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One would have to be a diehard pessimist not to acknowledge the fact that the flow of economic data over the past fortnight points to a possible improvement in India's macroeconomic situation for the coming year. The inflation print for March, for one thing, came as a pleasant surprise at a little less than six per cent. This was underpinned by an extremely low core inflation rate, of 3.4 per cent, which corroborated much of the anecdotal evidence strewn all over that tight monetary policy had completely reined in the pricing power of Indian companies. Even if there is an upward revision in the headline number for the month, core inflation is unlikely to budge much.
The second important development was the crack in gold prices driven partly by the news that Cyprus would sell its gold reserves as part of its crisis resolution package. Though this amount, euro 400 million, is indeed paltry, it has sparked fears that gold sales by central banks would emerge as part of the fiscal/banking stress mitigation strategies of other, bigger European economies such as Italy. These economies are saddled with much larger fiscal gaps and hold bigger gold reserves. Therefore, the supply of gold from their coffers could be much bigger.
The third bit of good news from India's perspective came from China, whose gross domestic product (GDP) for the first quarter recorded growth of 7.7 per cent, a fair bit lower than market expectations. Thus, the Chinese economic recovery that seems to have started in the last quarter of 2012 already appears to be losing steam. It is unlikely to re-emerge as a commodity-guzzling powerhouse and is, therefore, unlikely to drive up commodity prices sharply yet again. The sell-off in gold, coupled with the weak data point from China, pushed other commodity prices, including that of oil, down. The CRB index for metals, a commonly used benchmark of commodity prices, fell by nine per cent in April from its February level.
The final bit of good news came in the form of India's trade figures for March, which showed massive compression in the trade deficit to $10.3 billion, driven by both a pick-up in exports and a sharp drop in oil imports. This contraction came on the back of both lower prices and volumes - and the fall in volumes is a feature that has become visible through the three months of the last quarter. Thus, if one were to try and extrapolate the current account deficit from the last quarter's trade figures, it would show a precipitous drop to 3.8-4 per cent of GDP from the third quarter's alarming level of 6.7 per cent. For the year as a whole, the current account deficit is likely to be five per cent of GDP instead of the 5.5 per cent that most of us had pencilled in earlier.
The implications going forward for our economy depend on whether this relief is temporary or enduring. This, in turn, depends on how one predicts the direction of commodity prices. Some would argue that the fact that the sharp correction in commodity prices came in the middle of an unprecedented infusion of liquidity by the US Federal Reserve and the Bank of Japan suggests the beginning of a bear market that could take prices much lower. A trigger for further correction could be the rising expectations of the US Fed winding down its quantitative easing (QE) programme, an option that the American central bank's powerful open market committee seems to be considering seriously. I am making a more conservative assumption - commodity prices might not plunge from these levels, but the prospect of a sharp recovery over the year is somewhat remote. Of course, there will be pullbacks here and there. Gold, for instance, recouped some of its losses in the last couple of days - however, I am betting on the fact that the average price for commodities will be considerably lower than last year.
As far as gold is concerned, investors seem to be doing a serious rethink on valuations. This is bound to happen for an asset that has on average returned about 20 per cent each year for the past decade. Besides, if there is indeed a risk of some central banks selling gold, and if the dollar gets a pop from shrinking QE, a substantial portion of the speculative or investment demand for gold could wane. This would apply to India, too - there is already informal evidence that investment in gold exchange-traded funds has declined sharply. Of course, as gold prices fall, there could be some price-elastic purchase of gold jewellery. The net effect, in my estimate, would be a fair fall in gold imports this fiscal year. I would not be surprised if our gold import bill came down to $40-45 billion in 2013-14 compared to my estimate of $50 billion for 2012-13. As far as the current account deficit is concerned, I am placing it in the range of 4-4.5 per cent of GDP.
All this will not automatically translate into better growth rates. The government will have to ensure that bottlenecks are removed in vital infrastructure sectors and the private sector regains its confidence to consider setting up fresh capacity. However, a lower current account deficit and lower core inflation (on the back of softer commodity prices) do increase the degree of freedom that our policy makers can work with. The possibility of lower inflation and a smaller current account deficit certainly opens up the space for more policy interest cuts than were thought viable earlier. If growth refuses to pick up, the finance ministry could afford to let the fiscal deficit slip a little without fretting endlessly about the implications for the current account. Our community of economists and policy makers has become a little too fixated on the risks that lie ahead. Perhaps it is time to recognise some of the emerging comforts as well.
The writer is with HDFC Bank. These views are personal
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
