With Jaitley talking about 10% growth, should Rajan be cutting interest rates?


The budget presented by finance minister Arun Jaitley on Saturday, February 28, 2015, leads me to ask—will the Reserve Bank of India(RBI) governor Raghuram Rajan cut the repo rate now? Repo rate is the rate at which the RBI lends to banks and acts as a sort of a benchmark to the interest rates at which banks carry out their lending business. Rajan had last cut the repo rate in January by 25 basis points(one basis point is one hundredth of a percentage) to 7.75%.
In the commentary that accompanied the interest rate cut, Rajan had said that the
key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained high quality fiscal consolidation.”
What Rajan meant here was that further repo rate cuts would happen if inflation kept falling or remained where it was. At the same time he would expect the government to work towards bringing down its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
The government finances the fiscal deficit through borrowing. If the fiscal deficit goes up, the government borrowing also goes up, leading to what economists call the “crowding out” of the private sector.
The government borrowing more, leaves a lower amount of money for others to borrow and in turn pushes up interest rates. Further, increased government expenditure is also likely to lead to higher inflation, with more money chasing the same number of goods and services. In fact, the recent era of double digit inflation that prevailed in the country was primarily because of the Indian government increasing its spending. Given this, it is very important that the RBI governor keep a watch on the fiscal deficit number.
When Jaitley had presented his first budget in July 2014 he had said: “My Road map for fiscal consolidation is a fiscal deficit of 3.6 per cent for 2015-16 and 3 per cent for 2016-17.” Hence, the impression he had given in July and in the months that followed was that the government would work towards bringing down fiscal deficit in the years to come.
But in the budget speech that he made on Saturday, Jaitley abandoned this promise. As he said during the course of the speech: “I will complete the journey to a fiscal deficit of 3% in 3 years, rather than the two years envisaged previously. Thus, for the next three years, my targets are: 3.9%, for 2015-16; 3.5% for 2016-17; and, 3.0% for 2017-18.”
In absolute terms, the fiscal deficit that Jaitley is targeting is Rs 5,55,649 crore, against the Rs 5,12,628 crore, during this financial year. The question how is that will Rajan cut interest rates now, given that Jaitley has postponed the fiscal consolidation plans. The first bi-monthly monetary policy statement for fiscal year 2015-16 is scheduled on April 7, 2015.
The Economic Survey presented a day before the budget on February 27, 2015, forecasts that the economic growth during 2015-2016 (period between April 1, 2015 and March 31, 2016) will be between 8.1-8.5%.
The survey lists a number of reasons to back this forecast: “In the short run, growth will receive a boost from lower oil prices, from likely monetary policy easing facilitated by lower inflation and lower inflationary expectations, and forecasts of a normal monsoon.”
As I have written a few times by now the ministry of statistics and programme implementation recently revised the way in which the gross domestic product is calculated. This revised method led to the economic growth for 2013-2014 being revised to 6.9% against the earlier 5%. In fact, using the new model the growth projected for 2014-2015 is at 7.4%.
The high frequency data that keeps coming out suggests otherwise. For the period October to December 2014, corporate profits on a whole fell. Car sales which are an excellent economic indicator remain muted and are only expected to go up by 3-5% during this financial year. Lending by banks is much slower than it has been over the past few years. Exports during the course of this financial year have gone up by only 2.44% to $258.72 billion. The indirect tax collections have risen by 7.4% during this financial year. When the budget was presented in July 2014, it was expected that indirect taxes would grow by 20.3%.
Other data appearing in the Economic Survey all suggest that all is not well with the Indian economy. “The stock of stalled projects at the end of December 2014 stood at Rs
8.8 lakh crore or 7 per cent of GDP,” as per the Economic Survey. While the rate of stalled projects has come down a little, it still remains very high.
Further, data in the Economic Survey shows that household savings (both physical and financial) have collapsed from 25.2% of the GDP in 2009-2010 to 17.8% of the GDP in 2013-2014. This is a huge collapse.
Household financial savings have fallen from 12% of the GDP to 7.2% of the GDP. High inflation that prevailed over the last few years is a major reason for the same. Inflation has been brought under control only very recently. What this means is that the Indian consumer might decide to rebuild his savings over the next couple of years instead of getting his shopping bags out. This means that the consumer spending may not pick up, as it is expected to. And if consumers go slow on spending, it doesn’t help businesses as well as the overall economy.
Nevertheless, it seems that the finance minister has bought in to these new growth forecasts. As he said during the course of his speech: “Based on the new series, real GDP growth is expected to accelerate to 7.4%, making India the fastest growing large economy in the world…We have turned around the economy dramatically, restoring macro-economic stability and creating the conditions for sustainable poverty elimination, job creation and durable double-digit economic growth. Domestic and international investors are seeing us with renewed interest and hope.”
Given the fact Jaitley is now talking about 10% economic growth, should Rajan really be cutting the repo rate? Now that’s something worth thinking about.

The column originally appeared on The Daily Reckoning on Mar 2, 2015

Why 7% economic growth looks difficult despite new GDP data

deflationVivek Kaul

Pessimism sells. For reasons I have never understood, people like to hear that the world is going to hell, and become huffy and scornful when some idiotic optimist intrudes on their pleasure.” Professor Deirdre McCloskey – Quoted in The Absolute Return Newsletter

Last Friday the ministry of statistics and programme implementation released a new way of measuring the gross domestic product. The ministry changed the base year for measuring GDP from 2004-2005 to 2011-2012.
The structure of an economy keeps changing. Further, the quality of data that the government has access to keeps improving as well. These changes need to be incorporated in the way the GDP is calculated.
As Crisil Research points out in a recent research note: “The revised series is much wider in scope. The coverage has now expanded to include trade carried out by manufacturing companies (this was earlier a part of trade under service sector), and, among others, partnership firms covered under Limited Liability Partnership Act.”
In fact, as per the new GDP data the Indian economy grew by 4.9% during 2012-13, and 6.6% during 2013-14. The earlier calculations had suggested that the Indian economy grew by 4.5% in 2012-2013 and 4.7% in 2013-2014.
The expected GDP numbers for 2014-2015 calculated as per the new method will be released on February 9, 2015. While the difference in GDP growth is not much in 2012-2013, the difference in 2013-2014 is significant. “Private consumption, government consumption and fixed investment growth were all understated in the old series,” points out Crisil Research explaining why the GDP growth in 2013-2014 jumped as per the new method.
This jump in growth has been questioned by Arvind Subramanian, the chief economic adviser to the ministry of finance.
In an interview to the Business Stanard he said: “This is mystifying because these numbers, especially the acceleration in 2013-14, are at odds with other features of the macro economy. The year 2013-14 was a crisis year – capital flowed out, interest rates were tightened and there was consolidation – and it is difficult to understand how an economy’s growth could be so high and accelerate so much under such circumstances.”
Raghuram Rajan, the governor of the Reserve Bank of India, also advised caution.
As he said in a press conference on February 3, 2015: “We do need to spend more time understanding the GDP numbers and we will be watching February 9 releases with great care and delve in deeply into what we see there. At this point, it is premature to take a strong view based on these GDP numbers. Most of the data that we have seen for 2013-2014, except inflation which was very strong, give us a sense that there was lack in the economy.”
Nevertheless, this jump has led to the belief that the economic growth during the current financial year will be much higher than the 5.5% economic growth that has been previously projected.
An editorial in the Business Standard newspaper pointed out: “The new numbers for 2014-15 will be published on February 9, but the expectation certainly now is that the number will be even higher, perhaps in excess of seven per cent.”
Other ground level data suggests that this is too optimistic. As economists Taimur Baig and Kaushik Das of Deutsche Bank Research point out: “Evidence at the ground level (i.e. sales and earnings data from corporates) and other high frequency macro indicators continue to indicate that the economy is yet to see a capex recovery and meaningful pick-up in activities.”
The quarterly results of companies for the period October to December 2014 have been very poor
As Swaminathan Aiyar writes in The Economic Times: “CNBC data show that for 664 companies that till last week had declared their financial results for the third quarter, sales are up just 1.3% and net profits by just 3.4% on a year-on-year basis. On a quarter-on-quarter basis, sales are down 2.8% and net profits by 6.1%.”
Inflation is not factored into corporate results. Nevertheless, if we do that it is safe to say that sales and profits of companies have fallen on a yearly basis as well. This is clear evidence of the fact that the overall economy is not doing well. It also gives an indication of the fact that consumers are not ready to spend freely.
Given that companies are not doing well, it has also led to a slow growth in tax revenues for the government. At the time the government presented its budget in July 2014, it had assumed that the tax revenues would grow by 16.9% in comparison to the last financial year. But the tax collected for the first nine months of the financial year between April and December 2014 grew by just 5.4% in comparison to the same period in the last financial year. In fact, the growth in excise duties has been more or less flat at 0.2%.
Another factor to look at are bank loans. Latest data released by the RBI shows that bank loans have grown by just 6.6% during the course of this financial year. They had grown by 10.1% during the same period in the last financial year. This is a clear indication of the fact that businesses as well as consumers are not in the mood to borrow.
Then there are stalled projects as well. As Arvind Subramanian, the chief economic adviser to the ministry of finance wrote in the Mid Year Economic Analysis released in December 2014: “Stalled projects to the tune of Rs 18 lake crore (about 13 percent of GDP) of which an estimated 60 percent are in infrastructure. In turn, this reflects low and declining corporate profitability as more than one-third firms have an interest coverage ratio of less than one (borrowing is used to cover interest payments).”
Unlike the GDP which is a theoretical construct, these are real numbers and they don’t look very good. Even the Reserve Bank of India remained sedate about the growth scenario. As it said in the latest
monetary policy statement released on February 3, 2015: “Advance indicators of industrial activity – indirect tax collections; non-oil non-gold import growth; expansion in order books; and new business reported in purchasing managers surveys – point to a modest improvement in the months ahead.”
Given these reasons I would be surprised if the GDP growth number to be released on February 9, 2015, will turn out to be close to 7% or more. If it does that will certainly be a huge surprise.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Feb 5, 2015

The IMF growth forecast for India needs to be taken with a pinch of salt

imf-logoVivek Kaul

The only function of economic forecasting is to make astrology look respectable.” – John Kenneth Galbraith

Every bull market needs a story. In fact, different phases of the same bull market need different stories.
The latest story to hit the Indian stock market is that India will grow faster than China in 2016. This economic forecast has been made by the International Monetary Fund (IMF) in the World Economic Forum Outlook Update which was released yesterday (January 20, 2015). In this update, the IMF expects India to grow by 6.5% against China’s 6.3%.
This forecast is along the lines of another forecast made by the World Bank on January 14, where it said that India will grow by 7% in 2017-2018. It expects China to grow by 6.9% during the course of that year.
The IMF offers reasons as to why it sees growth in China slowing down from 7.8% in 2013 to 6.3% in 2016. “Investment growth in China declined in the third quarter of 2014, and leading indicators point to a further slowdown. The authorities are now expected to put greater weight on reducing vulnerabilities from recent rapid credit and investment growth and hence the forecast assumes less of a policy response to the underlying moderation,” the IMF states.
For India, the IMF states that the “weaker external demand” will be “offset by the boost to the terms of trade from lower oil prices and a pickup in industrial and investment activity after policy reforms.”
As far as justifications are concerned, you cannot get more general than this. Having said that, this bit of news drove the BSE Sensex to rally by 1.84% to close at 28,784.67 points on January 20. The foreign insitutional investors who have been at the forefront of driving the Indian stock over the last few years, bought stocks worth Rs 1275.59 crore. The domestic insitutional investors, who on most days do the opposite of what the FIIs are doing sold stocks worth Rs 761.7 crore.
With India likely to grow faster than China in the years to come, it is but natural that FIIs want to bet their money on India. Nevertheless, the question is, should the IMF forecast on India (or even their forecasts in general) be taken so seriously?
IMF forecasts in general have a certain amount of optimism bias built into them. As Chris Giles wrote
in the Financial Times in October 2014: “Between 2011 and 2014, these forecasts have averaged 0.6 percentage points higher than the outturn…In the very laudable exercise to examine what went wrong, the fund discovered about half of its errors came from predicting greater strength in Brics countries – Brazil, Russia, India and China – than occurred.”
So, in the recent years the forecasts made by IMF have been going wrong big time. In fact, in the aftermath of the financial crisis, the forecasts have been going wrong since 2009. As Alex Christensen writing
in a June 2014 article for Global Risk Insights points out: “Every year since 2009, the IMF has overestimated the growth of not only the US but also of Europe and the world…Since 2009, when economic prospects looked dour, these forecasts have consistently been too optimistic. In 2010 and 2011, the IMF projected the world to catch up to the pre-crisis GDP trend by 2015. Now, it projects that world output will still be 4% lower than the pre-crisis trend in 2018.”
What these insights tell us is that IMF forecasts usually turn out to be wrong. In fact yesterday’s outlook release was an update on forecasts first made in October 2014. And sample what IMF had to say in this release: “Global growth in 2015–16 is projected at 3.5 and 3.7 percent, downward revisions of 0.3 percent relative to the October 2014 World Economic Outlook (WEO). The revisions reflect a reassessment of prospects in China, Russia, the euro area, and Japan as well as weaker activity in some major oil exporters because of the sharp drop in oil prices.”
In a period of less than four months the IMF has had to revise the global growth numbers majorly. Taking these factors into account, it is safe to say that IMF’s forecast for India growing at 6.5% in 2016 will turn out to be wrong. And given this, this and other forecasts made by the IMF need to be taken with a pinch of salt.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The article originally appeared on www.firstpost.com on Jan 21, 2015

A day ahead, who is Chidambaram fooling?


An important part of finance minister P Chidambaram’s job for a while has been to keep telling us that “all is well” on the economic front.
He continued with this on the last day of the financial year when he said “the Indian economy is now stable and the fundamentals have strengthened.” The statement was in response to 18 questions on the economy posed by former finance minister and BJP leader Yashwant Sinha.
So how strong is the Indian economy? “We have contained inflation. Our biggest success is containing fiscal deficit,” said Chidambaram.
But how do the numbers stack out? In February 2014, inflation as measured by the consumer price index was at 8.1%. It has come down from levels of greater than 10%. The primary reason for the same has been a rapid fall in food prices. Food products make up for around half of the consumer price index. The question is how much credit for the fall in food prices goes to the government? Not much. Also, it is worth reminding here that unseasonal rains and hailstorms in parts of the country have damaged crops, and this is likely to push up prices again.
If we look at non fuel-non food inflation, or what economists refer to as core inflation, it stood at 7.9% in February 2014. This number has barely budged for a while now. Non fuel-non food inflation takes into account housing, medical care, education, transportation, recreation etc.
What about the fiscal deficit? “We will end FY14[period between April 2013 and March 2014] with a fiscal deficit of 4.6%, as planned,” Chidambaram said. Fiscal deficit is the difference between what a government earns and what it spends.
But how has this target been met? A lot of expenditure has simply not been recognised. Oil subsidies of Rs 35,000 crore have not been accounted for. Estimates suggest that close to Rs 1,23,000 crore of subsidies (oil, fertilizer and food) have been postponed to next year. A March 4 report in this newspaper pointed out that the central government owes the states Rs 50,000 crore on account of compensation for the central sales tax.
On the income side, public sector banks have been forced to give huge dividends to the government despite not being in the best of shape. Coal India Ltd has paid the government a dividend and a dividend distribution tax of close to Rs 19,600 crore. India has the third largest coal reserves in the world but still needs to import coal. Shouldn’t this money be going to set up new coal mines? Neelkanth Mishra and Ravi Shankar of Credit Suisse point out in a recent report titled 
Elections: Much Ado about Nothing dated March 19, 2014 that “True utilisation in thermal power generation is below 60%, near 20-year lows (reported plant load factor is 65%).” This is because we don’t produce enough coal that can feed into the power plants.
Getting back to Chidambaram, he further said “The CAD has contracted. We have added to reserves. FY14 CAD is likely to be about $35 billion.” 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.
This has largely happened because of two things. The government has clamped down on legal gold imports. But anecdotal evidence suggests that gold smuggling is back with a huge bang. This has a huge social cost. Also, over the last few months non gold non oil imports have fallen due to sheer lack of consumer demand. And that surely can’t be a good thing.
Chidambaram also expects “spirited growth going forward”. The finance minister has been spinning this yarn for a while now. In early February he had said that the economy will grow by 5.5% in this financial year.
Growth during the first three quarters of the financial year has been less than 5% (4.4% in the first quarter, 4.8% in the second quarter and 4.7% during the third quarter). A simple back of the envelope calculation shows that the economy will have to grow by 8.1% in January to March 2014, for the Indian economy to grow by 5.5% during 2013-2014. You don’t need to be an economist to realise that this is not going to happen.
Interestingly, in July 2013 Chidambaram had said that “People should remember India continues to be the second fastest growing economy after China.” By January 2014 this statement had changed to ““India remains one of the fast growing large economies of the world.” What happened in between? A whole host of countries in our neighbourhood have been growing faster than us. This includes countries like Cambodia, Philippines, Indonesia, Sri Lanka and even Bangladesh.
Given these reasons, it is fair to say that Chidambaram was cracking an April Fools’ joke, a day early.

The article appeared  in the Daily News and Analysis dated April 1, 2014
(Vivek Kaul is the author of Easy Money. He can be reached at [email protected]

If Chidu’s growth prediction has to be met India will have to grow by 8% this quarter

Economist Bibek Debroy in a recent column in The Economic Times wrote about a perhaps apocryphal story about John Maynard Keynes, the greatest economist of the twentieth century. Keynes it seems was once asked “How is your wife?”. “Compared to whose wife?” Keynes questioned back (on a totally unrelated note Keynes was married to a Russian ballerina named Lydia Lopokova).
The point Keynes was perhaps trying to make is that comparisons are always relative.
The finance minister P Chidambaram has been following this for a while now. He has been comparing the Indian economic scenario with the Western countries, and trying to tell us that we’re not in as bad a scenario as is being made out to be.
In interim budget speech Chidambaram said “World economic growth was 3.9 percent in 2011, 3.1 percent in 2012 and 3.0 percent in 2013. Those numbers tell the story. Among India’s major trading partners, who are also the major sources of our foreign capital inflows, the United States has just recovered from a long recession; Japan’s economy is responding to the stimulus; the Eurozone, as a whole, is reporting a growth of 0.2 percent; and China’s growth has slowed from 9.3 percent in 2011 to 7.7 percent in 2013…The challenges that we face are common to all emerging economies. 2012 and 2013 were years of turbulence. Only a handful of countries were able to keep their head above the water, and among them was India.”
So, if we compare India to the other countries, we are not in as bad a situation as is being made out to be. Or so Chidambaram has tried to tell us over and over again. In fact, in July 2013, 
he had said that “People should remember India continues to be the second fastest growing economy after China. Even China’s growth which was at 10% has come down to 7% now, while our growth has slid to 5% from 9%…Economic slowdown is there in all the countries. When there is slow growth rate in the world, India cannot remain unaffected.”
Now compare this with what he said in January, 2014. “India remains one of the fast growing large economies of the world,” Chidambaram 
said on January 15, 2014.
From being the second fastest growing economy in the world in July 2013, India had become one of the fast growing large economies in the world, as per Chidambaram. What happened during this period? What is Chidambaram not telling us?
As Mythili Bhusnurmath wrote in a recent column in the The Economic Times “Because we’re not even among the top five or 10! A look at recent World Bank data on GDP growth in 2013 shows we’ve been overtaken not just by China but by a host of countries: Cambodia (7.3%), Philippines (6.9%), Indonesia (6.2%), Myanmar (6.8%), Vietnam (5.1), Sri Lanka (7.0%) and, hold your breath, Bangladesh (5.8).”
The thing with comparisons is that one can choose who one is compared with, and make oneself look better. And that is what Chidambaram has been doing all this while. When Indian economic growth is compared with countries in the emerging markets, the ‘real’ picture comes out. Our economic growth (as measured through GDP growth) is slower than that of even Bangladesh.
Over and above this, when comparisons of these kind are made, the “base effect” also comes into play. As per World Bank Data the gross domestic product of the United States in 2012 was around $16.2 trillion dollars. If the US economy grows by 2% it adds around $324.9 billion of output to the economy.
The size of the Indian economy(i.e. Its GDP) in 2012 as per the World Bank data was $1.82 trillion. So, if the Indian economy has to grow by $324.9 billion in a year, it will have to grow at close to 17.6% or nearly nine times the pace at which the US economy grew. Hence, a 2% growth in the US goes a much longer way than even a 10% growth in India, because the growth is on a higher base. Also, this growth is to be shared among fewer people in comparison to India, and hence, has a greater impact.
Lets try and understand this through real numbers. During 2013, the US economy grew by 2.5%. At the end of 2012, the GDP of the US economy was $16.2 trillion, as mentioned earlier. A growth of 2.5% means that around $406 billion of output was added to the economy. This added output is to be shared among 32 crore Americans.
Now lets to the same exercise for India. During the period 2013, the Indian economy grew by around 4.7%. In 2012, the GDP of the Indian economy was at $1.82 trillion. This means an output of around $86.5 billion was added to the economy. This added output is to be shared among more than 120 crore Indians.
Hence, the US is much better of at 2.5% growth than India is at 4.7%.
Also, the United States, most countries in the Euro Zone and Japan are developed countries. Hence, even if they grow at low rates, it does not matter beyond a point. That is not the case with India, which continues to be a very poor country, and the only way for it to come out of this rut is faster economic growth.
India’s economic growth, as measured by the growth of the GDP, for the period between October and December 2013 came in at 4.7%. In fact, the fastest growing industry was financing, insurance, real estate and business services, which grew by 12.5%, in comparison to the same period in 2012.
This industry had grown by 10% in the three month period between July and September 2013. And it had grown by 8.9% during April and June 2013.
So how did this growth suddenly jump to 12.5%? 
An editorial in The Financial Express has an explanation. “Had it not been for the $34 billion the RBI managed to get by way of FCNR[Foreign Currency Non-Repatriable] deposits in the last quarter of 2013—the result of it agreeing to share the cost of currency hedging with investors—the growth would have been dramatically lower than even the 4.7% headline number. The bulk of growth in Q3 came from a bump in the financing/insurance sub-sector where the major change was really the FCNR deposits growth… Since this segment’s growth rose from 10% in Q2 to 12.5% in Q3, this alone resulted in a higher growth of 0.48 percentage points. In which case, it is a safe bet to assume Q3 GDP growth was around 4.3-4.4% without the one-time RBI bump.” Hence, if the FCNR deposits hadn’t suddenly shot up, the growth would have been lower than 4.7%.
In the first quarter of the 2013-2014(i.e. the period between April 1 and June 30, 2013) came in at 4.4%. In the second quarter (i.e. the period between July 1 and September 30, 2013) it came in at 4.8%. So what this means is that we are set of another year in which the economic growth will be less than 5%.
Chidambaram had said in February that there are signs of upturn in the economy and the economic growth for the year 2013-2014 (the period between April 1, 2013 and March 31, 2014) will be at 5.5%. A back of the envelope calculation shows that the economy will have to grow by 8.1% in January to March 2014, for the Indian economy to have grown by 5.5% during 2013-2014. And that is not going to happen. Economic growth for the period 2013-2014 will be less than 5% and that is a safe prediction to make. This is the first time since the mid 1980s that India will grow at less than 5% for two consecutive years.
Of course, Chidambaram is not telling us that.
The article originally appeared on www.FirstBiz.com on March 4, 2014

 (Vivek Kaul is a writer. He tweets @kaul_vivek)