The Hindu : A note of cautious optimism

Online edition of India's National Newspaper
Tuesday, Nov 11, 2003

Business

Business

A note of cautious optimism

By Prem Shankar Jha

As was to be expected, the Reserve Bank of India has struck a note of cautious optimism about the near term prospects of the Indian economy. It could hardly have done otherwise. The inflation rate has moderated after spiking above 6 per cent in April and May. Foreign exchange continues to pour in — $17.2 billion in April to mid-October, making the management of the external economy noticeably easier than it has ever been. The monsoons were wonderful, with 33 out of 36 meteorological divisions receiving normal to excess rainfall.

It is hardly surprising that the RBI has raised its estimate of growth to between 6.5 and 7 per cent this year. In fact this estimate is likely to prove too conservative, for it does not take into account the impact of the excellent monsoons on the area sown during the rabi season, and the further increase in industrial production that will occur in the last four months of the current year as the large increase in farmers' purchasing power hits the market.

All in all it would be surprising indeed if the GDP did not grow by 7.5 per cent or more this year. Were that to happen, it would raise the average growth rate for 2002-04 to just about 6 per cent, which would be a great deal better than the economy has been doing since 1997.

Where the report is less than satisfactory is in its delineation of the immediate risks to the economy that need to be guarded against. The first is the effect that the appreciation of the rupee is having on India's exports. The RBI says that exports have grown by 10 per cent in the first half of the year and that this is okay. What it does not point out anywhere is that the bulk of this increase took place between April and June. In July export growth fell to 5 per cent and in August to 4 per cent.

The reason for this is the 4.8 per cent appreciation of the rupee against the dollar since the end of March, which has come on top of a 3 per cent appreciation in the previous half year. The RBI seems to think that this does not matter too much because it reflects adjustments between the values of the currencies of the highly industrialised countries. Thus while the rupee has appreciated against the dollar, it has depreciated by 2.3 per cent against the Euro, 2.5 per cent against the pound sterling, and 4.2 per cent against the yen. The one therefore wipes out the other. This is where complacence creeps into the report. It is given away by the choice of currencies to compare the rupee against. These are all the main buyers of India's exports, not its main competitors in their markets. The RBI's complacence would have been justified if it had also compared the value of the rupee against the Chinese yuan, the Malaysian ringgit, the Thai baht, the Korean won and the Indonesian rupiah. Only if these too have appreciated against the dollar does India have nothing to worry about. I strongly suspect that they, or at any rate most of them have no done so.

There is also nothing specific in the report warning the government against the speculative nature of the capital inflows into the Indian market, especially in October. While foreign institutional investment accounted for only $2.8 billion out of the $6.4 billion of foreign exchange inflows between April and June, it has accounted for about $4 billion out of the $10.8 billion that has come in since then. Much of this money has gone into the share market, and as the 268 point drop in share prices in two days three weeks ago showed, several investors have already booked profits. This is gambling gains going out of the country, and to make matters worse, since many of the players have registered themselves in Mauritius, they pay no tax on their earnings either.

The RBI has fortunately taken a number of steps to make such short term investment in India less attractive. Among these is the sharp reduction in interest rates from 250 basis points above the U.S. Libor swap rates, fixed in July, to a mere 25 basis points above it, and a limitation of exposure in Indian domestic markets by offshore foreign banks to 25 per cent of their daily transactions. It remains to be seen whether these measures will prove sufficient, for the fact remains that India continues, for the second quarter in a row, to record a balance of payments deficit. It needs a lower exchange rate for the rupee, but this will not happen so long as speculative money keeps coming around sniffing at the Indian share market in search of a quick killing.

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