Budget Control Act 2011 in exchange of raising the debt limit by $2.1 trillion. The BCA 2011 was introduced to reduce the deficit of the country by $1.2 trillion by the end of 2012. However, there was this condition that if the government is not able to meet this target, spending cuts in defense and other discretionary expenditures will automatically trigger at the start of 2013. That’s exactly what happened on the 1^st of March this year!! This is referred to as the ‘sequestration effect’ which triggered automatic spending cuts of $85 billion over the remaining seven months of this fiscal year and will continue to cut $1.2 trillion every year till 2021. As one would easily interpret, the underlying aim here is to reduce the fiscal deficit of the country by cutting on expenditures, drastically.

An analysis, however, says that this automatic spending cuts is expected to put 2.14 million American jobs at risk pushing the unemployment rate to above 9% (current rate is 7.6%). It is also expected to push the US economy towards recession.

This leads to another argument: Won’t the (desired) impact of spending $85 billion per month be set off against the (undesired) impact of automatic spending cuts due to the sequestration effect? What about BB’s dream to reduce unemployment rate and boost economic growth? Pchch… wondering when will that turn into reality?

The current situation of the US economy reminds me of the 2008-09 recession. The only reason why we saw the recession of 2008-09 was that money was made available easily, at cheap rates. The current economic situation resembles very much to the situation of 2008-09. Money is available at cheap rates, housing prices are rising again, US stock markets have hit an all time high breaking 16 years record and there is political instability too.

Wondering over where’s the US economy going again? Well, we can only wait and watch and hope for the best!! *fingers crossed*

..And the buzz over the Budget 2013-14 is over!!

The so-called ‘responsible’ budget 2013-14 was presented by the Finance Minister P Chidambaram in the Lok Sabha yesterday. Union Budget 2013-14 was a special budget for many reasons: One, it was Mr. Chidambaram’s eighth budget presentation as the Finance Minister of the country. Two, India, today is in a very tight fiscal situation and the investment sentiments are hurt due to many reasons. The twin deficits i.e. the fiscal deficit and current account deficit are of prime concern to the government. Economists and industrialists have been shouting their throat out that only major policy reforms can pull India out of this worsening situation. This year’s budget, therefore, was expected to focus on fiscal consolidation and discipline. Three, to finance the rising CAD, we need foreign investments in the form of FII and FDI. But these investments have slowed down on account of rising uncertainty and increasing riskiness in the economy. A daunting task of Mr. Chidambaram is to attract foreign investments in the country. Remember, on his tour to various countries, he promised the foreign investors of a responsible budget. This budget was supposed to deliver his promises and to make investments and related policies easy and friendly for the foreign investors. Fourth, the country’s economic growth has been hampered due to lack of investments and infrastructure development. Central Statistical Organization (CSO) estimates India to grow at a rate of 5% in 2013, the lowest growth rate in a decade. This budget was expected to provide for steps that will promote investments and infrastructure development in the country. Fifth, it was supposedly Congress’ last budget to gain voters’ confidence before the general elections next year. Considering that, the FM had to keep the lady-in-power happy too. Overall, P Chidambaram had a very challenging task to deliver in this budget where hopes were high on account of his credibility.

They say in order to correct past mistakes, it is very important to first acknowledge them. In the budget speech today, it was noteworthy that the FM acknowledged 2012-13 has been the worst ever growth period in the UPA term. He looked very determined and serious about repairing the damages caused to the domestic environment. At the beginning of the budget speech, he noted that the widening CAD is more serious a concern than the fiscal deficit and bold steps are required to challenge this situation.

Let’s compare some of the elements of the budget 2014 with the expectations outlined above. Let’s understand if the budget answers the simple and difficult questions in the minds of the people.

From the fiscal consolidation front, the FM has fulfilled his promise of restricting the fiscal deficit to within 5.3% of GDP, at 5.2% of GDP in the current year. He forecasted the fiscal deficit for the next year at 4.8% of GDP in line with the aim to reduce the fiscal deficit to 3% of GDP by 2017. Also, noting that the CAD has been rising on account of huge imports of oil, coal and gold, he announced a slew of measures that would reduce dependence on these imported commodities. Estimating that India’s coal imports are expected to rise to 185 mt by 2017 driven primarily by the needs of the power sector, he said, “There is no alternative except to import coal and adopt a policy of blending and pooled pricing. In the medium to long term, we must reduce our dependence on imported coal”. He also suggested devising a PPP policy framework in order to increase the production of coal for supply to power producers and other consumers. Whereas to reduce gold imports the government wants to shift the focus of domestic investors from gold by introducing new investment instruments. Some of those announced in the budget are introduction of inflation-indexed bonds, modifications in the RGESS, reduction in STT and additional tax relief on house loans.

For the FII/FDI investors, the government has simplified the KYC norms and made rules uniform for all class of investors. It allowed them to transact in currency derivatives and also, use their investments in corporate bonds and government securities as collateral for meeting margin requirements. Postponement of GAAR implementation to April 1, 2016 was another relief for the foreign investors.

To promote investments in the country, the FM has allowed an investment allowance of 15% on new purchases of P&M valued above Rs 100 crore. This means apart from depreciation, companies can now use an additional deduction in the form of investment allowance to reduce their taxable income. This will drive investments overall. On infrastructure sector, the FM said, “While every sector can absorb new investment, it is the infrastructure sector that needs large volumes of investment...” For this, government will encourage infrastructure debt funds to raise resources and provide low cost debt for infra projects. Some institutions will be allowed to issue tax-free bonds in 2013-14 up to a sum of Rs 50,000 crore.

Though the budget meets some of the many objectives outlined above, it also raises few questions. It is very confusing when the government, in the Economic Survey 2013, says that its focus will be to fight inflation and in the budget, announces rise in government expenditure by 16% in 2014. How will the government control inflation when it is planning excessive spending in the form of government expenditure? Valid question, isn’t it?

#FiscalConsolidation: Revenue estimates look way too optimistic whereas expenditure estimates are way too conservative. Aren’t the revenue assumptions (e.g. divestment receipts of Rs 54000 crore and spectrum sales receipts of Rs 41000 crore) questionable? Looks like, basic accounting principles are simple to read and understand but difficult to implement!!

On one hand, the FM talks about deepening the debt markets and on the other hand, he plans to borrow huge amounts from the market (Gross borrowing in FY14: 6.29 lakh crore). The preferred way that the government borrows from the market is by issuing bonds. The excess government borrowing plans will increase supply of the bonds in the bond market and push the yields up - bad for bond market. Isn’t there a contradiction clearly?

To summarize, this budget is a balanced budget which not only addresses the problems of the country but also manages to gain voters’ attention. It is a reformist budget which is populist too. But what we must also wait for is the view of the RBI Governor on the budget and on the monetary easing scope following the budget.

The critics and markets have taken the budget positively...and the buzz over the budget is finally over!!