Tag: Current Account Deficit

12 January, 2015

The “real” implications of oil price falling below $50 per barrel

It has been widely reported in the media that falling oil prices are good for India. The reality, as always, is not so straight forward. While there are several points on which the country gains, there are several other points on which the country loses as well. Let’s look at both sides.
The Petroleum Planning and Analysis Cell (PPAC), which comes under the ministry of petroleum and natural gas, computes the international crude oil price of the Indian Basket. As on January 7, 2015, this price stood at $46.97 per barrel of oil.
The price of the Indian basket of crude oil had stood at $108.56 per barrel on May 26, 2014, the day the Narendra Modi government came to power. Hence, the price of oil has fallen by 56.7% since then.
There are several implications of this huge fall. One straight benefit of the fall in the price of oil is that Indian oil imports have been coming down. As author Satyajit Das puts it in a recent research article titled Reverse Oil Shock: “India should benefit as crude oil constitutes over 30 percent of total imports and around 70 percent of its current account deficit.”
Further, it has been suggested that falling oil price will help the government cut its oil subsidies by a huge amount. This really isn’t true. The budget presented by the finance minister Arun Jaitley in July 2014 had assumed a low oil subsidy number to start with.
It had been assumed that the oil subsidy for the year would work out to Rs 63,426.95 crore. This despite the fact that subsidies worth Rs 35,000 crore which were to be paid in 2013-2014, had been postponed to this financial year. So, in effect Jaitley only had a little more than Rs 28,400 crore to play around with on the oil subsidy front.
While the oil marketing companies no longer suffer any under-recoveries on the sale of petrol and diesel, the same is not true about domestic cooking gas and kerosene. PPAC data suggests that the under-recoveries for the month of January 2015 will be at Rs 19.46 per litre of kerosene and Rs 235.91 per cylinder of domestic cooking gas.
The government will have to compensate the oil marketing companies for these under-recoveries. In fact, the under-recoveries for the period April to September 2014 stood at Rs 51,110 crore. These under-recoveries are already higher than the Rs 28,400 crore that was left in the oil subsidy account after the pending under-recoveries for the past year had been paid for. Hence, there will be no cut in oil subsidies that were budgeted for.
Nevertheless, it needs to be said that if oil prices had continued to be at high levels as they were when the Modi government first came to power, then the amount allocated towards oil subsidies in the budget would not have been enough to compensate the oil marketing companies.
This would have led to the government expenditure shooting up, in turn pushing up the fiscal deficit to an even higher level than it currently is at. The fiscal deficit for the period April to November 2014 was at 99% of the annual target. Even this number was achieved after a massive fall in oil prices. Fiscal deficit is the difference between what a government earns and what it spends.
Falling oil prices have had some impact on inflation as well, with prices of petroleum products falling. Nevertheless, the impact has not been major given that the government has chosen not to pass on the total fall in crude oil price to the end consumer.
In fact, since October 2014, the government has increased the excise duty on petrol and diesel thrice. This has been done to shore up taxes which have been growing at a very slow rate. The tax growth had been assumed to grow at 16.9% at the time the budget was presented, whereas the actual growth in tax collections between April to November 2014 has been around one-fourth of that at 4.3%.
This is a good move as far as public finances are concerned. But it has a negative impact as well. As Satyajit Das points : “A number of governments, such as Indonesia and India, have taken the opportunity presented by low prices to reduce fuel subsidies. While positive for public finances and economic efficiency, the diversion of the benefits from consumers to the government is contractionary, reducing the effect on growth.”
If the government had not increased excise duties on petrol and diesel, it would have left more money in the pockets of people to spend on other things, which would have in turn helped businesses and economic growth.
On the flip side, the fall in oil prices will hurt petrochemical companies. As Crisil Research points out in a note released late last week: “The rapid slide in global commodity prices will hurt topline growth of steel, petrochemical, and commodity chemical producers during the quarter…On account of a 28% drop in crude oil prices, revenue growth of the petrochemicals industry is expected to decline by 14-16%.”
This fall in earnings of petrochemical companies is one of the reasons which will push the revenue growth of India Inc to “slip to a 6-quarter low of 7% on a year-on-year (y-o-y) basis in the December 2014 quarter.” “Revenue growth was around 9% in the preceding quarter and 13% in the December 2013 quarter,” Crisil Research points out.
There are other reasons to worry as well. Falling oil prices mean that countries which depend extensively on oil exports will earn lesser. Professor Eswar Prasad of Cornell University explained this point very well in an interview he gave to CNBC sometime back.
As he said: “There is going to be a lot of weakness in external demand and countries in Latin America like Venezuela which already have a very difficult situation, emerging markets like Russia and of course the Middle Eastern countries plus some of the European economies like the UK and Norway that rely on oil exports to a significant extent are going to be facing fairly difficult situations. This will affect their budgets and their current account balances which in turn will affect their consumption demand. So, softness in consumption demand is ultimately not good for anybody in the world including India.”
Norway, UAE and Saudi Arabia, which have earned a lot of money exporting oil over the years, run the three largest sovereign wealth funds in the world. The sovereign wealth funds of Norway and UAE are professionally managed and invest in financial markets all over the world. If these countries earn lesser because of lower oil prices then the capital flows from these countries will also slowdown.
As Neelkanth Mishra of Credit Suisse said in an interview to The Economic Times sometime back: “If Norway, Saudi Arabia, Abu Dhabi, Qatar, or Kuwait are not going to see the kind of surpluses that they used to then they will have less capital to send out, which will mean that capital flows into India will not be as strong as they were.”
Nevertheless, this can be balanced by capital inflows from the United States. How is that going to happen? Saudi Arabia has been driving down the price of oil in order to make the production of shale oil in United States and Canada unviable. Shale oil is expensive to produce and will not be viable to produce if oil price continues to stay at the current level.
It needs to be pointed out here that the recent revival in the US economy has primarily been because of a huge expansion in shale oil production. As analyst Jawad Mian points out in the Stray Reflections newsletter for January 2015: “It is undeniable that the oil and gas sector has become a key driver of US economic activity…It has been responsible for about 30% of the 10 million national increase in jobs since the global financial crisis. With oil prices plunging, the expected slowdown in drilling and weaker capex spending darkens the job market outlook for the energy sector.”
If that happens, then there will be two immediate repercussions. Job creation in the United States will slowdown. A bad job scene will mean a slowdown in consumer demand in the United States. United States constitutes around one-fourth of the global GDP and is the shopping mall the whole word caters to. This will be a negative for Indian exports as well.
At the same time the Federal Reserve of Untied States will act as well. As Mian puts it: “we think the Fed will adopt a more relaxed attitude to policy normalization than is currently anticipated.” In simple English what this means is that the Federal Reserve may not start raising interest rates any time soon, as the Fed Chairperson Janet Yellen suggested when she spoke to the media in December 2014.
Hence, institutional investors can continue to borrow dollars at low interest rates and invest that money in financial markets all over the world, including India. To conclude, low oil price is largely a mixed bag for India.

The article originally appeared on www.equitymaster.com on Jan 12, 2015

6 March, 2014

Dear FM, CAD is falling, but what about $10 bn worth smuggled gold?

Vivek Kaul
You can’t go wrong if you start off as a cynic – Hanif Kureshi in The Last Word
Like your relatives, you can’t choose your followers on Twitter. And so, you get all kinds.
Yesterday, a Congress troll, who follows me, tweeted to me “u concede defeat on CAD?”. This particular gentleman has been having a heated debate with me on the current account deficit (CAD) for a while now. He thinks that is the only economic worth looking at, given that he never has anything else to say on any other economic number.
Sometime last year he asked me what was my forecast for the CAD for the year 2013-2014 (the period between April 2013 and March 2014)? Those were the days when things on the rupee-dollar front were going all wrong. And in the heat of the moment I suggested a very large number.
In technical terms, the current account deficit is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances. Or to put it in simpler terms, it is the difference between outflow (through imports) and inflow (through exports and foreign remittances) of foreign exchange.
The actual CAD number as it stands now is considerably lower than I had predicted at that point of time. Of course, at that point of time I had no idea that the government and the Reserve Bank of India would clamp down on the import of gold as hard as they did. As John Maynard Keynes, the most celebrated economist of the twentieth century once said “When my information changes, I alter my conclusions. What do you do, sir?”
Data from by the Reserve Bank of India (RBI) shows that the current account deficit for the October to December 2013, narrowed sharply to $4.2 billion or 0.9% of the GDP.
In comparison, the CAD during the same period of 2012 had stood at $31.9 billion or 6.5% of the GDP. The CAD during the period July to September 2013 had stood at $5.2 billion or 1.2% of the GDP.
The fall in the CAD has particularly been on account of two reasons. The merchandise exports increased by 7.5% to $79.8 billion during October to December 2013, in comparison to the same period during 2012. As the RBI release points out this was “on the back of significant growth especially in the exports of engineering goods, readymade garments, iron ore, marine products and chemicals.”
The second and the major reason for the falling CAD was the government and the RBI clamping down on gold imports by increasing the import duty to 10% from 2%, over a period of time. Gold imports during October to December 2013, fell to $3.1 billion from $17.8 billion during the same period last year. Overall imports, also declined to $112.9 billion from $132.5 billion during the same period in 2012.
Hence, imports during the period October to December 2013, fell by close to $19.6 billion($132.5 billion minus $112.9 billion) and not all of it is on account of falling gold imports. What this tells us is that imports on the whole have slowed down due to a slowdown in economic growth leading to a dampening in consumer demand. As the recent IMF country report on India points out “In addition, non-oil, non-gold imports have declined in line with weak domestic demand.”
In fact, the IMF report projects that non oil non gold imports for 2013-2014 will come in at $321.3 billion. This is significantly lower than $333.8 billion in 2012-2013 and $344.6 billion in 2011-2012.
So, yes, the falling current account deficit is good news, but not all of it is good news. The falling CAD also shows sign of the overall Indian economy being in trouble.
In fact, a clamp down on the import of gold has led to huge smuggling in gold. As Somasundaram PR, the World Gold Council’s managing director for India recently told Reuters “Despite all the curbs, demand has come in at 975 tonnes. The question obviously is where the supplies came from…We have seen anecdotal evidence of smuggling. Our estimate is 150-200 tonnes, more towards the upper end.”
India officially imported around 655 tonnes of the yellow metal during the first 11 months of 2013. The demand for gold was at 975 tonnes. So how is the difference between supply and demand being met? Some part of the difference between supply and demand is being met through scrap gold. But the entire difference between supply and demand cannot be met through scrap gold.
This is where smuggling comes in. Now 200 tonnes of gold is not small change by any stretch of imagination. The average price of gold during 2013 was $1531 per ounce (one ounce equals 31.1 grams).
If we assume a gold price of $1300 per ounce that would mean around $8.4 billion worth of gold has been smuggled in. At a price of $1531 per ounce around $9.9 billion worth of gold has been smuggled in. Of course, this has huge social consequences, which no one is talking about.
A lot of this gold is being smuggled in through Bangladesh, Pakistan, Nepal and Sri Lanka. In these countries the import duty on gold has been less than the 10% duty in India, ensuring that there is money to be made first importing gold and then smuggling it into India. The Indian Express reports that Sri Lanka recently imposed a 10% import duty on gold. Pakistan recently temporarily banned the import of the yellow metal for a period of 30 days. The country had done so even in last August.
This can’t be good news for India and has the chances of making our neighbouring countries even more hostile towards us. All in all, yes the CAD is falling, but it has led to repercussions which no one seems to be talking about. Not even my Twitter follower.
The article originally appeared on www.FirstBiz.com on March 6, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)

4 December, 2013

Of Chidambaram, Salman Khan and the great Indian hope trick

Vivek Kaul
So India is out of trouble. The current account deficit for the period July to September 2013 is down to 1.2% of the GDP in comparison to 5% of GDP a year earlier. The current account deficit is the difference between total value of imports and the sum of the total value of exports and net foreign remittances. Or to put it in simpler terms, it is the difference between outflow (through imports) and inflow (through imports and foreign remittances) of foreign exchange .
The gross domestic product (GDP) grew by 4.8% during July to September 2013 as compared to the same period last year. This was much better than the growth of 4.4% seen during April to June 2013.
And given this improvement, the Indian economy is starting to recover. Or so we are being told by politicians, bureaucrats, financial firms and stock brokers. The great Indian hope trick is at work. Leading the pack is finance minister P Chidambaram. “ We are going through a period of stress but there is a ground for optimism…we hope things will become better in the second half of the current fiscal,” he said on December 2.
Montek Singh Ahluwalia, the deputy chairman of the Planning Commission, seems to be more optimistic than Chidambaram and he expects the GDP growth rate “in the second half of the current year to be better than the first half.”
That might very well turn out to be the case. But whether India grows at 4.8% or 5.1% that is purely of academic interest. It doesn’t matter. If the country needs to get people out of poverty it needs to grow at 8-9%. And the way things currently are it looks very difficult to achieve that kind of growth.
In a speech which was published as an editorial in The Times of India, Chidambaram said “In 2014-15 our growth rate will be close to 6 per cent, in 2015-16 it will be close to 7 per cent and, in the year after, we will be back to the high growth of 8 per cent.”
This is the great Indian hope trick at work. Yes things are looking a lot better on the current account deficit front and GDP growth also seems to have picked up, but there are a host of other economic factors which indicate that getting back to an era of high economic growth will be difficult.
1) The consumer price inflation was at 10.09% in October 2013. Food inflation was even higher at 18.2%. Half of the expenditure of an average household in India is on food. In case of the poor it is 60%. In such an environment people are likely to postpone other forms of consumption which are not immediately necessary, given that more and more of their money goes towards buying food. And this has an impact on economic growth. (In order to understand how inflation is inversely proportion to growth, click here).
2) The slowdown in consumption is clearly visible in the private final consumption expenditure(PFCE) which forms around 60% of the overall GDP, when measured from the point of view of expenditure. The PFCE for the period between July and September 2013 grew by just 2.2%(at 2004-2005 prices) from last year. Between July and September 2012 it had grown by 3.5%. What this tells you is that people are postponing consumption because of high inflation.
3) A slowdown in consumption is visible in a slowdown in car sales. In the month of November car sales of the major players Maruti Suzuki, Hyundai and Tata Motors were down. It is worth remembering that car sales unlike a lot of economic statistics is a real number and not a theoretical construct. Car sales of Maruti Suzuki fell by 5.9% to 85,510 units. The sales of Hyundai were down to 33,501 units by 3.6%. Tata Motors was the worst of the lot, with sales down by 39.8% to 26,816 units. What this tells you again is that people are postponing consumption because of high inflation.
This lack of demand is also reflected in the slowing down of consumer durables output. As Sonal Varma of Nomura wrote in a research note dated October 11, 2013 “consumer durables output growth remained in the negative, possibly due to a sharper slowdown in white goods production.” This is a clear reflection of the fact that people are not interested in buying things.
4) Economic growth in large parts of the world slowed down after investment bank Lehman Brothers went bust in September 2008. India beat the trend and continued to grow. This was primarily on account of the fact that the government decided to spend a lot of money in comparison to what it was doing in the past.
Given this, the actual fiscal deficit for the year came in at Rs 3,36,992 crore, though the target was Rs 1,33,287 crore. So the fiscal deficit basically more than doubled from a target of around 2.5% of GDP to an actual of 6% of the GDP. Fiscal deficit is the difference between what a government earns and what it spends.
This year the government of India does not have the same sort of flexibility. Data released by the Controller General of Accounts (CGA) shows that between April and October, 2013, the fiscal deficit touched 84.4% of the annual target. The fiscal deficit target for the year is Rs 5,42,999 crore or 4.8% of GDP. During the first seven months it was at Rs 4,57,886 crore or 84.4% of the target, suggesting that Chidambaram has very little room left to manage the fiscal deficit.
In this scenario there is very little chance for the government to increase expenditure to drive economic growth. In fact, if one looks at the GDP numbers for the period July to September 2013, the government final consumption expenditure fell by 11.7% in comparison to the period between April and June 2013.
5) Also, it is more or less certain now that the finance minister P Chidambaram will meet this year’s fiscal deficit target by delaying payments. .Reuters columnist Andy Mukherjee explained this best in a column he wrote on October 25, 2013. “India’s government recognizes revenue and costs not when it actually incurs them, but when it writes or receives cheques. By simply delaying payments, New Delhi can therefore give the impression it is sticking to its promise of keeping this year’s budget deficit within 4.8 percent of GDP,” wrote Mukherjee.
So oil marketing companies will not be paid for their under-recoveries in this financial year. Similarly, the Food Corporation of India(FCI) will not be compensated for the grains that it sells at a subsidised price, this year.
What this means is that by postponing payments, the current government will leave a bigger headache for the next government. As economist Abheek Barua writes in a column in the Business Standard “Let’s face the fact that even if Finance Minister P Chidamabaram were to produce a 4.8 per cent fiscal deficit-to-GDP ratio in 2013-14, it would not mark the end of India’s fiscal woes. The only way to compress the fisc this year is on the back of a hefty deferment of big-ticket expenditures such as subsidy payments for oil and fertilisers…How will a new government handle this? Will it have the courage to prune or jettison some of these revenue-guzzling welfare programmes, and risk eternal damnation by voters? Can it afford to finally do away with oil and other subsidies at one shot?”
Such a scenario will not be good for economic growth. Also, if the government continues in its current way, there is always the risk of a downgrade from one of the international rating agencies. And that will mean a run on the rupee.
6) Chidambaram in a recent speech said that “India is not an island. We are part of the global economy, and what happens in the globe will affect India.The global economy…is expected to achieve a growth rate of only 2.9 per cent in CY 2013. Advanced economies are expected to grow at only 1.2 per cent this calendar year. The eurozone area, which is one of our major trading partners, is expected to shrink 0.4 per cent this year. Therefore, what happens in and what we are able to do, must be seen in the context of the global economy.”
This is classic politician speak. When India was growing then it was because of all the things that the government was doing right. And now that we are not growing it is because of external factors. But let me not get into that. The point here is that if the global economy does start to recover, how well is the Indian economy placed to benefit from it through increased exports? Economist Rajeev Mallik of CLSA has an answer. “Recovery in global demand and trade flows will be positive for India, but it’ll be more positive for other Asian economies. This is because even though India’s ratio of exports in GDP has increased in recent decades, it remains the lowest among the Asian economies. Consequently, the incremental increase in growth in some other Asian economies will outstrip that for India,” explains Mallik in a column in the Business Standard.
7) The current account deficit has been brought under control by clamping down on gold imports. Another major reason for its fall is the slowdown in growth leading to lower imports. Imports declined 4.8% to $114.5 billion during the July to September 2013 period. As an editorial in The Financial Express points out “But, more than anything else, it is the continued collapse in GDP that has ensured CAD remains under control, implying that the situation can once again get out of control as GDP picks up—with no policy on opening up of the coal sector, for instance, coal imports will pick up once again as GDP rises.”
8) So in this environment few are investing. As The Financial Express editorial points out “a recent study by Kotak Institutional Equities shows how sanctions for fresh projects have been tapering off from R1,13,900 crore in Q1FY11 to R74,900 crore in Q1FY12, R41,300 crore in Q1FY13 and to just R22,000 crore in Q1FY14.”
What all this tells us is that there are serious economic issues that need to sorted out if India has to get back anywhere near 8% GDP growth rate. In this scenario anyone trying to tell us that India will soon go back to a high economic growth rate is like Salman Khan telling the world that he is a virgin who is saving himself for his wife. We all know that is not something to be taken seriously.
The article originally appeared on www.firstpost.com on December 4, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)

4 December, 2013

A fall in current account deficit need not mean a fall in gold demand

Vivek Kaul
The current account deficit for the three month period of July to September 2013 has come in at $5.2 billion or 1.2% of the gross domestic product (GDP). This number is so good that it prompted the Reserve Bank of India(RBI) to release the numbers a month earlier than scheduled.
In technical terms, the current account deficit is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances. Or to put it in simpler terms, it is the difference between outflow (through imports) and inflow (through imports and foreign remittances) of foreign exchange .
The current account deficit for the April to June 2013 period had stood at 4.9% of GDP, whereas for the July to September 2012 period it had stood at 5% of GDP. Also, this is the lowest current account deficit that the country has seen since the period of three months ending June 2009.
A high current account deficit is not deemed to be good for a country primarily because it means that the outflow of foreign exchange is much greater than its inflow. So in India’s case it means that the outflow of dollars is much greater than the inflow of dollars. This means a greater demand for dollars than supply. Hence, those who need dollars sell rupees to buy them. This leads to a situation where the value of the rupee falls against the dollar. This is precisely what happened between May and August 2013, when the rupee went from around 54 to a dollar to almost 69 to a dollar.
When this happened, Indian importers had to pay a significantly higher amount in rupee terms, for what they were importing. India produces very little oil and imports nearly 80% of its requirement. Hence, the oil marketing companies had to pay a higher amount for the oil that was being imported. But these companies are not allowed to sell cooking gas, diesel and kerosene at a price which is greater than the cost price. The government subsidies them for this under-recovery. This adds to the expenditure of the government and hence, leads to the fiscal deficit going up, which has its own set of problems. Fiscal deficit is the difference between what a government spends and what it earns.
There are two ways of controlling the current account deficit. One is to ensure that the country earns more foreign exchange than it was doing in the past. The other is to clamp down on the demand for foreign exchange. For a government it is always easier to clamp down.
Hence, the government went about increasing the import duty on gold. The duty is now at 10% in comparison to 2% earlier. Another rule, which required a gold importer to re-export 20% of all the gold that he imported, was also introduced by the government.
These two significant changes ensured that gold imports came down dramatically. Gold imports during the June to September 2013 period stood at $3.9 billion, down nearly 65% from the same period in 2012, when it had stood at $11.1 billion. In the period of April to June 2013, the gold imports had stood at $16.4 billion.
This dramatic fall in gold imports is a major reason behind this fall in current account deficit. In absolute terms the fall in gold imports has been $12.5 billion($16.4 billion – $3.9 billion) between the three month period ending in June 2013 and the three month period ending in September 2013.
The current account deficit for the April to June 2013 period was $21.8 billion. For the period July to September 2013 period, it has come in at $5.2 billion. The absolute difference is $16.6 billion. Of this nearly $12.5 billion or nearly three fourths of the fall has been because of lower gold imports.
A fall in the value of the rupee has also helped boost exports. Merchandise exports went up by 12% to $81.2 billion during the period in comparison to the same period last year. This was primarily on account of growth in export of textiles, leather and chemical products.
The major fall in current account deficit has been because of a massive fall in gold imports. And this has meant that the demand for dollars to buy gold has gone down dramatically as well. This has been one of the major reasons for the rupee increasing in value from around 69 to a dollar in end August to around 62.4 to a dollar currently.
The current account deficit was around $87 billion last year. With the clamp down on gold imports, the finance minister P Chidambaram has said in the recent past that he expects the current account deficit to be less than $56 billion in the financial year ending March 2014.
Does a fall in gold imports also mean a fall in demand for gold? India produces almost no gold of its own. But things are not as simple as that.
It is worth remembering here that gold imports were banned in India until 1990. At that point of time, gold smuggling was a fairly lucrative operation. As a recent article in The Economist points out “India consumed only 65 tonnes in 1982. Until 1990 imports were all but banned. Bullion had to be smuggled in and its price within India was about 50% higher than outside it.”
And that is precisely what has been happening over the course of this year. A recent report in The Hindustan Times points out “The Mumbai airport customs has seized around 73kg gold worth Rs.19.71 crore between April and October this year, more than double the quantity (31kg gold worth Rs 9.8 crore) it had seized during the same period last year. The spurt in smuggling activities is a result of the widening difference in the yellow metal’s price between the domestic market and Dubai. The price gap has gone up to Rs 5 lakh a kg in the past few months from being Rs 2.5 lakh a kg in June, and only Rs 1 lakh before that.”
Gold smugglers are also using neighbouring countries to get gold into India. A November 17, 2013, report in The Times of India points out “In the past few months, over 50kg of gold worth more than Rs 15 crore has been smuggled across the Indo-Bangladesh border alone. Sources in Directorate of Revenue Intelligence (DRI) said Nepal too has come up on the radar with some recent seizures on the border. Sources said this was only a fraction of what was being smuggled through these borders.”
A similar point is made by Dan Smith and Anubhuti Sahay of Standard Chartered in their September 12, 2013, report titled “Gold – India’s government gets tough.” As they write “There is much anecdotal evidence suggesting that increased amounts of gold are entering India through unofficial channels, which makes the official figures an understatement. Pakistan temporarily suspended a duty-free gold import arrangement in August, when gold imports doubled. According to media reports, much of this was crossing the border into India.”
A report in the DNA quotes Somasundaram P R, managing director (India), of the World Gold Council as saying “ demand in neighbouring countries such as Thailand has increased and some of this may be because of India demand.”
The World Gold Council in a recent report also makes the following point. “Gold entering the country unofficially through India’s porous borders helped to meet pent-up demand…It is likely that unofficial gold will continue to find its way into the country to satisfy demand. Reports that a good market for ten tola bars is re-emerging,due to the relative ease with which they can be concealed, reinforce this view.”
The point is that a clamp down on gold imports leading to a major fall in gold imports doesn’t necessarily mean a fall in gold demand. These are two difference things. An increase in gold smuggling has huge social implications. It is worth remembering that some of the biggest mafia dons of Mumbai in the seventies and the eighties started as gold smugglers before getting into other illegal activities.
That apart, there are financial implications to this as well. A major reason why Indians buy gold is to protect themselves from inflation. Over the last few years the consumer price inflation(CPI) has been higher than the interest being paid on fixed deposits and other fixed income instruments.
In this environment, gold has looked like a good bet given that it has given positive returns in each of the years between 2002 and 2011. As Chetan Ahya and Upasana Chachra of Morgan Stanley point out in a December 2, 2013 note titled India Economics: 2014 Outlook: A Year of Macro Adjustment “Persistently high CPI inflation has kept real interest rates negative since the credit crisis, encouraging households to reduce financial savings and increase allocation to gold and real estate.”
Hence, buying gold was a perfectly rational thing to do at an individual level. The Indian financial system is rigged towards helping the government borrow money at low interest rates (You can read the complete argument here). Given this, it is not surprising that Indians are fascinated by gold at an individual level. Though at an aggregate level it has led to major problems. One of the problems has been the weak deposit growth of banks. As Ahya and Chachra point out “This is reflected in deposit growth, which has stayed weak relative to credit growth now for the last three and a half years, elevating the loan-deposit ratio near full capacity levels (76.5% currently).”
This basically means that deposits have been growing at a much slower pace than loans being given by banks, due to the fact that people have been diverting their savings into gold and real estate, in the hope of beating inflation. And this in turn has led to higher interest rates.
With the government clamping down on gold imports, the hope was that it would lead to people saving more money in bank and other fixed income deposits. But is that really happening? The evidence available suggests it isn’t because the basic problem in India is high inflation and that hasn’t been addressed.
The article originally appeared on www.firstpost.com on December 4, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)

20 September, 2013

Phata Poster Nikla Zero – Why Rajan hasn't joined the party

Vivek Kaul
Raghuram Govind Rajan, the governor of the Reserve Bank of India, has refused to join the party.
The financial markets were expecting the Rajan led RBI to cut the repo rate in its Mid Quarter Monetary Policy Review. But that has not happened. Instead the repo rate has been raised by 25 basis points(one basis point is equal to one hundredth of a percentage) to 7.5%. Repo rate is the interest rate at which RBI lends to banks. Hence, the BSE Sensex has fallen by more than 500 points after the policy review was announced. As I write this it is down by around 350 points. The rupee is now quoting at 62 to a dollar, having touched 62.6 to a dollar earlier.
So now Rajan is suddenly looking like a villain after having been turned into a hero by the media over the last few weeks. As a Facebook friend quipped Phatta Poster Nikla Zero.
What Rajan has done needs to be analysed in line with the economic philosophy he believes in. A major reason for increasing the interest rate is high inflation. As the Monetary Policy Review points out “What is equally worrisome is that inflation at the retail level, measured by the CPI (consumer price inflation), has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence. Although better prospects of a robust kharifharvest will lead to some moderation in CPI inflation, there is no room for complacency.”
This statement is totally in line with Rajan’s thinking on the issue. In fact, Rajan has clearly pointed out in his earlier writings that RBI should simply concentrate on managing inflation instead of trying to do mulitple things at once.
As Rajan wrote in a 2008 article (along with Eswar Prasad) “The RBI already has a medium-term inflation objective of 5 per cent…But the central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”
And given this the RBI ends up being neither here nor there. As Rajan put it “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.”
Hence, Rajan felt that the RBI should ‘just’focus on controlling inflation. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms “The RBI can best serve the cause of growth by focusing on controlling inflation and intervening in currency markets only to limit excessive volatility…an exchange rate that reflects fundamentals tends not to move sharply, and serves the cause of stability.”

Currently, the RBI is trying to control inflation, accelerate economic growth and stabilise the value of the rupee, all at the same time. Something which is not possible. Rajan understands this well enough. “The RBI’s objective could be restated as low inflation, and growth consistent with the economy’s potential. They amount to essentially the same thing! But it would let the RBI off the hook for targeting the exchange rate. And that is the key point,” Rajan wrote in the 2008 article cited earlier. Given this focus on inflation, it isn’t surprising that Rajan has chosen to go against market expectations and raise the repo rate. His belief is that if inflation is brought under control, other things will sort themselves out.
Rajan is also trying to address the high current account deficit by raising the repo rate. Lets try and understand how. As the monetary policy review of the RBI points out “However, inflation is high and household financial saving is lower than desirable.” Lower savings have an impact on the current account deficit. As Atish Ghosh and Uma Ramakrishnan point out in an article on the IMF website “The current account can also be expressed as the difference between national (both public and private) savings and investment. A current account deficit may therefore reflect a low level of national savings relative to investment.”
If India does not save enough, it means it will have to borrow capital from abroad. And when these foreign borrowings need to be repaid, dollars will need to be bought. This will put pressure on the rupee and lead to its depreciation against the dollar.
This is something that Rajan said in an interview to the India Brand Equity Foundation. As he said “Current account deficit (CAD) essentially reflects the fact that you are spending more than you are saving. That’s technically the definition of the CAD, which means that you need to borrow from abroad to finance your investment. Ideally, the way you would reduce your current account deficit is by saving more, which means consuming less, buying fewer goods from abroad and importing less. Or, the other way is by investing less, because that would allow you to bridge the CAD. Now we don’t want to invest less. We have enormous investment needs. So ideally, what we want to do is save more.”
And to achieve this “the first way is for the government to cut its under-saving or its deficit.” “The second way is when the public decides to save more rather than spend. We need to encourage financial saving,” Rajan said in the interview.
The fact of the matter is that India has not been saving enough over the last few years. As the recent RBI financial stability report released in June 2013 points out “Financial savings of households…have declined from 11.6 per cent of GDP to 8 per cent of GDP over the corresponding period (i.e. between 2007-08 to 2011-12.”
Financial savings are essentially in the form of bank deposits, life insurance, pension and provision funds, shares and debentures etc. In fact between 2010-2011 and 2011-2012, the household financial savings fell by a massive Rs 90,000 crore. This has largely been on account of high inflation. Savings have been diverted into real estate and gold in the hope of earnings returns higher than the prevailing inflation.
Also people have been saving lesser as their expenditure has gone up due to high inflation. And the financial savings will only go up, if inflation comes down, pushing up the real returns on various kinds of deposits.
“Households also need stronger incentives to increase financial savings. New fixed-income instruments, such as inflation-indexed bonds, will help. So will lower inflation, which raises real returns on bank deposits. Lower government spending, together with tight monetary policy, are contributing to greater price stability,” wrote Rajan in a column in April 2013.
Rajan has increased the repo rate hoping that bank’s and other financial institutions increase the interest rates on their deposits. This will encourage people to save more. Also, by trying to control inflation Rajan hopes that the real return on deposits (nominal return minus inflation) will go up. Once this happens, people are likely to stay away from investing in gold. If people stay away from investing in gold, it helps bring down our imports and hence, also the current account deficit. This puts lesser pressure on the rupee. The current account deficit(CAD) can also be expressed as the difference between total value of imports and the sum of the total value of its exports and net foreign remittances.
Also, as India saves more the need to borrow from abroad will come down. India’s external debt as on March 31, 2013, stood at at $ 390 billion. Of this nearly 79% debt is non government debt. External commercial borrowings(ECBs) made by corporates form nearly 31% of the external debt.
The trouble is that a lot of this external debt needs to be repaid before March 31, 2014. NRI deposits worth nearly $49 billion mature on or before March 31, 2014. Nearly $21 billion of ECBs raised by companies need to be repaid before March 31, 2014.This will mean a demand for dollars and thus further pressure on the rupee. If India’s borrowing from abroad comes down in the coming years that will mean lesser pressure on the rupee, as the demand for dollars to repay these loans will go down. But for that to happen financial savings need to go up. And that can only happen if inflation is brought under control and real returns on fixed income instruments (like deposits, bonds etc) go up.
Of course, raising the repo rate just once by 25 basis points is not enough for all this to be achieved. Hence, chances are Rajan will keep raising the repo rate in the days to come.
The article originally appeared on www.firstpost.com on September 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)