Highlights of RBI’s Third Bi-monthly Monetary Policy Statement, 2016-17

Policy Measures

* Repo rate unchanged at 6.50 per cent, Reverse Repo at 6%, Bank rate and MSF rate at 7%

* Cash reserve ratio or CRR unchanged at 4%

*Continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL to a position closer to neutrality

Assessment

Since the second bi-monthly statement of June 2016, several developments have clouded the outlook for the global economy. Q2 growth has been slower than anticipated across AEs, with the Brexit vote increasing uncertainty. Among EMEs, activity remains varied. GDP growth stabilised in China in Q2. Recessionary conditions are gradually diminishing in Brazil and Russia, but the near-term outlook is still fragile. In India, monsoon related developments engender greater confidence about the near-term outlook for value added in agriculture. Barring the contraction in natural gas and crude oil on account of structural bottlenecks, the core sector has been resilient as of 2016-17 so far, and should support industrial activity going forward. There are some signs of green shoots in manufacturing too, with PMIs and the Reserve Bank’s industrial outlook survey indicating a pick-up in new orders, both domestic and external. High frequency indicators of service sector activity are still, however, emitting mixed signals, although a larger number of indicators are in acceleration mode in Q1 of 2016-17. Merchandise export growth moved into positive territory in June after eighteen months, with a reasonably widespread upturn. While lower crude oil prices continued to compress the POL import bill, non-oil non-gold imports continued to shrink. Successive downgrades of global growth projections by multilateral agencies and the continuing sluggishness in world trade points to further slackening of external demand going forward. The recent sharper-than-anticipated increase in food prices has pushed up the projected trajectory of inflation. CPI inflation rose to a 22-month high in June, with a sharp pick-up in momentum overwhelming favourable base effects. The rise was mainly driven by food, with vegetable and sugar inflation higher than the usual.

International financial markets did not anticipate the Brexit vote and equities plunged worldwide, currency volatility increased and investors herded into safe havens. Since then, however, equity markets have regained lost ground. Currencies, barring the pound sterling, have stabilized. While the pace of FDI inflows to India slowed in the first two months of 2016-17, net portfolio flows were stronger after the Brexit vote, notwithstanding considerable volatility characterising these flows. The level of foreign exchange reserves rose to US$365.7 billion by August 5, 2016.

Liquidity conditions eased significantly during June and July on the back of increased spending by the Government which more than offset the reduction in market liquidity because of higher-than-usual currency demand. The injection of durable liquidity through purchases under OMOs, amounting to Rs. 805 billion so far, also helped in easing liquidity conditions, bringing the system-level ex ante liquidity deficit to close to neutrality (without seasonal adjustment). Accordingly, the average daily liquidity operation switched from net injection of liquidity of Rs. 370 billion in June to net absorption of Rs. 141 billion in July and Rs. 405 billion in August (up to August 8). The Reserve Bank conducted variable rate repos and reverse repos of varying tenors in order to manage evolving liquidity conditions, with a more active use of reverse repos to manage the surplus liquidity. Reflecting the easy liquidity conditions, the weighted average call rate (WACR) and money market weighted average rate remained on average 15 basis points below the policy repo rate since June.

Policy Stance and Rationale

• A normal monsoon and the 7th Pay Commission award likely to boost growth
• Implementation of GST should raise returns to investment and thus business
  sentiment and eventually investment
• Impact of direct effect of house rent allowances under the 7th CPC’s award need to be watched
• Growth forecast retained at 7.6% for the current fiscal
• Inflation target kept unchanged at 5% by March 2017 with upward bias
• Easy liquidity conditions are already prompting banks to modestly transmit past policy rate cuts through their MCLRs
• Monetary policy to remain accommodative and will continue to emphasise the adequate provision of liquidity

The refinements to the liquidity management framework effected in April 2016 were intended to smooth the supply of durable liquidity over the year using asset purchases and sales as needed, and progressively lower the average ex ante liquidity deficit in the system to a position closer to neutrality. The Reserve Bank intends to continue with this strategy, with the intention of closing the underlying liquidity deficit over time so that the system moves to a position of structural balance. 

The Global Economy in the New Year: A Round Up

At the start the of the new year, the global economic and financial market conditions deteriorated drastically, and were dominated by a series of events such as a renewed fall in oil prices, fresh turmoil in China’s financial market, a looming European banking crisis, and policy variations by some of the world’s key monetary authorities. Some of these events, which could have boosted sentiments significantly, actually failed to do so. Cheaper energy and commodity prices, which enhance consumers’ disposable income and lower companies’ input costs, are hurting energy companies’ profits and now seen as a threat to lender banks.1 The International Monetary Fund (IMF) notes that though a decline in oil prices driven by higher oil supply should have supported global demand given a higher propensity to spend in oil importers relative to oil exporters, several factors have dampened the positive impact of lower oil prices.2 Given the lack of structured fiscal consolidation policies that are consistent with growth, private investment and consumption have stagnated in many parts of the globe. Risk perceptions have also changed with the gloomy growth prospects. The US Federal Reserve (Fed) decided to raise its key policy rate in mid-December, in what was considered to be a watershed moment for the global economic revival. However, the consequent intensification of capital flow reversal and rise in the US dollar is deepening problems of several emerging market economies (EMEs) that were already slowing at this juncture. On the other hand, the monetary authorities in Europe and recently in Japan have taken recourse to negative interest rates to avoid deflation. While the lack of monetary policy action at this juncture could further slow domestic demand, lower interest rates have begun to hurt global financial market sentiments. Banks in Europe are under pressure to clean up their balance sheets ridden with non-performing loans since the 2007-08 crisis, and policy induced negative interest rates are hurting banks’ profitability and asset quality, as demand has failed to pick up commensurately. Financial instability risks have again come to the fore with banking sector and emerging market vulnerabilities rising, and have led to sudden strong market reactions as seen by the declines in equity and bond prices worldwide at the start of 2016.

The global economic outlook has been made worse by productivity slowdown, policy gridlock, a widening geopolitical rift and increasing leverage in EMEs with tighter liquidity conditions. Downside risks have intensified again amid heightened uncertainty about EME growth prospects, further fallouts of China’s rebalancing, volatility in financial and commodity markets, and a rise in geopolitical tensions. Projections for global growth have been revised even lower in 2016.3 The severe financial market turbulence in the first six weeks of 2016, intensified by the fears about a sharper and prolonged slowdown in the world economy, has led to calls for changes in the policy environment from different quarters. Moody's Investors Service has warned that investors may start to price in the possibility of lower economic growth and returns, which could become partly self-fulfilling via negative wealth effects and tighter financing conditions. The impact on the global economy would be amplified if losses on trading portfolios and financial assets more generally led banks to tighten credit standards. The OECD points out that sole reliance on monetary policy has proven insufficient to boost demand and produce satisfactory growth, while fiscal policy is contractionary in several major economies and structural reform momentum has slowed. An increasing number of economic analysts are now calling for a stronger fiscal policy response, as a commitment to raising public investment would boost demand and help support future growth. The OECD has noted that with governments in many countries currently able to borrow for long periods at very low interest rates, there is room for fiscal expansion to strengthen demand in a manner consistent with fiscal sustainability.
1
The price of oil, which was trending lower in the last few months of 2015, dropped below US$30 a barrel in January; the markets are oversupplied at a time when demand is faltering because of the slowdown in key importers such as China, as well as exploration of alternate energy sources in some countries.
2
Fiscal strain in many oil exporters has reduced their ability to smooth the shock, leading to a sizable reduction in their domestic demand. The oil price decline has had a notable impact on investment and employment in oil and gas extraction, also subtracting from global aggregate demand. Finally, the pickup in consumption in oil importers has so far been somewhat weaker than evidenced from past episodes of oil price declines. The impact of the fall in commodity prices has not only hit oil producers in emerging economies but also US shale producers, with firms borrowing heavily from both banks and markets against oil reserves and projected revenue.
3
The IMF in January had already lowered its earlier projections for 2016, for global and US growth by 0.2 per cent to 3.4 and 2.6 per cent, respectively, for emerging Asia by 0.1 per cent to 6.3 per cent, and for Latin America by 1.1 per cent to -0.3 per cent as Brazil’s outlook was lowered by a sharp 2.5 per cent to -3.5 per cent. The IMF forecasts the Russian economy will shrink 1 per cent this year, after contracting 3.7 per cent in 2015. The Organisation for Economic Co-operation and Development (OECD) has in February lowered forecasts for 2016 global growth further, as well as for individual economies, with the largest impacts expected in the US, the euro area and major economies reliant on commodity exports, like Brazil. Growth in the US is expected to decelerate to 2 per cent in 2016 from 2.5 per cent last year, with the dollar’s strength weighing on exports and manufacturing activity and lower oil prices curtailing investment in mining and related industries. The euro area is projected to grow at 1.4 per cent, with German growth at 1.3 per cent, both lower than 1.5 per cent in 2015. While China is expected to continue to grow at 6.5 per cent, India is expected record a robust grow of 7.4 per cent. Brazil’s economy, which is experiencing a deep recession, is expected to shrink by 4 per cent this year.

Union Budget 2016-17: Striking the Right Chords

The government’s Union Budget for the fiscal 2016-17 has a number of announcements, which could, if implemented effectively, augment the real and financial sectors of the economy. Stability has been maintained in tax rates and structures, with some benefits to smaller individual and corporate tax payers, and an orientation towards domestic manufacturing, as well as rationalisation and simplification. The budget with a much needed emphasis on the agricultural and social sectors is a step forward in addressing some of the supply-side issues in agriculture and in skilled manpower,1 at the same time this would also help in demand generation from the rural sector and weaker sections of the economy. A consolidated set of proposals for the housing sector should help the sector clear some inventory and augment demand for downstream sectors. The infrastructure sector not only has a high allocation but also high priority accorded to public-private partnerships, including introduction of a bill for dispute resolution, renegotiation of concession agreements, and a new credit rating system which gives emphasis to various in-built credit enhancement structures aimed at alleviating problems of mispriced loans. Financial sector reforms proposed earlier have been taken forward in the budget and are mostly aimed at broadening the product and investor base, as well as providing transparency, dispute resolution and exit routes. The scope of foreign investment has been further broadened,2 while retail participation in government securities market, deepening of the corporate debt market and introducing more products in the commodity derivatives market has been envisaged. A specialised resolution mechanism to deal with bankruptcy situations in banks, insurance companies and financial sector entities has been proposed. Various steps announced for stressed assets and strengthening asset reconstruction companies (ARCs), which includes permissions for 100 per cent FDI and sponsor ownership on ARCs, would also help to unclog investment bottlenecks. The fiscal deficit target is being adhered to; this lends credibility to country’s fiscal consolidation efforts and improves the prospects for better sovereign ratings. This would help capital flows and the depreciating currency, and also allow for more expansionary monetary policy to counter sluggishness in private sector demand. [More...] [For a Summary of Measures see Sample issue of EUpDates below...]

1

This includes proposals for irrigation, electrification, e-marketing of produce along with amendments to the Agricultural Produce Market Committee (APMC) Acts, agricultural credit and interest subvention, crop insurance, increased warehousing facilities amongst others. There are also measures for affordable healthcare and health insurance, skill, education and entrepreneurship development and job creation.

2

FDI to be allowed in insurance and pension sectors up to 49 per cent under the automatic route, 100 per cent in ARCs under the automatic route and 100 per cent through the FIPB route in marketing of food products produced and manufactured in India. FPIs are allowed to invest up to 100 per cent of each tranche in securities receipts issued by ARCs subject to sectoral caps. Investment limit for foreign entities on Indian stock exchanges is to be enhanced from 5 to 15 per cent on par with domestic institutions. Limit for investment by FPIs in central public sector enterprises (other than banks) listed in stock exchanges to be increased to 49 per cent from 24 per cent. Basket of eligible FDI instruments is to be expanded to include hybrid instruments subject to certain conditions.

A Responsible Budget within a Restricted Space albeit some Worries on the Expenditure-Revenue Math

The Indian Union Budget for fiscal year 2013-14 has been termed as a responsible budget under difficult circumstances, but a disappointment to those who were expecting extraordinary measures to jump-start the economy. Fiscal deficit in the current financial year has been contained to 5.2 per cent of GDP; this averts any immediate crisis in terms of a sovereign rating downgrade, but has led to a decade low quarterly GDP of 4.5% in the final quarter of 2012, with plan expenditure meant for developmental projects slashed by over rupees 90 thousand crore. With very little room for fiscal stimulus, the Budget has concentrated on infrastructure development and inclusive growth, the most demanding issues at present. Pressing issues like stimulating domestic savings and channeling those to the capital market have also been addressed within the Budget. Some tax responsibility has also been shifted to those who are better equipped to pay.

The Budget included several measures to spur investment both in markets and by corporations, including an incentive on investments in plant and machinery exceeding Rs.100 crore and extending tax breaks for small companies that grow larger, and an expansion of tax-free bonds for infrastructure and broadening of the scope of the newly introduced RGESS. Emphasis was given to foreign investment, with investor registration norms also being simplified.

However, while there is no opacity in the figures, all agree that the revenue projections are overstated in some areas; slippages are expected in tax revenues and the disinvestment target that hinges on stock market sentiment. Non-plan expenditure could also overshoot the target on account of subsidies and any disruption in oil prices.

Following are some highlights of the Budget:

The Budget estimates *Fiscal deficit at 5.2% of GDP in current FY and at 4.8% of GDP in 2013-14 *Net market borrowing at 4.84 trillion rupees in 2013-14 *Major subsidies bill at Rs.2.48 trillion (up from Rs.1.82 trillion) *Petroleum subsidy at Rs.650 billion 2013-14 as against revised Rs.968.8 billion for 2012-13 *Food subsidies at Rs.900 billion against revised Rs.850 billion in 2012-13 *Total budget expenditure at Rs.16.65 trillion, with Plan expenditure pegged at Rs.5.55 trillion *Direct tax proposals to yield Rs.133 billion, indirect tax proposal Rs.47 billion.

The Budget allocates *Rs.2.03 trillion, including Rs.867.4 billion capital expenditure to Defence in 2013-14 *Rs.801.9 billion to rural development *Rs.270.5 billion for agriculture *Rs.140 billion capital infusion in state-run banks in 2013-14 *Rs 100 billion for incremental cost for National Food Security Bill over and above food subsidy

The Budget proposes *No revision of personal income tax slabs; relief in first bracket through tax credit of Rs.2000 for earnings up to Rs.0.5 million to benefit 1.8 crore people *Home loans upto Rs.2.5 million to be allowed an additional deduction of Rs 1 lakh. *Surcharge of 10% on income exceeding Rs.10 million a year; only 42,800 people have declared such income *No change in basic customs duty rate of 10% and service tax rate of 12% *Surcharge of 5% to 10% on domestic companies whose taxable income exceeds Rs.100 million *Capital allowance of 15% to companies on investments of more than Rs.1 billion *STT on equity futures to be reduced to 0.01% from 0.017 % *CTT on non-agriculture futures contracts to be introduced at 0.01% * Zero customs duty for electrical plants and machinery *TDS at the rate of 1% on the value of the transfer of immovable properties where consideration exceeds Rs.5 million; agricultural land to be exempted *a 20% final withholding tax on profits distributed by unlisted companies to shareholders through buyback of shares *to raise import duty on certain luxury items (cars) and certain other items to boost domestic manufacturing *to issue inflation-indexed bonds *to move to revenue-sharing from profit-sharing policy in oil and gas sector *to allow FIIs to use investments in corporate, government bonds as collateral to meet margin requirements *to allow insurance, provident funds to trade directly in debt segments of stock exchanges *to allow FIIs to hedge forex exposure through exchange-traded derivatives *to treat foreign investors with stake of 10% or less as FIIs; any stake more than 10% will be treated as FDI *to make mutual fund equity schemes eligible for RGESS.

Get detailed highlights with our March-2013 issue of E-Updates.

RBI takes pro-growth measures on decelerating growth as inflation expectations moderate

The RBI, which had clearly indicated an interest rate reduction at the start of 2013, took growth enhancing measures after a period of 9 months in its third quarter review of monetary policy stating that it is now critical to arrest the loss of growth momentum. The policy repo rate and the Cash Reserve Ratio (CRR) have each been reduced by 0.25 percentage points to 7.75 per cent and 4 per cent respectively; the latter will inject approximately Rs.180 billion into the banking system. These measures ease borrowing costs and are expected to prompt banks to lower their lending interest rates, a transmission process which has already been started by some banks led by SBI, India’s largest lender.  The challenge is now on banks to manage their deposit and lending rates in a manner that stimulates lending as without affecting their net interest margins.

RBI’s supportive monetary policy was constrained due to the preponderance of non-monetary factors behind the current slowdown along with risks emanating from high inflation, and the widening current account and fiscal deficits. The central bank’s step at this juncture is justified by a number of economic data, which has also prompted the central bank to lower the growth forecast to 5.5 per cent and the inflation forecast to 6.8 per cent for end-March. GDP growth in the first half (H1) of 2012-13 was 5.4 per cent compared with growth of 7.3 per cent in H1 of 2011-12. The manufacturing sector witnessed sharp moderation in growth to just 1 per cent during April- November 2012. Capital goods industries such as machinery and equipment, electrical machinery and computing machinery registered a sharp contraction in output of over 11 per cent during the same period. Industrial growth is expected to stay below its trend due to supply and infrastructure bottlenecks and slack in external demand. With investment activity remaining subdued, the prospects of a quick recovery in industrial growth appear weak. Real fixed investment too has been trending down and could lead to irreparable damage if not arrested in time. The prolonged slowdown in industrial activity is reflected in the services sector growth too. Growth in GDP at market prices decelerated sharply to 2.8 per cent in Q2 of 2012-13 from 6.9 per cent in the corresponding period of 2011-12, the lowest in the previous 13 quarters, primarily reflecting net exports and most importantly weakening private consumption demand, while government consumption is expected to moderate in coming quarters due to fiscal consolidation efforts. On the other hand, the most important factor, so far restraining any interest rate cuts by the RBI, which is headline inflation measured by the WPI index has been moderating recently. 

Even as the timing for this rate cut is right as the external environment is slightly less hostile compared to the first half of 2012, with China and some other emerging economies and the US showing strong growth, while Euro area financial markets look more robust, RBI’s guidance for its future stance on interest rate easing understandably depends on a number of factors. These include global economic risks, such as progress on the fiscal front for the US and the Euro zone and the growth fallout of fiscal austerity, as well as domestic problems such as the containment of the widening CAD and the high fiscal deficit. Future policy will therefore be conditioned by the evolving growth-inflation dynamic and the management of risks from twin deficits.

Get the detailed highlights with the February 9 issue of E-UpDates—Ecofin’s monthly statistical bulletin. 

Indian government unveils policy basket to counter staggering growth and downgrade risks

India’s slowing growth turned from a threat to reality with India recording the worst first quarter growth in a decade, with no significant improvement in available second quarter numbers for industrial output. Growth forecasts have thus been lowered by every agency making such projections; the lowest being that by IMF at below 5% for the year 2012. Even as threats of rating downgrades were dismissed by some as of no consequence, the fact remains that our financial markets are driven by FII sentiments and many of these entities are barred from investing in junk rated countries. The Indian government has now responded with a basket of measures which not only boosts market sentiment, but if implemented could go a long way in boosting longer term capital inflows and tackling domestic issues such as supply-constraint driven inflation and the clearing of infrastructure bottlenecks.  In a string of bold initiatives to revive economic growth, the central government, first announced Rs 5 per litre increase in the regulated diesel prices and a cap on subsided cooking gas usage. It later withdrew customs and excise duties on non-subsidised LPG cylinders, a move that will help bring their prices down. The government followed up these measures with a liberalisation of foreign holding caps in the aviation, multi-brand retail, non-news broadcast media and power exchanges. Multinational retailers can invest up to 51% to open stores in states and UTs which agree to implement the decision. Minimum amount to be brought in by the foreign investor would be USD 100 million and outlets may be set up only in cities with a population of more than 10 lakh. At least 50% of FDI should be invested in 'back-end infrastructure' within three years of the first tranche. FDI in multi-brand retail, once strongly in motion, is expected to bring about significant improvements in agricultural warehousing and supply-chains.

The government also announced a plan to divest its stake in five companies. The rate of withholding tax on overseas borrowings has been reduced to 5% from 20%. The lower rate will be applicable for overseas borrowings made after July 1, 2012 and before July 1, 2015. Borrowings under a loan agreement or by way of issue of long-term infrastructure bonds that comply with External Commercial Borrowings regulations as administered by the RBI would be eligible for benefits of the concessional tax regime. The RGESS an initiative intended to support first-time equity investors not only expects to promote a ‘equity culture’ in India and discourage investments in gold, but also aims to revive the mutual fund industry, which has now been included in the scheme along with exchange traded funds.

The government set in motion a second wave of reforms, approving proposals allowing foreign investors to own up to 49% in insurance firms and pension funds. Signaling the government's intent to continue with reforms to boost economic growth and investor sentiment, the Cabinet cleared all amendments to the insurance bill. The cabinet also cleared the Pensions Bill and allowed FDI in Pension Funds. It also took the cap in the pension sector to 49 per cent following the insurance sector. The proposed changes to both the bills will now have to be cleared by both houses of the Parliament before they can come into effect. Till now, 26 per cent FDI was allowed in the insurance sector while the pensions business was closed to foreign investment. Looking to better serve the interests of all stakeholders, the government approved amendments to Companies Bill 2011, including changes related to spending on CSR activities. The proposed legislation will bring the law on the subject of corporate functioning and regulation in tune with the global best practices so that there is further improvement in corporate governance in the country through enhanced accountability and transparency. A provision has been introduced to make expenditure on Corporate Social Responsibility (CSR) mandatory. Giving a reform boost to commodity markets, the government approved the FCRA Bill that seeks to provide more powers to the regulator Forward Markets Commission (FMC) and allow a new category of products and to facilitate entry of institutional investors.

A segment within the government has been leaning towards cash transfers to poor households as the way out to deal with an unwieldy subsidy bill estimated at Rs 2.5 trillion (on three major subsidies—food, fuel and fertilizer). The government is set to step up its push for cash transfer of subsidies with two pilot projects validating the assumption that it would lead to significant savings for the government while enhancing benefits for users.

Get regular updates on Growth, Inflation and other Indian & Global Macro-Financial indicators/data with E-UpDates—A Monthly Statistical Bulletin by Ecofin-Surge.

Challenges for India’s policymakers on the rise as India records worst 1st quarter growth in a decade and key debt and deficit indicators rise

Robust growth by construction, real estate and financial business services, which together account for 27% of the GDP, along with a 2.9% growth in agriculture took India’s Q1 2012-13 growth to 5.5%, even as the manufacturing sector slowed to a near-zero (0.2%) growth. All three critical drivers of growth, namely, private consumption, investment and exports continued to slow. The decline in the growth of fixed investment to 0.7% in Q1 of 2012-13 as against 14.7% in Q1 of 2011-12 is the major source of concern, as it indicates further deceleration in growth going forward. While the high rate of growth (10.9%) of construction is on a low base (3.5% in Q1 last fiscal), the 'financing, insurance, real estate and business services' sectors together grew 10.8%, even on a high base of 9.4%. The 'trade, hotels, transport and communications' sectors witnessed just 4% growth, owing partly to a high base effect (13.8% in Q1 of the last fiscal). Overall, services output slowed sharply to 6.9% in Q1 from 7.9% in the previous quarter, reflecting the lagged adverse effects of the industrial slowdown on the services sector. A survey by the central bank has shown that estimated total fixed investment by large firms in new projects which were sanctioned financial assistance nearly halved during 2011-12 indicating further slowdown in economic activity and job creation.

Slowing growth is taking its toll on revenues while government was unable to rein in its expenditure: fiscal deficit during April-July reached Rs 2.64 billion or 51% of the budgeted estimate of Rs.5.1 billion, raising fears of the government breaching its fiscal deficit target of 5.1% of GDP for the current fiscal. Government's total receipts in the first four months of the fiscal was at Rs. 1.73 billion, just 17.7% of the budgeted amount, while its expenditure climbed to Rs. 4.37 billion, or 29.3% of the budgeted amount. With increasing recourse to debt flows and drawdown of reserves to finance the CAD, various external sector vulnerability indicators showed considerable deterioration during 2011-12. The central bank’s report on India’s external debt showed that reserve cover of imports, the ratio of short-term debt to total external debt, the ratio of foreign exchange reserves to total debt, and the debt service ratio deteriorated during the financial year. On the positive side the share of government (external) debt has gone down and the country remains in a comfortable position with regard to short term debt and the debt service ratio relative to other indebted countries.  

Get regular updates on Growth, Inflation and other Indian & Global Macro-Financial indicators/data with E-UpDates—A Monthly Statistical Bulletin by Ecofin-Surge.

What has changed Between Then and Now*?

Since 2011, we are faced with a situation where most analysts have come to agree that Europe needs fiscal integration with a fiscal authority and banking integration, a banking union with eurobonds, a banking supervisor and a European guaranteed deposit fund. Most agree even more that European deposit insurance and debt mutualisation are not optional; they are essential to avoid an irreversible disintegration of Europe’s monetary union as the ERF is a temporary programme that does not lead to permanent euro zone bonds. The main problem remains that any proposal acceptable to Germany could imply a significant loss of sovereignty over fiscal policy for the periphery, particularly Italy and Spain. On the other hand, German concerns about the moral hazard of risking German taxpayers’ money will indeed be hard to justify if meaningful reforms do not materialise in the periphery. But such reforms do take time and the human costs being inflicted in the process are turning out to be more than significant.

Coming Home, the headline figures for economic growth in India have been revised downwards; despite putting in place policy measures that have choked domestic demand and hence growth, prices continue to rise; government spending continues to grow faster than tax revenues, private and foreign investment have slowed down and the rupee has been devalued sharply by market forces, with the rupee hitting an all-time low against the dollar in late-May. Every discussion on the Indian economy centres around the need for filling chronic gaps in areas like infrastructure, skilled labour and productive farming, or on the inefficiency of the system of subsidies. Yet the government remains undecided on crucial issues like removing certain barriers to investment that could put growth back on track, while the central bank is circumstantially forced to remain hawkish in stance even though the latest numbers on growth and inflation increasingly have a stagflationary ring. Yes even in India there is a human cost involved in achieving a 6% vs a 9% growth, which may go un-noticed as the notional loss of being able to change the lives of several waiting to be pulled out of poverty and unemployment.

Missing is the swift and almost unanimous decisions taken by policy makers/implementers through the globe and missing is the flurry of actions taken to stem the Meltdown of 2008. As Time Slips By policy implementers are bent on Defying Gravity and say they are In Control and keep waiting for the Panic Attack. We are left to be Saved By A Miracle, wondering what has changed Between Then and Now? While they found institutions too big to fail they are not so unwilling to fail the very people for whom the institutions supposedly are set up. When would the time be right to come out of the moralistic view on the burden of future generations and look to the sufferings of the present one? If I Could I would be a Time Traveller to Check It Out if ignoring the Echoes and Shadows of Yesterday did we walk Into The Sunset or did we win our Race With Destiny.

(* a la Vinnie Moore)

Get regular updates on Growth, Inflation and other Indian & Global Macro-Financial indicators/data with E-UpDates—A Monthly Statistical Bulletin by Ecofin-Surge.

RBI Makes a Move—Will the Government Reposition?

Surprising analysts and the market alike, the RBI reduced its key policy rate, the repo rate under the LAF, by a higher than expected 50 basis points to 8%. If the Government in turn can make a quick move to push forward important reforms measures, together it can provide tremendous boost to India’s wilting economy hurt by weak global growth. RBI’s decision could have been guided by the fact that India's industrial output not only rose a much slower-than expected 4.1% in February, the January figure was sharply revised downwards to a growth of 1.14% from 6.8% announced earlier.

CRR has been left unchanged at 4.75% against expectation of a reduction, instead liquidity cushion has been provided by raising the borrowing limit of banks under the marginal standing facility (MSF) from 1% to 2% of their NDTL outstanding; the MSF rate, determined with a spread of 100 basis points above the repo rate, stands at 9%. Liquidity in the system has improved since end-March with daily average borrowings by banks under the LAF averaging less than rupees one trillion in April as compared with Rs1.9 trillion in end-March.  Interest rates on short-term monetary market instruments such as commercial papers and certificates of deposits as well as 91-day treasury bills have come down in April, but the stiff long-term rates signal that the outlook on interest rates is not benign and market participants are betting on a rise in rates. Banks have already started passing on the reduced rates to their borrowers, while some banks with strong deposit bases have also reduced the rates offered on deposits. RBI’s stance however, remains hawkish; in terms of bias or guidance, the RBI has clearly indicated that headroom for further rate reduction remains limited given the upside risks to inflation in the near-to-medium term. In this situation it is now clearly the Government’s turn to show some progress in its multi-pronged reforms agenda put forward in the Union Budget, before the positive effects of the central bank’s rate cut wear off.    

The highlights of the RBI’s Annual Monetary Policy for 2012-13 will be presented in the May 2012 issue of E-UpDates, Ecofin’s Monthly Statistical Bulletin.

Some Facets of India’s Union Budget for 2012-13

The budget mostly promised to reduce the nation’s fiscal deficit and rein in costly subsidies and bring in critical reforms, but for the moment given the political situation garnering the necessary revenue has been done through increases in indirect taxation. Though allocation to critical sectors has been increased there is no immediate focus on putting the economy on a high growth trajectory.

Some Measures and Effects: Tax burden for individuals to come down slightly; income tax exemption limit has been raised. Small savers to benefit from exemptions for investments in equity and bank fixed deposits up to a limit. Inflationary in the short-run; no change in corporate tax rate, but standard rate of excise duty, as also service tax rates, raised from 10 per cent to 12 %. Capital markets get a boost; securities transaction tax (STT) on cash delivery reduced by 25 % to 0.1 %. A new equity saving scheme to allow income tax deduction to small retail investors in stocks. Corporate debt market has been opened up for qualified foreign investors (QFIIs). Provision for re-capitalising public sector banks and FIs. To tackle slowdown and supply-side bottlenecks; additional capital has been provisioned to boost agriculture, agricultural research, fertilizer industry, irrigation, infrastructure and energy. External commercial borrowing has been allowed in sectors like airlines, power projects and low-cost housing. Tax relief for stressed sectors; agriculture, infrastructure, mining, railways, roads, civil aviation, manufacturing, health and nutrition, and environment have been provided with duty relief. Social sector is a focal point; higher allocation for education, health and financial inclusion. Several legislative reforms have also been proposed in the budget. The cut down in oil subsidy bill shows intentions of increased oil-price pass-throughs.

Some Budget Numbers: Total expenditure in 2012-13 seen to be up by 29 %. Gross Tax Receipts estimated at 15.6 per cent higher than original budget estimates and 19.5 per cent over the revised estimates for 2011-12. Fiscal deficit targeted at 5.1 per cent of GDP in 2012-13, to be reduced from 5.9 per cent in 2011-12. Aim to keep subsidies under 2 % of GDP in 2012-13. Central Government debt is at 45.5 per cent of GDP.

Some Hidden Numbers: Revenue foregone on custom duties constitute over 40% of total revenue foregone on account of exemptions and special rates; the items which account for the major amount of customs duty foregone are Gold & Diamonds (mainly for export promotion) followed by Crude & Mineral Oils, which together with Fertilisers make up of almost 25% of customs duty foregone. Revenues foregone for customs and excise duties are nearly 150% of revenue collections on those accounts. With corporate tax rate held at 30%, effective tax rates for corporates have risen from around 20% in 2006-07 to 24.1% in 2010-11, due to phasing out of exemptions.