If the perception of foreign investors was the final aim, government won the battle the moment they announced FDI in retail and took bold steps like restricting number of subsidised cylinders and increasing diesel and fertiliser prices. The resulting euphoria caught the market unaware, resulting in hectic buying in the stock exchanges and strengthening of the rupee. But as the dust settled, realisation crept in that government had little choice but to cut down on subsidy. Going by the sound bites and coalition partners' reactions, FDI in retail is likely to be only an announcement.
The sharp move in the markets however, did the trick for the government, perception among a number of analysts and commentators changed. Bullish reports with new levels of the indices were released. Various data points were used to justify the changing environment after the announcement. Commentators once again praised the economic proficiency of the PM and FM. But the data points selected to build the case were superficial at best and did not catch the underlying facts.
There was one important person who did not share the euphoria. RBI Governor D Subbarao, the man in charge ensuring price stability, growth and financial stability (including currency stability). The central bank has its ears closer to the ground and is any day a better judge than any of the other financial market participants, both public and private. A veteran central banker Subbarao has experienced many such ‘flash in the pan’ movements and knows its end results.
Like a seasoned banker he has chosen his words well when he highlighted these concerns in his Second Quarter Monetary Policy statement where he said ‘Domestically, a revival in investment activity, which is key to stimulating growth, depends particularly on the recent policy announcements by the government being translated into effective actions.’ In other words what he is telling the government is announcements are fine, but you need to convert them into action.
As is pointed out by the governor, revival of ‘investment activity’ is key for revival of the economy. All other parameters will have only marginal impact to growth. Kotak Institutional Equities has recently pointed out in a report that India faces an ‘investment cliff’ unless the government can conceptualise and award new projects in new sectors. The report based on data taken from RBI says that the economy will be looking at a severe slowdown in investments in projects and for capital expenditure in about two years unless the government shows urgency to approve new projects and shifts from investments in the traditional sectors like power, roads and telecom.
Gross Fixed Capital Formation (GFCF) which measures future capital addition has shown no signs of improvement. Corporate India is not willing to commit themselves to capacity addition. Recent land reforms measures proposed by the government have made it tougher for them to set up capacities in the country.
The underlying data does not suggest any improvement in the economy. RBI’s credit data for the month of September shows shrinking non-food credit growth. Though banks are flush with funds they are not willing to take the risk and lend to corporate but find it safer to deploy in government bond.
With little help from Indian corporate, government took steps to attract foreign capital. In a review of Rakesh Mohan’s book Growth with Financial Stability, Rajeev Malik of CLSA points that ‘Just because India is a capital hungry economy, it does not mean that it has the ability to absorb those capital inflows without causing unpalatable side effect.’
Rajeev Malik adds India’s inflation rate is what the GDP growth rate should be, and its GDP growth rate is what the inflation rate should be. Indeed, inflation remains uncomfortably high, but the RBI has been undertaking “stealth” easing despite its hawkish talk. Fiscal consolidation is more in sound bites than in credible actions and sustainable outcomes. Some politicians and policy makers just chose to ignore the lessons of history.
Government cannot talk its way out of the mess, it needs to take steps which are which are implementable. Till it gets its act in order, there is enough room for the economy to slip.