Friday, November 12, 2010

Tiding over some Crisis Induced Weaknesses

Fiscal risks remain elevated in advanced economies where public debt ratios as percentage of GDP are still rising rapidly, the International Monetary Fund (IMF) said in its latest edition of the Fiscal Monitor. Market views on fiscal developments are being reflected in bond yields and spreads becoming more polarized; yields have declined in countries regarded as safe, or at least safer, havens, while they have increased (and spreads have widened) for a few countries that are considered to be more at risk. Developments in Europe also seem to have favored a portfolio reallocation toward emerging markets, particularly emerging Asia. EMEs are seeing historically low spreads, reflecting large capital inflows spurred by their relatively strong growth and fiscal positions and prospects. An analysis of the determinants of polarization of some specific type of spreads reveals that, although cross-country variation in spreads reflects country-specific fiscal fundamentals and other variables affecting solvency (growth prospects and banks balance sheet fragilities), global variables—such as risk aversion and global growth—have recently played an important role.

The Monitor, drawing on projections from the October 2010 World Economic Outlook (WEO), shows that: global fiscal deficit is projected to fall from 6.75 percent of GDP in 2009 to 6 percent this year, in line with earlier projections. Deficit declines are mostly due to improved economic conditions and to lower support to the financial sector. Further, in 2011, the global fiscal deficit will fall further, to about 5 percent of GDP. About 90 percent of countries are projected to record smaller deficits in 2011 (relative to 2010), with most of the deficit decline due to policy tightening. The advanced G-20 economies on average plan to improve their CAB by 1.25 percentage point annually during 2011–13, including through the unwinding of the 2009–10 stimulus. In the United States, the largest adjustment is expected to come in 2012. Fiscal consolidation plans of most economies are tilted toward expenditure cuts and spending cuts are more tilted toward the wage bill, size of civil service, and social transfers rather than public investment. On the revenue side, measures affecting direct taxation dominate, which may raise concerns for the impact on growth. Of the announced and already implemented revenue measures, personal income tax , corporate income tax, and social security contributions accounted for nearly half of all revenue measures, while increases in the value-added tax (VAT) (ranging from 1 to 4 percentage points in Europe) and excise taxes represent some additional revenue generating measures.


India faces a dilemma similar to some other emerging markets; on the one hand the return to fiscal sustainablility has led to cut back in government expenditures and stimuli once growth revived, on the other hand private sector demand is being pushed back through rate hikes in the fear of stoking inflation. The Reserve Bank of India recently increased both its policy rates by a quarter of a percentage point; the rate at which the central bank lends to banks was raised to 6.25%, and the rate at which it borrows from them was increased to 5.25%. The tightening was India’s sixth this year, mainly driven by the need to tame inflationary expectations. However, food price inflation the main cause for concern seems very unlikely to soften significantly as the spectre of inflation looms larger over global agricultural markets after the US slashed key crop forecasts and warned of shortfalls in grains, adding to problems raised by a massive drought in Russia; the UN’s Food and Agriculture Organisation noted the inevitable tightening of the overall food price situation as we go into 2011. On the other hand, successive rate hikes By RBI is now accompanied by a certain renewed sluggishness in industrial growth borne out by the vertiginous fall in IIP number to 5.6% (6.9 revised) in August and 4.4% in September predicted by the 18 month low September growth figures of 2.5% for the 6 infrastructure industries which account for over a quarter of IIP.

Despite being delinked with the global financial sector, the Indian banking sector has witnessed a relatively sluggish performance in the year 2009-10 with some emerging concerns with respect to asset quality and slow deposit growth. Bank deposits, which constituted around 78 per cent of the total liabilities of SCBs, registered a decelerated growth for the third consecutive year since 2007- 08. One of the factors responsible for a decline in the deposits growth in 2009-10 was the prevalence of low interest rates for a major part of the year. The other emerging concern was with respect to asset quality of banks. The gross Non-Performing Assets (NPAs) ratio showed an increase from 2.25 per cent in 2008-09 to 2.39 per cent in 2009-10. Moreover, there was an increase in the proportion of doubtful and loss assets in 2009-10. The increase in gross NPA ratio coupled with a decline in the (outstanding) provisions to gross NPA ratio in 2009-10 at the aggregate level, underlined the need for further strengthening of provisions by banks, though, notwithstanding the weakening asset quality, the Capital to Risk-Weighted Assets Ratio (CRAR) of Indian banks remained strong at 14.5 per cent, way above the regulatory minimum of 9 per cent after migration to the Basel II framework, providing banks with adequate cushion for emerging losses. In 2009-10, the profitability of Indian banks captured by the Return on Assets (RoA) was a notch lower at 1.05 per cent than 1.13 per cent during the previous year. Low levels of financial penetration and inclusion in the global comparison continued to be an area of concern for the Indian banking sector. However, data on sectoral deployment of gross bank credit does show significant improvement in credit flow to industry, services and personal loans during the current financial year, while credit to agriculture has declined further. Overall flow of resources from the financial sector to the commercial sector increased significantly in the first half of 2010-11 relative to the flows in the corresponding period of last year, though domestic non-bank sources of funds have declined.

Thus looking ahead, given the unstable global scenario, as the balancing act continues considerable volatility in all indicators of the Indian economy could be expected for some time to come. Track the global and Indian economy with our monthly statistical bulletin E-UpDates with monthly as well as daily data on the Indian and global economy for over 20 indicators.

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