Indian economy: Misplaced elation

India is in the euphoria of WPI inflation at zero level and the inflation based on CPI at 4.4 per cent in November, 2014.

The ring out of December 2014 will be pleasant on account of the continuous reduction in the prices of petroleum, petroleum products and coal. The reduction in petrol and diesel prices in various doses has led to drop in the prices of food products, vegetables and commodities on account of transportation costs becoming cheaper.

The collapse of the global brent prices from $110 per barrel to $59 per barrel has helped the government save oil subsidies that marginally helped in narrowing the current account deficit.

One swallow doesn't make a summer. The “zero” inflation and the CPI at sub 5 per cent are all good sweeteners, solely as a positive fall out of the collapse of the global brent prices.

Brent prices can again raise, within March 2015, once OPEC and US takes corrective steps by slowing down the petroleum output and by plugging the loop holes in the petroleum value chain. So, fall in inflation rates is not directly correlated with India’s real economic growth and the GDP.

India’s exuberance will be short lived and misplaced if we fail to understand the real issues plaguing the economy. Even the “zero” inflation is not desirable, as the continued levels of low inflation will gradually slide the economy to the deflationary orbit.

The signs of deflation are visible with the dip in Index of Industrial Production (IIP) to minus 1.2 per cent, slump in manufacturing and the metal sectors which can pull the economy to the recession mode if corrective steps are not taken on an urgent basis.

In the WPI, manufacturing products have 65 per cent weightage out of which, 35 per cent of the composition of the goods is in deflation levels, which clearly signals our entry to the danger zone. Hence, reversal in fuel prices can see a sudden surge in the index and consequent rise in the inflation back to 5 plus percentage.

India also has the dubious distinction of having couple effect of double deficit – current account deficit at $7.8bn – 1.7 per cent of GDP and fiscal deficit of nearly ₹5 trillion – which has already surpassed the 90 per cent of the budgeted bench mark of 4.1 per cent of GDP. The combo effect of double deficit can have lethal effect and is disastrous to the economy.

This situation, to our economy, which will initially lead to further depreciation of the rupee and can breach ₹64-65 against the dollar, will have ripple effect. It will make imports costly, stunt exports, deplete forex reserves and lead to flight of capital by the FIIs.

The FIIs pulled out nearly ₹2000 crore during October-November 2014. To counter that, RBI is purchasing dollar to build the dollar reserves. India’s GDP is around $ 2 trillion which is roughly equivalent to ₹118 trillion.

Since the deceleration of inflation is greasy, solely on account of the collapse of the oil prices, RBI has not succumbed to pressure and clamour of reduction in the repo rates by the bankers, corporates and from the finance ministry. RBI governor Raghuram Rajan has prudently adopted the wait and watch approach as he feels that the economy is not ripe and matured to warrant the rate cut.

The RBI is expecting upturn in the investment cycle and its durability to merit reduction in the repo and the CRR rates. The RBI’s rigid stance gets the stamp of credibility as banks are flushed with funds, gone for downward revision in the fixed deposit rates and sitting on a pile of stressed assets.

Reluctance to lend
It is basically the bankers’ reluctance to lend to the corporates on account of the
monstrous levels of non-performing assets (NPA) roughly at ₹6 trillion, which forms 10-15 per cent of the total bank advances. From April 2015, even the “restructured/ rescheduled” loans will be brought under the NPA category which will further erode the bottom line of the banks in addition to $100 billion  required as capital infusion as per the BASEL III compliance requirement spread over time frame till March 2019.

The need of the hour is to curb non plan expenditure, fiscal consolidation, austerity measures, mop up revenues through better tax collections, improve supply chain mechanisms etc.

The government should also go for effective storage for surplus food grains, disinvestment of identified PSUs, curbs on import of gold, to go ahead with aggressive policy reforms in the areas of GST, coal and the insurance sector, to boost public investment and savings, to spur the economy so that 5 - 5.5 per cent growth in the GDP is achieved by March 2015.

If the fall in inflation rates continues, coupled with fiscal consolidation by keeping the fiscal deficit less than 4.5 per cent GDP and the government demonstrating aggressive policy reforms, the RBI may offer a candy of 0.5 per cent reduction in the bank rate as a New Year gift in January 2015, even before the scheduled review of the monitory policy, in February 2015.