RBI raises concerns about India’s worsening economic indicators and their impact on growth.
In its mid-quarter monetary policy review, the Reserve Bank of India has effectively explained where the Indian economy stands vis-à-vis the rest of the world. The picture is far from rosy. The 25-basis points increase in the repo rate announced on Friday must be seen in this context. The statement makes for interesting reading, not because of its hawkish tone, but for the rather dismal picture painted.
While the central bank has reiterated that economic indicators are worsening and growth is being adversely affected, what is apparent is that RBI is fighting a lone battle against inflation. According to RBI, the central government’s fiscal imbalances widened during the April-July quarter, reflecting primarily the impact of decline in revenue receipts, coupled with pressures from non-plan revenue expenditures on account of higher petroleum and fertiliser subsidies. “The fiscal deficit at 55.4 per cent of the budget estimates in the first four months of the current fiscal was significantly higher than that of 42.5 per cent during the corresponding period last year (when it was adjusted after the more than budgeted spectrum proceeds).”
Clearly, the time is not right for a “premature reversal” in the rate cycle. India has two options in the current scenario. The first is to accept high inflation as the new normal, but this would significantly erode India’s competitive advantage in the world market. The other is to live with lower growth, even below the level of eight per cent. Given that the government does not seem inclined to tame prices, growth could even slip below seven per cent in FY13.
Sticky inflation and slowing growth, which spooked equity market investors, is now having a cascading effect on other financial markets. The rupee has lost much more than other emerging currencies, thanks to India’s high current account deficit and sticky inflation. According to Deutsche Bank, the persistence of high inflation over many years is bound to impact the economy’s competitiveness, as was evidenced by the rise in the real exchange rate. “Going forward, one can envision one of the two scenarios — either India brings down inflation sharply to stem the rise in the real exchange rate or it succumbs to a bout of nominal exchange rate depreciation. This issue is independent of the ongoing bout of global risk aversion. We see the rupee's vulnerability rising, unless inflation is brought back to the previous trend of 4-6 per cent.”
For now, the equity markets might have discounted the rate rise, as all attention is on global factors, but Sudhakar Shanbhag, chief investment officer of Kotak Mahindra Old Mutual Life Insurance, says: “The government focusing on some of the reforms process can get interest back in the market. Global uncertainty and continued lack of movement on the development front locally can lead to corrections.”
