RBI keeps all rates unchanged in December policy review

The RBI kept repo rate, at which it lends to banks, constant at 8.5%, reverse repo rate at 7.5. Cash reserve ratio (CRR) which is the amount of cash the banks have to maintain with the Reserve Bank of India as a percentage of their net demand and time liabilities (NDTL) has been maintained at 6%.

Guidance is now biased towards growth if inflation continues on its projected downward trajectory; this indicates that if inflation threats are not further heightened, the RBI may start reversing its rate cycle after 13 consecutive increases in the policy rates, which have risen by 375 basis points since March 2010.

RBI announces slew of measures to support the rupee

Business Line : Industry & Economy / Banking : To support rupee, RBI tightens forward contracts

India's inflation eases to 9.11% for November 2011

http://netindian.in/news/2011/12/14/00017685/indias-inflation-rate-eases-slightly-911-november-2011

India's Industrial output contracts 5.1% in October

Business Line : Industry & Economy News : Manufacturing, capital goods drag down IIP

India’s GDP Numbers Confirm Marked Slowdown

Indian economy expanded at its slowest pace in two years at 6.9% during the second quarter of fiscal 2011-12, compared with growth of 7.7% in Q1 of 2011-12 and 8.4% growth in Q2 of 2010-11. There was a significant downward revision in GDP growth rate of second quarter of 2010-11 from the earlier 8.9 per cent to 8.4 per cent. During the quarter, manufacturing sector growth slowed sharply to 2.7% in Q2 of 2011-12 compared with 7.8% for the previous year period. In Q1 of 2011-12, manufacturing sector grew at 7.2%.Agriculture growth also fell to 3.2% in Q2 of 2011-12 compared with 5.4% for the previous year period. It grew 3.9% during Q1 of 2011-12. Mining sector witnessed a drop of 2.9% during Q2 of 2011-12 compared with growth of 8% for the same period last year. It grew 1.8% during Q1 of 2011-12.Construction sector growth improved in Q2 of 2011-12 to 4.3% compared with 1.2% growth in previous quarter. However, Q2 growth was lower than 6.7% growth witnessed in last year period. Growth for electricity, gas and water supply registered a sharp rise of 9.8% in Q2 of 2011-12 compared with growth of 2.8% for the same period last year. It grew 7.9% during Q1 of 2011-12. Trade, hotels, transport and communication growth slowed to 9.9% in Q2 of 2011-12 compared with growth of 10.2% for the same period last year. It grew 12.8% during Q1 of 2011-12. Financing, real estates and business services growth improved in Q2 of 2011-12 to 10.5% compared with growth of 10% for the same period last year. It grew 9.1% during Q1 of 2011-12. Community, social and personal services growth improved in Q2 of 2011-12 to 6.6% compared with 5.6% growth in previous quarter. However, Q2 growth was lower than 7.9% growth witnessed in the similar period of last year.

Private final consumption expenditure (PFCE) at current prices was estimated at Rs. 12,436.81 billion in Q2 of 2011-12 as against Rs. 10,712.21 billion in Q2 of 2010-11. Government final consumption expenditure (GFCE) at current prices was estimated at Rs. 2,223.56 billion in Q2 of 2011-12 as against Rs. 1,964.98 billion in Q2 of 2010-11. Gross fixed capital formation (GFCF) at current prices was estimated at Rs. 5,842.36 billion in Q2 of 2011-12 as against Rs. 5,456.60 billion in Q2 of 2010-11. The slowdown in private consumption is worrying; as India’s growth is driven by domestic consumption if this shows signs of coming off, then fear of a protracted slowdown may become real. PFCF (at constant prices) grew at 5.9 per cent in Q2, compared to 8.9 per cent in the similar quarter of last year. What is also surprising is the fact that, while export growth has held up well despite the deteriorating global economic scenario, import growth has halved in the second quarter to 10.9 per cent compared with 23.6 per cent recorded in the previous quarter.

The GDP figures are a vindication of the weakness already apparent in the industrial sectors, according to the Confederation of Indian Industry; industrialists have been dealt the double whammy of a gloomy external scenario and increasing borrowing costs at home. Output growth in eight core industries, including steel, cement and coal, , with more than one-third weight in the Index of Industrial Production, dropped to near-zero in October, a sharp decline from 7.2% a year ago, signaling the possibility of a sharp deceleration in industrial growth. The uncertain global outlook has led to the shelving of several projects, while tougher credit conditions have eroded corporate profits mainly through interest outgoes. The weakness in the Indian rupee, which touched a historic low of 52.73 against the dollar in November, has contributed to the woes of several importers and corporates; in 2011 so far the rupee has depreciated by 14.8 per cent against the US dollar. India’s headline inflation has remained above the 9 per cent mark for 11 consecutive months; businesses are finding it increasingly difficult to pass on price pressures to the consumer, without losing out on sales.

On the other hand, the fiscal deficit for the first seven months (April-October) of the current fiscal has already hit 75 per cent of targeted deficit for the entire year, according to data released by the Controller General of Accounts (CGA); the Centre has pegged the fiscal deficit target for 2011-12 at 4.6 per cent of GDP. With industrial output slowing down, not much growth is expected in advance tax collections and thus the possibility of a slippage in the fiscal deficit is not ruled out. The Finance Minister, however, has cautioned that too much emphasis on meeting the fiscal deficit target may hurt economic growth—a pointer that the government may refrain from any aggressive tightening on the expenditure front in a falling growth scenario. Central banks across the globe have turned dovish as growth has stalled; even the central bank of China has decided to lower the reserve requirement ratio (RRR or the amount of cash that lenders must set aside as reserves) at China’s financial institutions by 0.5 per cent in order to ease credit crunch that is stalling growth. The RBI has already indicated a neutral bias unless the inflation situation spins out of control.

Have a closer look at the GDP figures and more data in our forthcoming monthly statistical bulletin—E-UpDates.

GDP growth slows to 9 quarter low of 6.9% in Q2

Business Line : Industry & Economy / Economy : GDP growth slows to 6.9% in Q2

FDI in Retail—A Mixed Bag...

The Indian government has finally paved the way for the entry of global retail giants into India. Foreign direct investment (FDI) of up to 51 per cent has been allowed in multi-brand retail. Simultaneously, the FDI limit in single-brand retail ventures has been increased to 100 per cent; the government had in February 2006 permitted 51 per cent FDI in single-brand retail.

The clearance comes with several riders; multi-brand foreign retailers need to make a minimum investment of $100 million in the country. They would be allowed to set up shop only in cities with a population of more than 10 lakh as per the 2011 Census; there are about 55 such cities so it means big retail chains can move beyond the metros to smaller cities. Foreign investors will be required to put up 50 per cent of total FDI in back-end infrastructure. Such infrastructure will include capital expenditure on all activities, excluding that on front-end units. Expenditure on land cost and rentals will not be counted for purpose of back-end infrastructure. Retailers will need to source at least 30 per cent of manufactured/processed products from small industries. However, there will not be any obligation on the part of retailers to source agricultural produce such as fruit and vegetables. The Government has also retained the first right on sourcing agricultural produce. In terms of single-brand retail, just one important condition has been added to the existing one. It makes 30 per cent sourcing from small and medium enterprises mandatory, as soon as the FDI limit exceeds 51 percent.

The Government believes opening up of FDI in multi-brand retail trade and further liberalisation of single-brand retail trade will facilitate greater FDI inflows besides additional and quality employment. It is being assumed that it would make eminent commercial sense for the retailers to source fresh produce locally. It is unlikely that retailers would undertake large-scale imports of agricultural products. It will also bring a lot of benefits to the consumers and farmers in terms of quality, price and removal of inefficiencies in the agricultural sector. The Government has maintained that farmers will get higher remuneration and FDI will help in the development of much needed logistics and cold chains in the country. All sections of Indian industry of course have welcomed the move as any such investment spurs up industrial activity.

Global chains may face problems in opening stores in 28 of the 53 cities which have been thrown open to retailers. A long deliberation had been keeping the decision on hold as political opposition as well as store owners voiced their concerns on the fate of the small retailers once global giants like Walmart, Carrefour and TESCO open stores next doors. However, there doesn’t seem to be much reason for such extreme concern. The Indian consumer is a quirky brand itself; after the initial excitement dies down most consumers may remain loyal to their very own corner store. We have seen brands like Spencer’s close shop in localities where thriving traditional shops existed, even in more elite localities in metros. Street fashion shops continue to be crowded despite the opening up of several clothes retailers in the metros. Given the large scope and size in the retailing business in India there is every possibility that both parties face initial difficulties but eventually gain some mutual benefits.

RBI Adjusts Stance to Reflect Deepening of the Global crisis...

The RBI formulated its second quarter review of the Annual Monetary Policy for the year 2011-12 against a backdrop of decelerating domestic demand and growth, led by global economic sentiments. A slew of regulatory and developmental policy measures have been announced; these include new products to widen and deepen the financial markets and measures to increase financial inclusion and strengthen the banking system. The most important measure however, was the deregulation of the Savings Bank Deposit Interest Rate, which so far remained the so called last bastion of interest rate regulation in India. Though this could lead to both intra- and inter-bank deposit migration in the short-term, it is expected that the move will lead to efficiency in banks’ credit-deposit management and would benefit a large number of small savers in the country.

As inflation expectations are likely to be controlled due to previous policy measures as well as the slowdown in both global and domestic growth and demand, RBI has now shifted its stance from hawkish to neutral. This has provided significant breathing space for domestic financial markets and corporates who have been facing shrinking profits due to shrinking global demand, rising borrowing and input costs as well as fluctuations in foreign exchange rates. India’s October exports slackened to about 11 per cent from a peak of 82 per cent growth registered in July, widening the country's trade deficit to a four-year high. India’s industrial output growth for September has also decelerated, for the third consecutive month, to a mere 1.9 per cent the lowest reading in two years. Going forward, the developments—related to the sovereign debt crises across the globe, in the global financial markets and the actual trajectory of both global and domestic commodity prices—would determine necessary changes in the policy stance. The highlights of the Second Quarter Review of Monetary Policy 2011-12 is presented here :E-UpDates-November2011

The Hindu : Business / Industry : IIP dips to 2 year low of 1.9 per cent

The Hindu : Business / Industry : IIP dips to 1.9 per cent

Business Line : Industry & Economy / Economy : Slowdown chill: Exports fall to 12-month low in October

Business Line : Industry & Economy / Economy : Slowdown chill: Exports fall to 12-month low in October

Double Policy Impasse — Near Double Dip

The global economy was feared to be on the brink of another recessionary phase, pulled down not only by stalling demand and growth arising from persistently high levels of unemployment in major advanced economies, but this time precipitated by a dearth of business and consumer confidence as showing up in various confidence indexes across the globe. This crisis of confidence, as it has been termed, sparked off by sovereign debt crises and a series of rating downgrades of the US and the Euro zone countries, intensified as policy making reached an impasse on both sides of the Atlantic. Unlike the first phase of the global financial crisis when policy makers had unanimously called for expansionary policies to avert crisis, this time around there is a clear divergence in policy stance of various stakeholders and analysts leading to standoffs on critical issues like raising the ceiling on US government debt or the Greek bailout.

In mid-May US national debt approached its statutory limit of $14.29 trillion and measures were taken to stave off a default until August 2. (The US government is able to auction off new debt typically in the form of US Treasury securities in order to finance annual deficits. However, instituted with the Second Liberty Bond Act of 1917, the debt limit places an absolute cap on this borrowing, requiring congressional approval for any increase or decrease from this statutory level.) A political impasse over reduction in defense spending and tax hikes that could be biased against the wealthy and tax reforms involving fewer deductions and loopholes for both individuals and businesses held the global financial system to ransom. A legislation to raise the US sovereign debt limit by at least $2.1 trillion through the Budget Control Act of 2011, was finally enacted a day before the threatened default. The deal puts in place measures to cut the US deficit by $2.1 trillion over 10 years with initially about $100 billion reduction when the deal passes and another $1.5 trillion to be agreed upon by the end of the year; the first group of spending cuts apply progressively over the years to the discretionary programs that are approved annually, with automatic triggers for cuts if the targets are not adhered to. Adding to the financial market turmoil, in early August the US lost its highest safety or AAA credit rating, potentially further increasing funding costs for US public debt and the cost of borrowing for consumers and investors; this triggered off a slide in the US and global equity markets and this time around even emerging markets were not spared. However, strong growth figures released last week have for now pushed back fears of another recession, however concerns loom large that the austerity measures taken to avert the debt crises though beneficial for reducing government debt, are in fact debilitating for growth and employment. Unless there is a significant expansion in business and consumer confidence and in private demand in response to these measures, recessionary tendencies may only aggravate.

The end of the policy impasse on the other side of the Atlantic doesn’t seem to be in sight. Escalating concerns over sovereign debt default in the Euro zone and in particular potential losses to banks holding this debt greatly impacted global financial markets and spilled over to economic sentiments across the globe. Differences within economies undergoing adjustment and those providing support impeded achievement of any quick solution; this precipitated a loss of consumer and business confidence. An emergency three-pronged deal was finally reached last week to fix the Euro zone's debt crisis: (i) Private banks holding Greek government debt which now stands at about 144% of GDP, will accept a write-off of 50% of their returns; (ii) the main euro bailout fund - known as the European Financial Stability Facility (EFSF) - is to be boosted from the 440 billion euros set up earlier this year to 1trillion euros; (iii) around 70 European banks will be required to raise about 106 billion euros in new capital by June 2012. It is hoped that this would help shield them against losses resulting from any government defaults and protect larger economies like Italy and Spain from the market turmoil. However, the Greek PM’s unexpected decision of calling for a referendum on the bailout agreement, whereby the people of Greece would decide whether or not the packages of austerity measures needed to qualify for bailout payments would be implemented, has now shocked the global economy.

India’s Growth — An Opportunity Missed?

India’s industrial growth plunged to a 21-month low of 3.3 per cent in July; the 3.3 per cent year-on-year increase in the official Index of Industrial Production (IIP) — the lowest since the 2.3 per cent of October 2009 — has primarily been dragged down by capital goods. The output of capital goods nosedived into negative territory by 15.2 per cent in July as compared to a growth of 40.3 per cent in the same month last year. This manufacturing sub-segment has, in fact, been showing huge volatility, having grown by 38.2 per cent in June. However, even intermediate goods — a proxy for investment activity in the economy — registered a negative growth rate of minus 1.1 per cent in July as against a growth of 8.5 per cent in July, 2010.

Among the major IIP segments, Manufacturing, which accounts for more than 75 per cent of the index, rose by a paltry 2.3 per cent in July. Within manufacturing (besides capital goods and intermediate goods), the basic goods sub-segment grew by 10.1 per cent (against 4.4 per cent in July 2010), with consumer durables (8.6 per cent versus 14.8 per cent) and non-durables (4.1 per cent versus minus 0.9 per cent) also doing relatively well. The cumulative industrial growth during the first four months of this fiscal worked out to just 5.8 per cent (compared with 9.7 per cent for April-July 2010-11), with growth rates at 6 per cent (10.5 per cent) for manufacturing, 1.1 per cent (8.2 per cent) for mining, and 9.4 per cent (5 per cent) for electricity. For the April-July period, capital goods production grew by 7.6 per cent (against 23.1 per cent in the four months of 2010-11), with the corresponding growth rates at 4.2 per cent (18.4 per cent) for consumer durables, 4.9 per cent (3.8 per cent) for non-durables, 7.9 per cent (5.2 per cent) for basic goods and 0.8 per cent (10.1 per cent) for intermediate goods. Prime Minister's Economic Advisory Council (PMEAC) Chairman viewed that the industrial growth target for the current fiscal — projected at 7.1 per cent — will have to be revisited.

Such growth numbers are not unanticipated given the central banks 11 rate hikes since March 2010 in a yet to succeed effort at cooling inflationary pressures. The problem is that India’s growth reversal comes at a time when the global economic gloom unleashed by the sovereign debt crises in the European nations as well as policy deadlock in the US has taken on enormous proportions threatening another fallback of some developed economies into recessionary territory. Economic recovery appears to have come close to a halt in the major industrialised economies, with falling household and business confidence affecting both world trade and employment, while the risk of hitting patches of negative growth going forward has gone up, according to the OECD. The palpable negative fallout of the fresh global downturn is bound to be a fall in export revenues; as markets accounting for close to a third of India’s exports (the European Union and US together) are stagnating or falling back into recession. Demand from developing Asia (excluding China) and the OPEC countries which together account for another 40 per cent of India's exports are highly unlikely to remain unaffected by the downturn either. The fact that governments have fewer options to boost growth are driving both business and consumer confidence downward; this is also true for India as falling growth and taxes now leaves the government with much lesser room for expenditure to boost the economy and spearhead much needed infrastructure investment. The uncertainty in the business environment created by the repeated rate increases through the year has also affected hiring intentions of businesses. One cannot but feel that India has missed an opportunity to address several issues pertaining to infrastructural bottlenecks and inclusive growth, during the post-crisis revival years — such steps would have lent more credibility to the inflation fighting exercise as well as to India’s growth story.

India's Weakest Growth in Six Quarters

GROSS domestic product (GDP) growth in India continued to slide falling to 7.7 per cent in the first quarter of the current financial year (April-June 2011-12), against a 7.8 per cent growth in the preceding quarter and an 8.8 per cent growth recorded in the first quarter of the previous year (according to the revised estimates based on the new series of IIP). The country's GDP at factor cost at constant (2004-2005) prices stood at Rs12,26,339 crore, as against Rs11,38,286 crore in the first quarter of the previous fiscal (2010-11), according to figures released by the Central Statistical Organisation (CSO). Sectors driving the first quarter growth include electricity, gas and water supply (7.9 per cent), trade, hotels, transport and communication (12.8 per cent), financing, insurance, real estate and business services (9.1 per cent). As per the latest estimates of the index of industrial production (IIP), growth in the index of mining, manufacturing and electricity slowed to 1.0 per cent 7.5 per cent and 8.2 per cent, respectively, in April-June 2011-12 against growth rates of 8.0 per cent, 10.3 per cent and 5.4 per cent, respectively, during the first quarter of the previous fiscal. GDP at factor cost at current prices is estimated to have grown 16.7 per cent year-on-year to Rs19,37,123 crore during the first quarter of 2011-12 quarter, against Rs16,59,708 crore in the corresponding period of 2010-11. The sector-wise breakdown showed that the construction sector had been one of the worst-performing parts of the economy.

Construction grew at 1.2%, down from 8.2% in the previous quarter, as rising interest rates and delays in planning approvals held up building projects. Agricultural output rose 3.9%, which was down from the previous quarter but above the level of 2.4% in the same period last year. Manufacturing grew 7.2%, an improvement from the previous quarter, but well below the 10.6% in the corresponding quarter of 2010-11.Private final consumption expenditure (PFCE) at constant (2004-05) prices is estimated at Rs7,95,683 crore in Q1 of 2011-12 against Rs7,48,395 crore in Q1 of 2010-11, while Government final consumption expenditure (GFCE) at constant (2004-2005) prices is estimated at Rs1,36,935 crore in Q1 of 2011-12 against Rs1,34,161 crore in Q1 of 2010-11. Gross fixed capital formation (GFCF) at constant (2004-2005) prices is estimated at Rs4,10,533 crore in Q1 of 2011-12 against Rs3,80,544 crore in Q1 of 2010-11.

The first GDP numbers for the current fiscal confirm several analysts’ assessment of economic prospects for the financial year which would involve further moderation in growth due to stricter monetary policy to curb inflationary pressures. Signs are already visible as according to data from the Centre for Monitoring Indian Economy, new investment announcements by companies have more than halved to Rs 32.5 lakh crore during April-June 2011 from Rs 71.4 lakh crore in the corresponding period last year as high interest rates, decline in demand and policy uncertainty have taken a toll. Declining investment can only aggravate inflationary pressures as supply–side bottlenecks increase. While the 7.7 per cent growth silhouetted against a murky

New Investment Announcements
Industry	Apr-Jun 2011-12 (Rs. Crore)	%change over April-Jun 2010-11
All	32,53,158	-55
Manufacturing	13,31,621	-52
Electricity	9,02,591	-61
Cement	30,000	-83
Services (Non-financial)	6,85,889	-59
Source: Times of India, 1st Sep, 2011

global scenario seems impressive, given the estimated requirements that we spoke about in our previous blog, a 7.7 per cent and slower future growth could well jeopardize a lot of calculations on achieving deficit targets as well as infrastructure development and inclusive growth.

India’s Road to Fiscal Consolidation — Diversions Ahead

Total public debt of the Indian government stood at Rs. 31.5 trillion at that end of June 2011 against Rs. 29.7 trillion at the end of March 2011 according to the June 2011 public debt management report released by the finance ministry. Central government debt rose nearly 6 per cent, but dropped as a percentage of GDP because of a revision in GDP estimates. The gross fiscal deficit (GFD) stands at 39.4 per cent of budget estimates (BE) during the first quarter of 2011-12 compared to 10.5 per cent at the same time last year. The major reason for a worsening fiscal situation is the fall in receipts, particularly non-tax receipts. Revenue and non-tax receipts were at 11.5 and 9.7 per cent of BE respectively during Q1 2011-12, compared with 29.3 and 78.2 per cent respectively during Q1 of last fiscal. The fiscal outcome during the first of quarter of 2011-12 indicates that all the key deficit indicators as percentage of budget estimates (BE) for 2011-12 were substantially higher than their levels during the corresponding period of the previous year because of lower revenue collections both from tax and non-tax sources. Gross tax collections during the quarter at 6.6 per cent of BE were lower than 8.3 per cent a year ago. In the direct taxes, corporation tax collections showed a negative growth of (-) 27.8 per cent while personal income tax increased by 6.5 per cent as against budgeted growth rates of 21.5 per cent and 16.2 per cent, respectively, for 2011-12. All the major indirect taxes (customs, excise and service tax), however, showed buoyant growth rates (37.7 per cent, 23.2 per cent, and 31.1per cent, respectively) during April-June 2011 as against budgeted growth rates (15.1 per cent, 19.2 per cent and 18.2 per cent, respectively) for 2011-12. This, combined with the facts that India's high savings rate allows a larger share for internal debt (90.3 per cent of public debt, at end-June 2011) vis-à-vis other countries and a small share of external debt along with a comfortable maturity profile improves the credibility of government debt and increases sustainability, gives some reason to rejoice.

India’s central bank in its recently published Annual Report has asked the crucial question whether the fiscal consolidation witnessed in the fiscal year 2010-11 is sustainable or not. The RBI mentions that the fiscal deficit ratios in 2010-11 turned out to be better than envisaged in the Union budget as the Central government’s gross fiscal deficit (GFD) was 4.7 per cent of GDP against 5.5 per cent budgeted. This compared with a GFD of 6.4 per cent of GDP in 2009-10 was indeed impressive. However, the RBI notes that a qualitative assessment of fiscal correction during 2010-11, raises concerns as improved fiscal position had a large temporary component arising from a business cycle upswing and one-off non-tax revenue gains from spectrum auctions, which resulted in the improvement in headline deficit numbers. Not accounting for the revenue proceeds of two main one-off items – spectrum auction and the disinvestment – the GFD/GDP ratio works out to be 6.3 per cent of GDP during 2010-11. Also, revenue buoyancy was supported by a cyclical upswing in the global and Indian economy that led to above trend growth. So the one-off gains and higher growth in nominal GDP of 20 per cent against the budgeted 12.5 per cent contributed largely to lower deficits. Moreover, not only did the correction in revenue account reflect more than- anticipated revenues there has been a spillover of subsidy expenditure from the last quarter of 2010-11 to the current fiscal year. Although the share of capital expenditure in total expenditure increased in 2010- 11 from 2009-10, it was marginally lower than the budget estimates. In particular, capital outlay-GDP ratio fell short of the budgeted ratio in 2010-11 and is still significantly lower than that achieved during pre-crisis period. Consequently, in outstanding terms, the Central government’s capital outlay (as ratio to GDP) as at end-March 2011 was lower at 12.9 per cent than 13.8 per cent a year ago.

Further, both internal and external dynamics could well alter the course of fiscal consolidation taken during 2010-11. The darkening external environment leaves little space for complacency as export revenues are very unlikely to remain elevated particularly if the downturn in the US and EU/UK affect the demand for exports, and particularly software exports, as also a prolonged recession like scenario in the developed world may destabilize India’s so far successful strategy of expansions in export destinations. Domestic demand is being curbed through tight monetary policy to fight inflation, however, the hardest hit has been investment demand which has started to show up in slowing growth and dwindling revenues. Growth projections have been revised down in the range of 8 to 7 per cent by several agencies (see www.ecofin-surge.co.in); falling growth and inflation eating into budgets leaves little room for any expectations of tax buoyancy. India has also lost some of its attractiveness as a destination for international capital flows due to staggering growth; short-term portfolio flows have seen reversals and the Indian stock market gains in 2011 have been much lower than some of the Asian markets. Given the strong positive relation between international flows and public debt, India should be wary as India’s public debt to GDP ratio is among the highest in the region (the ratio stands at 69.2 per cent for India in 2010, compared with 17.7 per cent for China, 26.9 per cent for Indonesia, 44 per cent for Thailand and 54.2 per cent for Malaysia, according to the IMF, WEO Database). On the other hand getting back to the concerns on the Indian economic outlook raised by RBI which mentions that apart from monetary tightening, complementary policies to lower inflation and inflation expectations need to be put in place including improved supply response for food, higher storage capacity for grains, cold storage chains to manage supply-side shocks in perishable produce and market-based incentives to augment supply of non-cereal food items, management of water as also technical and institutional improvements in the farm sector and allied activities. Further, the infrastructure gap of India, both in relation to other major countries and its own growing demand has been a key factor affecting the overall productivity of investments. As per the assessment of the Planning Commission, during the Twelfth Plan (2012-17) India may need infrastructure investments of over US$ 1 trillion. Fiscal consolidation and reorientation of expenditure towards capital expenditure is necessary to meet such targets. The RBI rightly points out that the challenges faced by the Indian economy that are constraining growth relate to education, health, energy, infrastructure and agriculture sectors, where public policy interventions are needed as markets by themselves may not be able to do enough to remove the constraints. Thus, we have reason to believe that addressing these concerns in all seriousness could well call for policies that lead to a diversion, may be a welcome one, in the road to fiscal consolidation.

Global Gloom — Decelerating Growth & Accelerating Deficits

Recent global economic assessments and outlooks of major international agencies like the IMF, United Nations and World Bank, show slowing global growth and worsening of unresolved problems related to fiscal crises. The global economic growth after powering up to 3.9 per cent in 2010 will slow to 3.2 per cent, as high food prices, possible additional oil-price spikes, and lingering post-crisis difficulties in high-income countries pose downside risks, according to the World Bank. According to the UN new headwinds have also emerged in 2011; the earthquake, tsunami and nuclear crisis in Japan shook world financial markets and disrupted important global supply chains. The political unrest in Western Asia and North Africa has been a source of a renewed surge in oil prices and international prices of food and other primary commodities have also soared in the year.

The United States economy expanded by 2.9 per cent in 2010, driven mainly by domestic demand, while weaker net exports had a dampening effect on growth; the economy is expected to slow down or at best stagnate in the current year. In April 2011, Standard & Poor's downgraded its outlook on United States sovereign debt, underscoring the urgency for policymakers to set up a credible framework to address its public debt. According to the IMF, the deficit projection for 2011 has been revised significantly downward, as post–April 15 data on revenues have come in stronger (in part because of sizable capital gains in 2010) and expenditures have been more contained than initially projected. However, the situation stands nowhere near resolved.

In the Euro zone negative sovereign ratings actions have spread beyond Greece, Ireland, and Portugal further into other euro area countries reflecting concerns that it will be difficult to reach the political consensus necessary for fiscal consolidation and structural reforms, according to the IMF. According to the United Nations, the recovery in Western Europe continues at a modest and uneven pace. Industrial business confidence indicators have returned to pre-crisis peaks in early 2011, but economies will face strong headwinds during the remainder of the year: GDP growth in the euro area is expected to average 1.6 per cent in both 2011 and 2012. Germany is expected to grow by 2.9 per cent in 2011, while the countries most affected by the fiscal crisis—Greece, Ireland, Portugal and Spain—will either remain in recession or, at best, register very modest growth rates. The positive demand effects from slowly improving employment conditions will be dampened by the negative impact of fiscal retrenchment.

Policy Measures Adopted or Announced for 2011 in Selected European Countries
(Announced impact on 2011 general government balance in percent of GDP)

---

Country	Revenue and other receipts	Expenditure	Total
Greece	Reduction in tax expenditures, including property taxes and VAT; various measures to speed up collection of tax arrears and penalties; measures against fuel smuggling; renewal of Telecom licenses; and extension of airport concessions (2.4 percent of GDP)	Wage cuts and tariff increases in public enterprises; restructuring of public entities; reduction in public wage bill (e.g. through reduction in short-term contracts and attrition-based reductions in employment); health reforms (drug and other cost savings and increases in co-pay for hospitals); rationalization of entitlements, including means-testing of family benefits; and reductions in transfers to public entities outside general government, operational expenditures, and military deliveries (2.7 percent of GDP)	5.1
Ireland	Revisions to PIT bands and credits; integration of health and income levies into universal social charge; tightening of various tax reliefs on private pensions contributions; and reduction in tax expenditures (1.2 percent of GDP)	Reduction in public payroll and discretionary expenditure, non-progressive social welfare benefits and capital spending (2.6 percent of GDP)	3.8
Portugal	Increase in the VAT standard rate (by 2 percentage points) and PIT and CIT rates; broadening of the SSC base; introduction of a new tax on the banking sector; adoption of tolls; and revision of penalties and fees (2 percent of GDP)	Reduction in public payroll (cuts in wages and the number of employees); pension freeze; cuts in social transfers and improvement of means-testing; reduction in capital expenditures and intermediate consumption; savings in health/pharmaceutical products; and cuts in transfers to SOEs and local governments (3.7 percent of GDP)	5.7

Fiscal Monitor Update, June 2011, IMF.

Market concerns about debt sustainability remain acute in Greece, where spreads have risen by 600 basis points since end-2010, to almost 1,700 basis points in early June. In Ireland and Portugal spreads have risen by 100–230 basis points to reach more than 700 basis points. Contagion to other Euro-area countries has been more limited, with spreads broadly stable in Belgium, Italy, and Spain. Despite ongoing fiscal consolidation, however, spreads remain in the 140–260 basis points range for these countries. Purchases of government bonds by the U.S. Federal Reserve since end-2010 have amounted to US$500 billion—with total envisaged asset purchases of US$600 billion under the second round of quantitative easing slated to end in June—bringing its holdings to 15 percent of publicly-held government debt. Securities purchases by the Bank of Japan (BOJ) are continuing. The BOJ now holds 7½ percent of outstanding government debt. Meanwhile, there have been no further market interventions by the ECB since March; its holdings of government securities remain equivalent to 11 percent of the outstanding debt of Greece, Ireland, and Portugal. In contrast, the Bank of England essentially halted its net purchases of government debt about a year ago, though its stock of holdings still stands at 16 percent of outstanding U.K. sovereign debt.

At home the Indian economy has slowed down resultant on the tight monetary and fiscal policies needed for fighting accelerating inflation. The government has been banking on strong economic growth to help meet its deficit target of 4.6 per cent for the current fiscal, but a spike in global oil & commodity prices leading to a slowing economy and a rising subsidy bill could well upset the fiscal calculations. In a signal that the government is worried about the state of its finances, the finance ministry announced a host of other measures to reduce expenditure and restrict the fiscal deficit. The last time such measures were taken was in 2008-09 after the collapse of Lehman Brothers that pushed the global economy into recession, when the finance ministry had asked all departments to cut non-Plan expenditure by 10 per cent.

Another Move towards Market-Linked Interest Rates...

Another Move towards Market-Linked Interest Rates — Reforms to Small Saving Schemes (NSSF)

A government panel, headed by RBI deputy governor Shyamala Gopinath, was set up to review the small investment schemes of post offices and banks. The panel has recommended — a 0.5% raise in the interest rate for post office savings account to 4% in line with the rate on savings bank deposits; raising the annual contribution limit in Public Provident Fund (PPF) to Rs.1,00,000, from the current Rs.70,000; discontinuation of the Kisan Vikas Patra; reduction in the maturity period of National Savings Certificates (NSCs) to five years from six, and introduction of a 10-year NSC scheme.

The panel has also advocated benchmarking of interest rates on other small savings schemes to rates of government securities of similar maturity with positive spread of 25 basis points for most schemes, while it proposes a 100 basis points spread for senior citizens' schemes, keeping in view its social objective, and a 50 basis points spread for the proposed 10-year NSC, keeping in view of its higher illiquidity.

The administered rates may be notified by the government at the beginning of every financial year based on the average yields on government securities in the previous calendar year. The Committee also agrees with an earlier recommendation made by the Rakesh Mohan Committee on placing a cap of 100 basis points so that the administered rates are neither raised nor reduced by more than 100 basis points from one year to the next, even if the average benchmark interest rates rise or fall by more than 100 basis points. This would keep in check undue volatility in the administered rates, which if approved will be effective July 1, 2011 .

The proposed benchmarks and the administered (/current) rates for various instruments are given in the following tables (Table 1 and Table 2).

As for the usage of small savings funds the panel recommends that the mandatory component of investment of net small savings collections in state government securities be reduced to 50%. States can access up to 80% of NSSF for financing their annual expenditure. (The funds are given as a 25-year loan carrying 9.5% interest, higher than market rates. It has been proposed that the tenure of these loans may be reduced from the current 25 years, so states might be able to minimise their interest outgo and borrowing requirement by opting for 10-year loans at lower rates.) The balance amount could either be invested in central government securities or could be on-lent to other states on basis of requirement or could be lent for financing infrastructure projects requiring long-term finance, according to the panel.

The share of small savings as a percentage of net financial savings of households increased sharply from 7.9 per cent in 1996-97 to 22.3 per cent in 2004-05. Thereafter, the share declined and even turned negative during 2007-08 and 2008-09 as the alternative savings instruments became relatively more attractive. The outstanding amount of collections under small savings stand at Rs. 7,93,447 Crore in 2010-11. The measures to reform the small savings plans offered by the government, if implemented, would help to ensure transparency, move towards market-linked rates and reduce the government’s fiscal burden.

RBI Unmoved by Pointers to Moderating Demand and Growth

The RBI formulated its Annual Monetary Policy for the year 2011-12 against a backdrop of moderating demand and growth, however, uncontrolled inflation has led the central bank to raise its key policy rates, for the 9th time since March 2010 and this time, quite sharply. While the RBI’s strong hawkish stance and bias, has been lauded by many, several analysts have also expressed the view that it is time that the emerging economy’s central bank adds to its arsenal more specific weapons to fight inflation rather than simply sacrificing the growth momentum. The RBI has of course pointed to the need to adjust domestic energy prices in line with the rising global prices, in order to reduce misalignment of energy demand with prices. Energy price adjustments may raise inflationary pressures in the short term but should definitely help curb the twin (fiscal and current account) deficits through adjustment of demand to actual prices. The problem with the continued hawkish bias is that it is the infrastructure sector which suffers most leading to further supply bottlenecks fuelling and adding to inflation imported from overseas.

The Review states that :

• According to the IMF WEO (April 2011), global growth is likely to moderate from 5.0 per cent in 2010 to 4.4 per cent in 2011. Growth is projected to decelerate in advanced economies due to waning of impact of fiscal stimulus, and high oil and other commodity prices. Growth in EMEs is also expected to decelerate on account of monetary tightening and rising commodity prices. Consumer confidence in major countries, which improved during January-February 2011, moderated in March 2011 on the back of higher oil prices.

• The Indian economy is estimated to have grown by 8.6 per cent during 2010-11. The index of industrial production (IIP), which grew by 10.4 per cent during the first half of 2010-11, moderated subsequently, bringing down the overall growth for April-February 2010-11 to 7.8 per cent. The main contributor to this decline was a deceleration in the capital goods sector. The growth is projected to be in the range of 7.4 per cent and 8.5 per cent in 2011-12 with 90 per cent probability

• According an RBI Survey (OBICUS), the order books of manufacturing companies grew by 7 per cent in October-December 2010 as against 9 per cent in the previous quarter indicating some moderation. The Reserve Bank’s forward looking Industrial Outlook Survey (IOS) shows a decline in the business expectations index for January-March 2011 after two quarters of increase. The services PMI for March 2011 showed some moderation as compared with the previous month.

The baseline projection for WPI inflation for March 2012 is placed at 6 per cent with an upward bias. Inflation is expected to remain at an elevated level (around 9 per cent in the first half of the year due to expected pass-through of increase in international petroleum product prices to domestic prices and continued pass-through of high input prices into manufactured products. Against this backdrop the Monetary Policy Measures announced are

• The repo rate under the liquidity adjustment facility (LAF) has been increased by 50 basis points. Accordingly, it goes up from 6.75 per cent to 7.25 per cent.
• As per the new operating procedure, the reverse repo rate under the LAF, determined with a 100 basis point spread below the repo rate, will stand adjusted at 6.25 per cent.
• The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, gets calibrated at 8.25 per cent.
• The Bank Rate remains at 6.0 per cent.
• The cash reserve ratio (CRR) remains unchanged at 6 per cent of NDTL of scheduled banks.

Savings Bank Deposit Interest Rate

• Pending a final decision on the policy of deregulating the savings bank deposit rate, it has been decided to increase the savings bank deposit interest rate from the present 3.5 per cent to 4.0 per cent with immediate effect.

Changes in operating procedures of Monetary Policy and several developmental and regulatory policies have also been announced. Detailed Highlights are presented in our monthly statistical bulletin EUpDates (contact for subscription: ecofin.surge@gmail.com)