While inflation has been picking up in India, even causing a significant stock market correction over consumer price worries, government leaders are unlikely to take strong off-setting monetary measures in the short term. Instead, they appear to be adopting a watchful stance while taking relatively modest steps to ease inflationary distress. The steps include some changes in bank rules, relieving pressure on some politically sensitive food prices and divesting of some public sector undertakings, which could cut the spending deficit by up to 2% of GDP.
Like many countries that have relied on monetary and fiscal relief policies to ride out the financial crisis, India knows it will one day have to wind down its stimulus measures or face a steep inflationary spiral that could derail economic growth longer term. Because the country suffered less than most economies during the global downturn, it looks to be recovering quickly, and decisions regarding a stimulus exit strategy have become all the more critical. The governor of the Reserve Bank of India (RBI), D. Subbarao, now predicts that inflation will be 6.5% at the end of March 2010 — more than the policy comfort zone of 4% to 5%. Others think it could go to 8%.
The challenge for the RBI now is to avoid withdrawing spending and interest rate support too soon — before the economy is running on its own steam — or keeping it going too long, which could cause inflation to soar. In India, as in many economies, timing is everything. As the International Monetary Fund noted recently in regard to Asia generally, policymakers must “continue to provide support to economies until it is clear that the recovery is self-sustaining” — and at the same time, ensure that policies are not “maintained for so long that they ignite inflation pressures or concerns about fiscal sustainability.” The task has shifted from “managing the crisis to managing the recovery…,” Subbarao said. “The time has come to start thinking of an exit strategy” from an expansionary monetary stance.
For most industrialized countries, the immediate worry is more about deflation than inflation, though many analysts expect that to change in the medium term. At the moment, inflation is the bigger worry in India, however. Abheek Barua, chief economist at HDFC Bank, says the fact that the RBI has revised its projection for inflation to 6.5% — “with an upside bias” — by March 2010 from its earlier projection of 5% sends a strong enough signal that it is concerned about inflation. It admits that its “current monetary stance is not the steady state and [it needs] to reverse the expansionary stance. However, the fact that the RBI also introduces a rather detailed discussion on the factors in favor and against exit at the stage seems to suggest that it is not keen on a quick exit. We predict a hike in the policy rates by 25 basis points [100 basis point equals 1 percentage point] in the January 2010 credit policy meet.”
Comments by leading officials have been contradictory when it comes to inflation, making it difficult to get a good read on intentions. It does not seem that government leaders will take any strong steps to curb inflation immediately. More generally, officials appear to be adopting a watchful stance, while adopting some modest measures to lower inflationary fears.
Among those measures, the RBI increased the statutory liquidity ratio (SLR) — the amount a bank needs to keep in cash or liquid instruments — from 24% to 25%. This was in effect going back to the pre-stimulus regime. “This, however, is just a signal,” says one banker. “It won’t have any impact on the system as banks already have SLRs of more than 25%. Banks are sitting on cash and are being very choosy about who they lend to.” Adds Barua, “For those concerned about inflation, the SLR increase has a monetary policy dimension as well — it sterilizes some of the excess liquidity in the banking system. A 1% increase in SLR translates roughly into Rs. 40,000 crore. However since many banks already hold SLR securities in excess of the stipulated norm, the exact impact on liquidity is a little difficult to gauge.”
The RBI also withdrew some other “unconventional refinance facilities” for exporters, non-banking finance companies and housing finance companies that had been introduced as part of the stimulus. “The RBI increased provisioning for commercial real estate from 0.4% to 1% and raised the total provisioning coverage ratio, including floating provisions, to at least 70%,” says Nandan Chakraborty, head of research at Enam Securities. The latter, in particular, “was a big negative surprise for some banks that have a lower provisioning, as they have to provide for the remainder by September 2010.”
The stock markets read into these measures a coming end to the stimulus package and plunged. A tight money policy is not conducive for growth, and the RBI seemed to be sending signals that interest rates would be hiked in the next few months. On the day of the policy announcement, the Bombay Stock Exchange Sensitive Index (Sensex) fell 387 points or 2%, the main losers being the State Bank of India and ICICI Bank. Finance Minister Pranab Mukherjee had to step in to assure jittery operators and investors that there would be no premature withdrawal of the stimulus.
Since then, the signals have been more mixed, and the RBI has been indicating that nothing will be done in a hurry. At an India-China Financial Conference in Mumbai on November 11, RBI deputy governor Shyamala Gopinath said exit from an easy monetary policy must keep inflationary expectations well-anchored. “India is actively confronted by an upturn in inflation,” she told the assembled bankers. The country will have to take its own path. “A withdrawal from the supportive monetary policy may diverge considerably between developed and emerging nations.”
“There is a need to ensure that inflationary expectations are managed appropriately,” says ICICI Bank managing director and CEO Chanda Kochhar. “The RBI has indicated that its exit strategy from the monetary stimulus conditions will take into account the pace and depth of economic recovery…. The RBI, while indicating the beginning of the exit process, has also signaled very clearly that any such exit will be non-disruptive to the growth momentum.”
But a few days later, Prime Minister Manmohan Singh indicated that the sops were soon to go. “There are clear signs of an upturn in the economy,” Singh told the India Economic Summit organized by the World Economic Forum (WEF) in New Delhi in early November. “Like other countries, we resorted to a significant stimulus and we will take appropriate action next year to wind this down.” According to Bloomberg, India could be the first among the Group of 20 nations to begin winding back its fiscal stimulus.
Too Many Voices?
At other venues — like the Economic Editors’ conference in Delhi, which is often used to transmit government thinking to the media — there has also been the spectacle of various government ministers and bureaucrats expressing contradictory views. Business channel CNBC-TV18 posed the question directly to Montek Singh Ahluwalia, deputy chairman of the Planning Commission (the Prime Minister is ex-officio chairman): “[At] the WEF, the Prime Minister said we would take appropriate action next year to wind [the stimulus] down, but hours later the minister for commerce and industry struck a very different note. For many people, that sounds as though the government is speaking with two voices?”
Ahluwalia responded by suggesting that the different voices are simply going through the process of seeking a necessary consensus. And that process will not happen overnight. “There is a lot of concern in the markets as to whether we are now ready to withdraw the stimulus. Very often, newspaper men ask me, ‘Are we going to withdraw the stimulus now? Are we going to tighten the monetary policy now?’ The signal that the government has given very consistently is that neither fiscal nor monetary policy needs to be changed during the current fiscal year and the time to make further adjustments to one or both of these instruments will be during the next fiscal year.”
That thinking may go out of the window if inflation starts to rise. In October, the government started calculating the Wholesale Price Index (WPI) on a monthly rather than a weekly basis. Inflation rose 1.34%. In September, it had been 0.5%. Meanwhile, industrial production in September rose 9.1% over the corresponding month of the previous year. “The finger is on the [interest] rate trigger now” due to the combination of stronger-than-expected industrial output figures and mounting inflationary concerns, HSBC economist Robert Prior-Wandesforde told AFP in Singapore. He predicts inflation will be at 8% by February or March.
Inflation forecasts by others have risen sharply. The IMF, which in March 2009 projected inflation of just 2% for the fiscal year ending March 2010, now sees inflation at 8.7% for the calendar year of 2009. In October, its Regional Economic Outlook warned: “In India … industrial production is recovering rapidly, and core inflation and inflation expectations are rising.”
A July 2009 report by apex chamber of commerce Assocham, titled “Inflation concerns for the Indian economy,” notes that inflation is likely to average near 5% in 2009-2010. The report, which now looks a bit dated, rightfully pointed to some of the principal causes of inflation: poor monsoons in India and “the surge in the international commodity markets led by energy (crude oil, natural gas and coal), metals (copper, aluminum and iron ore) and food (cereal and meat).” The fiscal stimulus will do its bit, too. “(The) heavy fiscal stimulus totaling close to 4% of GDP and monetary measures to ease money supply would commensurate (sic) into a fresh lease of demand that would give a push to the general price level in the economy,” the report notes.
At the WEF meeting in Delhi on November 8, Ahluwalia of the Planning Commission said: “I think we are on target for anything near 5%-6% inflation. I would like it to be 5% rather than 6%. But at the point when growth is distinctly below potential, the balance of the concern is essentially maintaining the growth rate. The real concern on the pricing front is that you have food price inflation somewhat high. But that reflects partly the bad monsoon. I expect by the end of this financial year, food price inflation will come down.” The monsoon rainfall this year has been 23% below normal — the worst in 37 years. It was followed by floods, which further damaged crops.
Sharp Rises in Food Prices
Food inflation is the major culprit behind the rising numbers. In October, food prices increased by 13.32% year-on-year. Rice was up 13.22%, pulses 22.81%, sugar 45.70% and potatoes and onions a whopping 96.43% and 37.60% respectively. In India, governments have fallen because of onion price increases. It matters because it hits the common man. Sharp rises in food prices, especially for “rice and pulses, other primary food products and of sugar is a major policy concern,” says C. Rangarajan, chairman of the Economic Advisory Council to the Prime Minister in an October report. “Even in the winter of 2008-09, as world prices of manufactured goods and internationally traded basic foods were declining, the domestic prices were increasing. The weak monsoon rains and available acreage data suggest a lower kharif [crop season] output rendering the management of inflation in food products a severe challenge in this fiscal year. While the current weather conditions favor a strong rabi [winter] crop, the possibility of adverse weather conditions in rabi cannot be completely ruled out.”
Rangarajan’s prescription: A strong supply response — a more coordinated release of stocks through the public distribution system, open market sales of public stocks, precautionary arrangements for importing some food grains and attention to ensuring a strong rabi harvest.
India has already allowed the duty-free import of one million tons of sugar. The cap is likely to be raised to two million tons, and the import duty on rice has been scrapped. Government organizations have floated tenders for 30,000 tons of rice and 18 bids came in earlier this month. As expected, global prices have firmed up now that India is shopping. According to finance minister Mukherjee, however, India has adequate stocks. It can even export if need be, he says. India has a buffer stock of eight million tons of wheat and seven million tons of rice.
The government is also taking action regarding the fiscal deficit. The stimulus is headed towards creating an untenable spending deficit of 6.8% of GDP in 2009-10. “Fiscal deficit can be financed through domestic borrowing, external borrowing or by printing money,” according to a paper by Alamuru Soumya, a consultant at the Indian Council for Research on International Economic Relations, a Delhi-based think tank. “Excessive domestic borrowing may put upward pressure on interest rates and external borrowing may result in an external debt crisis. Printing money may lead to high inflation.”
The government proposes to bridge this gap through disinvestment of public sector undertakings (PSUs). In early November, the Cabinet Committee on Economic Affairs (CCEA) decided that all listed and profitable Central PSUs would have to maintain a minimum of 10% public shareholding. The CCEA also proposed that unlisted PSUs with a three-year track record of net profits and positive net worth should get listed.
The government can raise US$12 billion through this disinvestment, former Securities & Exchange Board of India member J.R. Varma told CNBC-TV18. “It’s doable,” he says. An Assocham report puts the figure at US$16.6 billion. The union Budget earlier this year had estimated the takings from PSU disinvestment at a paltry US$200 million this year. There are hurdles however. This money cannot automatically be used to balance the deficit. It needs special Parliamentary dispensation. That may happen. Curiously neither the Left nor the Right has protested against the disinvestment initiative. “This is the single largest disinvestment decision that any government has taken so far, and could generate up to 2% of GDP,” wrote editor T.N. Ninan in business daily Business Standard. The stock markets have bounced back on news of the disinvestment.
For the government, this is a time to wait and watch. Ahluwalia says he is not too worried. “[Right] now, I don’t think we are in a position where the inflation issue is anything other than something we keep a close watch on,” he told the WEF.
“Inflation management has moved up in the hierarchy of RBI priorities,” says Chakraborty of Enam Securities. He expects the RBI to raise banks’ cash reserve ratio — or the amount banks have to keep with the central bank, currently at 5% — by December-January. “However, weak growth, due to the impact of the monsoon, will keep policy rate increases at bay till the end of the fourth quarter [January-March 2010].”