Six reasons why the PM’s prediction of growth will be right for a change

Manmohan-Singh_0Vivek Kaul
Over the last few days a whole host of stock brokerages and financial institutions have downgraded India’s expected rate of economic growth for 2013-14 (i.e. the period between April 1, 2013 and March 31, 2014). Even Prime Minister Manmohan Singh conceded a few days back that the projected growth of 6.5% might be difficult to achieve. “We had targeted 6.5% growth at the time the budget was presented. But it looks as if it will be lower than that,” he said.
Politicians are typically the last ones to concede that things are going wrong. And when they do come around to admitting it, then that is the time one can really believe what they are saying.
So to cut a long story short, for a change, Manmohan Singh’s statement made a few days back might very well come out to be true by the end of this financial year.
Attempts are being made by the government to revive the economy (or at least that is what they would like us to believe), but they are unlikely to lead to any immediate improvement. Analysts at Nomura led by economist Sonal Varma give out some likely reasons for the same in a recent report titled 
India: turbulent times ahead. “We are downgrading our GDP(gross domestic product) growth forecasts to 5.0% year on year in FY14 (from 5.6%),” write the Nomura analysts. 
Lets look at some of the reasons:
The government’s current reform zeal isn’t going last for long. Elections in five states are to be held in December 2013/January 2014. These states are Delhi, Mizoram, Madhya Pradesh, Rajasthan and Chattisgarh. The Congress is not in power in three out of the five states. Also, the party is likely to face a tough time in Delhi. Given these things it is highly unlikely that the party will continue with the “so-called” reform process that it has initiated in the recent past.
One of the lasting beliefs in Indian politics is that economic reform is injurious to electoral reforms. Or as the Nomura authors put it “The window for reforms is fast closing…(It) will close after September…Given the negative consequence of past government inaction(on the reform front), this is a case of too little, too late (to revive growth).”
Also, as the elections approach it is likely that prices of petrol, diesel and cooking gas will not be raised in line with the international price of oil. This happened before the recently held Karnataka assembly elections as well. Hence, the fiscal deficit of the government is likely to continue to go up. “We are concerned with the government’s ability to stick to its budgeted fiscal deficit target,” write the Nomura analysts. Fiscal deficit is the difference between what a government earns and what it spends.
When a government spends more, it has to borrow more in order to finance that spending. Hence, it “crowds-out” other borrowers, leaving a lesser amount of money for them to borrow. This pushes up interest rates. At higher interest rates people and businesses are less likely to borrow and spend. This impacts economic growth negatively.
New investments have dried down: Investments made by companies to expand their current businesses or launch new ones have dried down. “New investment projects announced have fallen from a peak of Rs 2300000 crore in the first quarter of 2009 to Rs 300000 crore in the second quarter of 2013…Investments are long-term decisions and there is a lag between an investment’s announcement and its execution,” write the Nomura authors. Hence, even if a company starts with an investment now, its impact on economic growth will not be felt immediately.
What adds to India’s woes is the fact that sectors like power generation & distribution, infrastructure developers & operators, construction, telecom services etc, which drove the last round of investments between 2004 and 2007 are deep in debt, and in no position to continue investing.
The political uncertainty that prevails will also lead companies to postpone long term capital expenditure decisions till there is hopefully more certainty next year after the Lok Sabha elections in May 2014. As the Nomura analysts write “Given this political uncertainty and an already dismal starting position, we believe that corporates will choose the prudent option of delaying long-term capex decisions until there is more political certainty.”
In fact this trend was visible in the poor results of the heavy engineering and construction major Larsen and Toubro, for the three month period ending June 30, 2013.
Banks have become cautious while lending. Even if a company may be ready to invest they might find it difficult to get the loans required to get the project going. This is primarily because the non performing loans and restructured loans of banks have risen to around 10% of their total loans. This figure was at a level of around 4% four years back. As the Nomura authors write “This worsening credit quality has impelled banks to become more risk averse when lending.”
Consumer demand will continue to remain sluggish. Car sales have now fallen nine months in a row. High interest rates are often offered as a reason for the falling sales. But as this writer has pointed out in the past, in case of car loans, even a cut of interest rates by 100 basis points brings down the EMI only by around Rs 200.
Hence, people are not buying cars primarily because they are insecure about their jobs and businesses. As the Nomura analysts point out “The job market remains moribund. India does not have good employment data, but given continued job losses in banking and financial services, slowing job growth in the IT sector and sluggish manufacturing sector employment, we do not see a sustainable consumption recovery without an improvement in employment prospects.” Weak consumer demand translates into lower profits for businesses and low economic growth.
One of the main reasons for weak consumer demand has been the fact that till very recently the government did not pass on the increase in the price of oil to the end consumers in the form of a higher price for diesel, petrol or cooking gas. But that has changed now. “Consumers used to be insulated from rising fuel and energy costs (diesel, petrol, LPG cylinder, electricity), but now they are forced to bear a higher burden of adjustment, thereby reducing their disposable income,” the Nomura analysts point out. Add to that a very high food inflation of nearly 10% and you know why the Indian consumer is not spending as much as he was in the past.
Indian imports will continue to remain high. The government and the Reserve Bank of India have gone hammer and tongs after gold imports. Through various measures they have managed to bring down gold imports to 31.5 tonnes for the month of June 2013. Hence, gold imports are down by nearly 81% from the 141 tonnes that the country imported in May 2013.
The government’s hatred for gold is primarily because India’s foreign exchange reserves are at very low levels when compared to its imports. Indians foreign exchange reserves are now down to a little over six months of imports, a level last seen in the 1990s. 
By making it difficult to buy gold, the government hopes to preserve precious foreign exchange reserves. The trouble is that such an alarming fall in gold imports has led the intelligence agencies to believe that a lot of gold is now being smuggled into the country.
The government may be clamping down on gold imports but there are other imports it really doesn’t have much control on. “The commodity intensity of imports is high,” write Nomura analysts as India imports coal, oil, gas, fertilizer and edible oil. And there is no way that the government can clamp down on the import of these commodities, which are an everyday necessity.
When these commodities are imported they need to paid for in dollars. Hence, rupees are sold and dollars are bought. This leads to a surfeit of rupees in the market and a shortage of dollars, and pushes down the value of rupee against the dollar further.
A weaker rupee will lead to Indian oil companies having to pay more for the oil they import. If this increase is not passed onto end consumers (given the upcoming state elections), then it will add to the fiscal deficit of the government.
RBI can’t manage the impossible trinity: The RBI currently faces the trilemma of ensuring that the rupee does not go beyond 60 to a dollar, allowing free capital movement and at the same time run an independent monetary policy. This is not possible. Expectations were that the RBI will cut the repo rate in its next monetary policy to help revive economic growth. Repo rate is the interest rate at which the RBI lends to banks.
But at lower interest rates chances are foreign investors will pull out money from the Indian bond market. When they do that they will be paid in rupees. These rupees will be sold and dollars will be bought. When this happens there will be a surfeit of rupees in the market and which will weaken the value of the rupee further against the dollar. This will create problems for the government which will have to bear a higher oil bill. Businesses which have borrowed in dollars will have to pay more in rupees in order to buy the dollars they will need to repay their loans. Imports will become costlier and that will add to inflation, impacting economic growth further.
Given these reasons it is unlikely that India will return to high economic growth rates of 8-9% any time soon. Manmohan Singh might be finally proved right on something.

The article originally appeared on on July 23, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Gold fever accelerates, never mind the trade deficit


Vivek Kaul

The law of demand in economics states that all other things remaining the same, the demand for a good is inversely proportional to its price. So if the price falls, the demand goes up and vice versa.
This identity holds on a lot of occasions but not on all occasions.
Allow me to elaborate.
Indian gold and silver imports for the month of April 2013, were at $7.5 billion. This was 138% more than imports during April 2012. This has come across a surprising development for many. “The rise in gold imports is surprising,”
Trade Secretary S.R. Rao told reporters at a press conference after the import numbers came out. “It wasn’t expected,” he added.
In fact predictions made by people who follow the gold market closely were exactly the opposite. Mohit Kamboj had
told PTI in middle of last month that “the imports of the yellow metal is likely to be 25 per cent less than the corresponding month last year as the gold prices are declining steadily.” He has been way off the mark. Kamboj is the President of the Bombay Bullion Association.
So why did Rao find this sudden increase in the import of gold surprising? Or why did Kamboj expect gold imports to fall?
The rise in gold imports is in line with the law of demand. As gold prices fell, people got out and bought more of it. The trouble is that people were buying more gold even when its price was going up. As economists Sonal Varma and Aman Mohunta of Nomura wrote in a report titled
India: Correlation between gold prices and demand released on April 23, 2013, “The correlation between the gold price and gold demand (import volume) in India shifted from being negative pre-2008 to positive since 2009. This means that in recent years a rising gold price was accompanied by rising demand, and vice-versa.”
So people were buying gold when its price was going up and now people are buying gold again, when its price has crashed. Also in between gold imports fell as gold prices crashed. Between January and March 2013, India imported 200 tonnes of gold which was around 23.7% lower than during the same period in 2012.
Let me rephrase the entire argument again then. People were buying gold when its prices were going up. People went slow on buying gold when its prices were coming down. And people are now buying gold again with a vengeance, when the prices have crashed and have started to go up again.
How do we explain this? What is happening here? Maggie Mahar has some sort of an answer for this in her book
Bull – A History of the Boom and Bust, 1982-2004. As she writes “In the normal course of things, higher prices dampen desire. When lamb becomes too dear, consumers eat chicken; when the price of gasoline soars, people take fewer vactations. Conversely, lower prices usually whet our interest: colour TVs, VCRs, and cell phones became more popular as they became more affordable. But when a stock market soars, investors do not behave like consumers. They are consumed by stocks. Equities seem to appeal to the perversity of human desire. The more costly the prize, the greater the allure.”
Replace the word ‘equity’ with gold here and the argument stays the same. When the price of gold was going up, people were looking to make a quick buck because they expected that the price of gold will continue to go up, and so they bought. Hence, higher prices of gold, led to higher demand and thus to higher imports in the Indian case. It is important to remember here that those who were buying gold at higher prices were looking at it as a mode of investment/speculation.
When the price of the yellow metal started to fall, the speculators got out of the race. And thus the demand fell, and so did the imports. After the price had fallen sufficiently enough, only then did the consumers of gold start to buy it. It is important to remember that world over gold is looked upon as a hedge against inflation but in India it is a hedge against inflation as well as a consumable good. Gold jewellery is a very important part of the Indian way of life. And once prices had fallen to the levels they have in the last one month, it is this demand that has come in and pushed up gold imports by 138%.
Hence, those making predictions on gold, should well remember that in India, it is both a mode of investment/speculation as well as a consumable good. And when prices fell, it is those who look at gold as a consumable good, start buying.
As Sonal Varma and Aman Mohunta of Nomura write in a report titled
India: Trade deficit worsened sharply in April on higher gold imports released on May 13,2013 “The recent fall in gold prices suggests that gold import volumes should moderate this year. This is not yet happening, but we see the recent rise in gold imports as a bunched up rise in consumption demand, which should fade over the coming quarters.”
Of course this is assuming that the price of gold continues to remain flat. If it starts to rise (in fact it has already risen by more than 5% from the low of $1360 per ounce (1 troy ounce equals 31.1 grams)) then investor/speculator demand will come in again. In fact, if the price of gold falls further, the speculators/investors might come back in again, sensing a good trade.
What this means is that despite massive efforts by the government to bring down gold imports, Indians have continued to buy gold. And since India produces very little amount of gold, it has to import almost all of what it consumes. This is reflected in the trade deficit (or the difference between imports and exports) for the month of April 2013, which has come in at $17.8 billion. This is a jump of 72% from March 2013. Gold and silver imports at $7.5 billion, formed a major part of it. The gold import numbers for May are likely to be high again, given the festival of Askhay Tritya which is being celebrated today (i.e. May 13, 2013)
will trigger a rush for the yellow metal. Askhay Tritya is considered to be an auspicious day to buy gold.
Since gold is imported, a demand for gold triggers a demand for dollars, which are used to buy gold. And this leads to the rupee losing value against the dollar. This in turn makes other imports like oil and coal also expensive. Hence, efforts have been made by the government in the past to limit gold imports.
To conclude, in March, the finance minister P Chidambaram had told CNBC TV 18 “On gold, I can only appeal to you and through your channel to the people that to not demand so much gold.”
Of course people have gone ahead and done exactly the opposite. Chidambaram had also told CNBC TV 18 “However, I am not sure too many people will listen to me on that.”
Not many did, it seems.
The article originally appeared on on May 14, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)