Rupee fall and supply rigidities

Rupee fall and supply rigidities
India’s economic ills emerge too daunting, from the latest OECD Economic Outlook, with persisting high inflation, fiscal balance under challenge, external vulnerabilities from dependence on volatile debt-creating flows to finance current deficit adding to pressure on the rupee, and supply constraints restraining growth.

Nevertheless, OECD, with its low growth projections, based on market prices, of 3.4 per cent in current fiscal and rising to 5.1 and 5.7 per cent over the next two years, looks for a ‘gradual’ recovery in economic activity ‘as the rupee depreciation supports exports, infrastructure projects cleared by the Cabinet Committee come on stream and political uncertainty declines after the general election due in the spring of 2014’.

Welcome is accorded to the new monetary policy framework putting more weight on inflation as policy anchor. However, containing inflationary pressures, the OECD outlook points out, also require reducing fiscal deficit and dealing with supply constraints that limit growth. To reduce inflation, actual and expected, to acceptable levels, the repo rate has still to be raised but ‘care will be needed to avoid choking off economic recovery’. According to OECD, the economy had grown by 3 per cent (at market prices) in the first half (by 4.5 per cent when GDP is measured at factor cost). Good monsoon and burgeoning public consumption have failed to compensate for sluggish industrial production, investment and exports. However, rupee depreciation is putting pressure on inflation, public finances as well as on corporates and banks with high external debt exposures.

Emerging economies like India may have little comfort to fall back on global environment as OECD has projected a moderate and uneven global growth over the next two years with instability in financial markets lurking behind. The major responsibility is cast on advanced countries, USA, EURO, and Japan whose policy-makers must ensure that financial and other underlying fragility are not allowed to derail growth.

In advanced economies, a continuation of accommodative monetary policy has been urged by OECD which suggests US FED undertaking a gradual winding up of asset purchases in such a way as would limit the impact on vulnerable emerging market economies.   At the same time, it has warned against ‘brinkmanship’ (in Congress) over ending fiscal deadlock and against another threat like the one in October over debt ceiling due to be re-visited early in 2014, which would knock US and global recovery off course.

From the OECD-projected quarterly data over 2013-15, it would seem fair to assume that tapering of asset purchase could begin in the second quarter of 2014 when unemployment would likely be at 7 per cent. OECD Outlook suggests that as economic growth strengthens, Fed could start to raise the policy rates, in the course of 2015, ‘toward a more neutral stance’. (The Fed’s policy rate has remained at near zero rate since 2008). By early 2015, unemployment rate is also projected to fall to 6.5 per cent in line with Fed objective for policy rate easing. Overall, global economic resurgence is impaired by a ‘worrisome’ slowdown in world trade growth and in FDI flows and fixed investment as well as the stubbornly high unemployment, particularly in Europe.  Growth has begun picking up in China, OECD notes and has projected 7.7 per cent growth in 2013 and 8.2 per cent in 2014 and 7.5 per cent in 2015.
For India, both inflation and fiscal and current deficits as well as public debt to GDP ratio are higher in relation to other leading emerging nations. OECD estimates India’s WPI to rise by 6.1 and 6.6 per cent in 2013 and 2014 and CPI by 11.1 and 9.0 per cent respectively. CA deficit is put at minus 4.1 and minus.3.5 per cent of GDP for these two years while the fiscal deficit (central and state combined) is placed at -6.9 and -6.5 per cent respectively. But the fiscal road-map targets would not be met.

Persistently high inflation and low productivity has contributed to a loss of competitiveness, OECD notes. Though the rupee depreciation over summer has largely corrected past appreciation, along with rising oil and food prices, it adds to inflationary pressures. Fiscal balancing in the current year would be challenging and would need additional consolidation measures to avoid slippage.

Complying with the medium-term fiscal road-map would become difficult because of subsidy rise under the new food act to cover two-thirds of the population, a fiscally costly move. Tax revenues have suffered due to economic slowdown. Priority should now be given to cutting energy subsidies, better targeting of household transfers, implementing pending tax reforms and improving infrastructure and reforming labour market. OECD says India’s gradual recovery and growth over the next few years would be below rates by past standards. The expectation now is that the rupee depreciation combined with some increase in external demand could boost exports. Also, investment could recover as infrastructure building accelerates helped by the new land acquisition law to reduce business uncertainty. But recovery would be subdued with strong supply constraints and tighter domestic financial conditions limiting the pace of upturn.

On inflation, OECD says a likely moderation in domestic food price pressures, recent tightening of monetary policy and rising spare capacity could eventually ensure that inflation begins to moderate, provided the exchange rate does not depreciate much further. This is how Dr Raghuram Rajan, RBI Governor, expects disinflationary forces setting in hopefully to lower the current levels of high inflation.

For inclusive growth, OECD looks for an agenda which is more forward-looking than our planners envisaged. Apart from addressing structural bottlenecks, in particular gaps in energy, transport and water, and shortage of skills, it has urged tax reforms which would raise revenue, ‘less distortive for growth’ and also ‘redistribute more from the rich to the poor’. There is also a caveat for India in OECD’s survey of leading emerging economies, namely, that the rapidly expanding balance-sheets of banking and corporate sectors may trigger some deleveraging and put investment recovery at risk.

This, coupled with impact of depreciation of the rupee on oil and fertiliser subsidies, could make needed and planned fiscal consolidation more challenging.

S Sethuraman

S Sethuraman

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