A hard day’s fight in store for UPA

Just as United Progressive Alliance- II (UPA) wakes up to economic realities and gropes for some solid actions to restore a sense of confidence, both of investors and the public at large, the Congress-led government remains challenged by growing political tensions and worsening domestic and global growth outlook. The immediate focus for the party leadership is on consensus-building for the presidential election subordinating any bolder moves for the economy.

Over the last year and a half, India’s image abroad has taken a beating undergoing a thorough reversal from a vibrant economy to one of being the poorest performers, notably among BRICS, with its unabated inflation, fiscal and current imbalances, rupee spiralling down and loss of foreign investor faith.

It is not so much the growth decline to between six and 6.5 per cent – no matter the pep talk by finance minister Pranab Mukherjee – as the extent of deterioration in the economic fundamentals that are troubling for the short and medium-term prospects. The uncertainty from monsoon, on which India critically depends for agricultural sustenance, is also adding to current worries.

India’s international rating has taken a series of hits with growth projections drawn down by International Monetary Fund (IMF), Organisation for Economic Co-operation and Development (OECD) and the United Nations (UN) to the 6-7 per cent range, which again are subject to institutional reforms, credible inflation management, less volatile oil prices, and resolving supply constraints for the economy. Global rating agencies have given harsh judgements including a second warning from S&P of risk of India losing investment grade if slowdown is not reversed and 'political roadblocks' for economic liberalisation are not lifted.

The retroactive tax and other 'controversial' provisions that Mukherjee unfolded in his March budget seem to have added fuel to the fire, as international investors look at it. It is now cited as one of the major negative factors holding back private capital flows, which in any case have become volatile in the prevailing global environment, especially with the deepening of the Eurozone debt crisis. The scars are visible in the recurrence of strains in India’s external sector from the latter half of fiscal 2012.

No wonder that the big guns in the finance ministry are pressuring the RBI to slash the policy lending rate suitably to trigger the growth engine, even if there is implicit confession of their own inability to do much on the fiscal side or on the reform agenda at present. Reserve Bank of India (RBI) monetary policy has not been faulted by international institutions which consider India’s real interest rates still low.

RBI will certainly look at the industrial and price data being released this week to make an appropriate response to the needs of the situation – on the liquidity side or key lending rates by readjusting Cash Reserve Ratio (CRR) and repo rates as may be justified – besides providing its insights on the economy and the exchange rate in its mid-quarter review on 18 June.

Latest to join the international chorus is the Washington-based Institute of International Finance (IIF), which keeps track of private capital flows to emerging economies and has attributed slackening of investment flows to India to a mixture of factors, such as 'controversial' tax measures, 'fractitious' politics which stymied reforms, and a large current deficit besides global turmoil.

IIF, representing global banking firms, says net private capital flows – market-based and banking related flows – to emerging market economies remain quite volatile with mood swings and are set to further moderate in 2012 and 2013. This moderation, it points out, is not solely due to risk factors from mature economies but also emerging market-specific factors (India specifically mentioned) which have dampened flows. From above one trillion dollars last year, private capital flows (net) are now projected at 921 billion dollars in 2012 and again below one trillion dollars in 2013.

Traditionally, emerging Asia, particularly China, has attracted bulk of private flows including direct investment. The region’s share in total private capital flows to emerging markets is set to edge down from 52 per cent in 2011 to 44.5 per cent in 2013. It would reflect a Foreign direct investment-led moderation in China, whose currency appreciation may also be dampening speculative capital inflows. The real appreciated value of RMB is making China less attractive to foreign direct investors, IIF notes.

Flows to India moderated amid 'concerns' over government policies and being the only country in emerging Asia with current account deficit likely to have jumped to a record $72 billion, 3.9 per cent of GDP, in fiscal 2012. At the same time private capital inflows fell from 81 billion in fiscal 2011 to 72 billion dollars because of global turmoil as well as 'an expanding list of negative domestic factors'.

(According to RBI data for 2011-12 just released, FDI including acquisition of shares and reinvested earnings amounted to 46.84 billion, an increase of 12 billion over fiscal 2011 but foreign portfolio investments declined to 17.41 billion from 31.47 billion in the previous year. The total foreign investment flows at 64.25 billion in fiscal 2012 was thus short by two billion over the previous year).

The slippage in private capital inflows (excluding FDI and FIIs) in 2011-12 was 21 billion, according to IIF, under both foreign portfolio equity inflows and net new credits from foreign banks. However, the raising of limits on foreign holdings of domestic bonds along with higher interest rates on NRI deposits boosted inflows by two billion.

As per latest RBI data, NRI deposits outstanding at end of March 2012 stood at over 58 billion, an increase of seven billion over March 2011, while in April (fiscal 2013) the inflows was over three billion dollars as against 407 million in April 2011, apparently from enhanced rates to mobilise non-resident flows. But all this has not eased BOP strains and the rupee was still under downward pressure by mid-June with over 12 per cent depreciation in a period of some six months. With RBI interventions to prevent excessive volatility of the rupee, the reserves had also come down by nine billion dollars to 285.85 billion by 1 June.

Notwithstanding a likely return of global risk aversion to impact India further with its current deficit, rupee slump, and 'policy missteps' in mid-March budget, especially unwelcome tax measures for foreign investment, IIF assumes the current deficit to moderate from the second half of 2012-13, given the recent fall in elevated global oil prices and the imposition of a four per cent tariff on gold imports. CA deficit could progressively decline to $64 billion in 2012-13 and $54 billion next fiscal at 2.3 per cent of gross domestic product.

IIF’s base case scenario points to private capital inflows to India stabilising at around $72 billion this fiscal year and next. Net inflows of FDI may slip to $26 billion in 2012-13 due to the tax controversy but may revive to $30 billion in 2013-14 if some concerns dissipate with more positive steps by government. In addition, portfolio flows should stabilise at around $13-16 billion this fiscal and next. Along with moderate foreign bank lending and NRI deposits, BOP could become positive by $6.5 billion this fiscal and $19 billion in 2013-14. Till durable improvement in CA position, the country would remain vulnerable to recurring bouts of global financial turmoil and unpredictable changes in investor sentiment over the near term, according to IIF.
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