Borrow less, don’t blame RBI: Time Jaitley stops doing a Chidu on us

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010Vivek Kaul

A favourite pastime of former finance minister P Chidambaram other than telling us that the Indian economic growth was about to bounce back, was to ask the Reserve Bank of India (RBI) to cut interest rates.
The new finance minister Arun Jaitley has carried on from where Chidambaram left.
On August 10, Jaitley had nudged the RBI to cut interest rates after taking various factors into account.

The thing with most politicians is that either they do not understand how a market operates or they pretend otherwise. Jaitley and Chidambaram, I assume would fall into the latter category. Allow me to explain.
The latest RBI annual report points out that “
the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”
Household financial savings is essentially the money invested by individuals in
fixed deposits, small savings scheme, mutual funds, shares, insurance etc. The household financial savings were at 12% of the GDP in 2009-10. Since then, they have fallen dramatically to 7.2% in 2013-14. A major reason for the fall has been the high inflation that has prevailed since 2008.
This has had two impacts. One is that expenses of people have consistently gone up, leading to lower savings. Further, of the money that was saved a higher proportion was directed towards physical savings like gold and real estate. This was done because the rate of return available on financial savings was much lower than the rate of return on gold as well as real estate. The average savings in physical assets between 2005-06 and 2007-08 stood at 11.4% of the GDP. This shot up to 14.8% in 2012-13(the data for 2013-14 is not available).
What has not helped is the fact that over the last few years the fiscal deficit of the government shot up dramatically, as its expenditure shot up at a much faster rate, in comparison its income. Fiscal deficit of the government is the difference between what it earns and what it spends. This increase in fiscal deficit was financed through increased borrowing.
In fact, buried in the
second chapter of the Economic Survey of 2013-2014 is a very interesting data point. In 2012-2013, the household financial savings amounted to 7.1% of the GDP. The government borrowing stood at 7% of the GDP. A similar comparison for 2013-2014 is not available yet. Nevertheless, it would be safe to assume that it won’t be materially different from the 2012-2013 comparison.
The conclusion that one can draw from this is that entire household financial savings were used up to fund the fiscal deficit. This is also reflected in the
following table from the Economic Survey.
average cost of borrowing
As the government borrowed more and more, eating up into the household financial savings, the cost of its borrowing also went up. In 2009-10, the average cost of borrowing stood at 7.5%. By 2013-2014, this number had shot up to 8.3%.
Lending to the government is the safest form of lending. Hence, the rate of interest that the government pays on its borrowing becomes the benchmark for all other kind of loans. Also, with greater borrowing, it left a lower amount of money available for others outside the government to borrow. As the
Economic Survey pointed out “In recent years, with a decline in the savings rate and an enlarged fiscal deficit, the external capital from outside the firm, available to the private sector has declined.”
So, with the government paying a higher rate of interest on its debt, and not enough money going around for others (which included banks) to borrow, it isn’t surprising that you and I had higher EMIs to pay.
To cut a long story short, if interest rates need to come down, the government needs to borrow less. If the government has to borrow less, it needs to spend less or try and increase its income. If this happens, there will be more money going around for everyone else to borrow, and will lead to a fall in interest rates.
Unless these things happen, any call by the finance minister asking the RBI to cut interest rates needs to be taken with a pinch of salt. The RBI may decide to humour the finance minister and go ahead and cut the repo rate (the rate at which it lends to banks). Nevertheless, any material fall in interest rates will happen only once the government is able to make serious efforts towards curtailing the fiscal deficit.
And the next time you hear Jaitley asking the RBI to cut interest rates, remember, he is trying to do a Chidambaram on us.

The article originally appeared on www.Firstbiz.com on August 23, 2014

Budget 2014: When it comes to the fiscal deficit, Jaitley has done a Chidambaram

 Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

Vivek Kaul

Alfred Hitchcock, the British director, who taught Hollywood how to make thrillers, once famously said: “The length of a film should be directly related to the endurance of the human bladder.” On a lighter note, this rule should apply to the speeches that politicians make, as well.
Arun Jaitley in his maiden budget speech as the finance minister of India, junked Hitchcock’s bladder test and went on and on and on. Early on in his budget speech Jaitley said : “My predecessor has set up a very difficult task of reducing fiscal deficit to 4.1 per cent of the GDP in the current year. Considering that we had two years of low GDP growth, an almost static industrial growth, a moderate increase in indirect taxes, a large subsidy burden and not so encouraging tax buoyancy, the target of 4.1 per cent fiscal deficit is indeed daunting. Difficult, as it may appear, I have decided to accept this target as a challenge. One fails only when one stops trying.” Fiscal deficit is the difference between what a government earns and what it spends.
So, the question is how does Jaitley plan to meet the fiscal deficit target of Rs 5,31,177 crore or 4.1% of the GDP? Jaitley has assumed that tax receipts will go up by 16.9% to Rs 9,77,258 crore during the course of this financial year (April 2014 to March 2015). In the economic survey released yesterday, the economic growth for the current financial year has been projected to be at 5.4-5.9%. Governments projections typically tend out to be more optimistic than they actually turn out to be.
In this scenario how feasible is an assumption of 16.9% growth in tax receipts? Jaitley’s predecessor P Chidambaram had assumed a growth of 19.2% in tax receipts for the last financial year. The actual growth turned out to be much lower at 12.7%. In a scenario of low growth and high inflation an assumption of 16.9% growth in tax receipts is highly optimistic and is unlikely to be achieved.
Chidambaram had gone about achieving a fiscal deficit of 4.6% of the GDP for the last financial year(April 2013 to March 2014) by largely doing two things. Subsidies on petroleum, food and fertilizer which should have been paid up by the government during the course of the last financial year, were postponed to this financial year. Estimates suggest that this amount was greater than Rs 1,00,000 crore.
Jaitley doesn’t seem to have taken this into account while working out the numbers. The total cost of subsidies for this financial year has been budgeted to be at Rs 2,55,707.62 crore. This is more or less similar to the last year’s number. Hence, unless subsidies are brought down majorly, which remains a politically unpopular move and inflationary in the short-term, this amount is unlikely to be sufficient to meet the subsidy commitments of the government. And if subsidises are not brought down, Jaitley will either have to let the fiscal deficit go up or like Chidambaram push their accounting to the next financial year.
The second thing Chidambaram did in order to achieve a fiscal deficit of 4.6% of GDP was to cut down on plan expenditure. The government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government. Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government needs to keep paying salaries, pensions and interest on debt, on time. These expenses cannot be postponed. The only thing it can do is to postpone making the subsidy payments. Hence, when expenditure needs to be cut, it is the asset creating planned expenditure which typically faces the axe and that is not good for the overall economy. If one looks at the numbers Jaitley has assumed that is the direction we seem to be headed.
The planned expenditure target of the government during the last financial year was at Rs 5,55,322 crore. The actual planned expenditure came in at Rs 4,75,532 crore, which was close to Rs 80,000 crore or 14.4% lower. This is how the fiscal deficit of 4.6% of GDP was achieved.
Jaitley has set the total planned expenditure for the year at Rs 5,75,000 crore. It is highly likely that during the last few months of this financial year (i.e. the period between January and March 2015) Jaitley might like Chidambaram have to put a freeze on this expenditure, if he hopes to achieve the fiscal deficit target that he has set. And this can’t possibly be good for the Indian economy.
Another area where Jaitley could have been aggressive is the money that can be raised through the disinvestment of public sector companies. During the course of this financial year the government hopes to earn Rs 58,425 crore through disinvestment. Chidambaram had set a target for Rs 54,000 crore but managed to earn only around Rs 19,000 crore. The advantage that Jaitley has is that the stock market has been rallying for a while. Given this, the government could have been aggressive and set a disinvestment target of close to Rs 1,00,000 crore.
What makes the fiscal deficit target of 4.1% of GDP further unrealistic is the legacy that the Congress led United Progressive Alliance has left for the Narendra Modi led National Democratic Alliance. The fiscal deficit number for the first two months of this financial year(April-May 2014) does not look good at all. Numbers released by the Controller General of Accounts suggest that for April-May 2014, the fiscal deficit of the government has already touched Rs 2.41 lakh crore.
This works out at around 45% of the fiscal deficit target of Rs 5,31,177 crore that Jaitley has set. Hence, he has only around Rs 2,90,000 crore to play around with between June 2014 to March 2015. This, of course is not Jaitley’s fault.
To conclude, this was Jaitley’s chance of presenting the true financial situation of the Indian government. He seems to have lost that chance by projecting a higher revenue than the government is likely to earn and a lower expenditure than the government is likely to spend.
The article also appeared on www.firstbiz.com on July 10, 2014

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

Continuing a legacy? When Jaitley does a Chidambaram on food inflation

 

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
Complex problems do not have straightforward answers. But politicians need to come up with simple answers in order to explain things, especially if they happen to be lawyers.
In order to tackle the high food inflation finance minister Arun Jaitley has asked states to “crack down on hoarders”. The food inflation for the month of May 2014 was at 9.5%(as measured by the wholesale price index and 9.4% (as measured by the consumer price index). Over the last ten years food inflation has averaged at 8.1% and has even gone above 10% in recent times.
Jaitley’s response to tackle food inflation was similar to what P Chidambaram had said in December 2013. “There is also a need to deal wisely with harvesting and marketing and deal strictly with hoarding and profiteering,” the former finance minister had said.
So is India’s food inflation problem only because of hoarding? As mentioned at the beginning, complex problems do not have simple answers. And India’s food inflation is a really complex problem.
One of the biggest hoarders of food is the government of India. The Food Corporation of India (FCI) indicates its grain stock at the beginning of every month. As on June 1, 2014, the food grain stock stood at 74.8 million tonnes. This primarily included rice and wheat.
This stock is much more than what is required by the government to run its various subsidy programmes and also to maintain an emergency stock and strategic reserve requirements. In fact, the Commission for Agricultural Costs and Prices(CACP), a part of the ministry of agriculture, estimated in May 2013, that anywhere between 41-47 million tonnes, would be a comfortable level of buffer stocks.
In fact, the level of the stocks with FCI has gone up dramatically since May 2004, when the Congress led United Progressive Alliance (UPA) first came to power. At the beginning of June 2004, the stock of food grain had stood at 32.3 million tonnes. It has more than doubled since then.
With more and more food grains landing up in the godowns of the government it is not surprising that price of food grains has risen over the last few years. The price of rice has risen by 12.75% over the last one year. The rise in the price of wheat has been rather subdued at 3.64%. But around the same time last year, the price of rice had risen 12.37% over a one year period.
In order to control grain prices, in the short run the government needs to sell some of its hoard in the open market. And that is exactly what it plans to do. It plans to sell 50 lakh tonnes of rice in the open market at a price of Rs 8.3 per kg. More importantly the government needs to stop hoarding rice and wheat, and not buy more than what it requires.
Other than the price of rice, the price of milk, fruits and egg, fish and meat has also risen at rapid rates of 9.57%, 19.4% and 12.47%, respectively. As far as hoarding is concerned India does not have the supply chain infrastructure required to hoard these food products. In this case, the inflation is clearly a case of the demand outstripping supply.
In a recent report titled
What a Waste Crisil Insight points out that “inflation in egg, fish and meat has consistently [been] at 10-15% since 2009. The story is similar for milk and milk products where inflation peaked above 15% in 2012.” Hence, inflation in these products is not a recent phenomenon and more than that it has nothing to do with hoarding.
Crisil Insight points out that “loose fiscal policy, rising demand for high-value food items and substantial increase in wages — especially rural wages, as a spillover [of] the rural employment guarantee scheme – have translated into higher demand for proteins. This has raised the prices of items such as milk and milk products, egg, fish and meat as supply falls short of demand. The production of milk and eggs has risen only 3-4% a year, compounded annually, during 2009-10 to 2012-13, while inflation in this category has risen 14-15%.” Hence, the only way to control inflation in this area is to encourage more production of milk, eggs, fish and meat, and that of course, needs a lot of effort and cannot happen overnight.
So that leaves us with vegetables. Vegetable prices on the whole have fallen by 0.97% over the last one year. But this aggregate hides the fact that potato prices have risen by 31.44% in the last one year. In this case, the hoarding argument can apply given that hoarding potato is far more easier than hoarding other vegetables or fruits or meat for that matter.
Interestingly, onion prices haven’t gone up in the last one year. They have fallen by 2.83% during the period. At the same time last year, onion prices had gone up by 94.28% over a period of one year. In order to stop anything along similar lines from happening again, the government has imposed a minimum export price of $300 per tonne for onions. In fact, the ministry of commerce has been asked to come up with a similar measure for potatoes as well.
Hopefully, all these measures should have some impact on the burgeoning food prices. To conclude, it is important to understand that food inflation is not just because of traders hoarding food products. Prices of different food products have risen due to different reasons over the last ten years. And these reasons need to be specifically addressed, if food prices are to be controlled.
The article was originally published on www.firstbiz.com on June 19,2014

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

 

A day ahead, who is Chidambaram fooling?

P-CHIDAMBARAMVivek Kaul 

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

P-CHIDAMBARAMVivek Kaul
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)