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??