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Business
Challenging task of managing supply-side constraints
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Economy coming to terms with a hardening rupee
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The Indian economy may not repeat this year the smooth sailing it had in 2006-07 because of the high world prices for crude, petro-products and fertilizers. Crude prices were much lower in the earlier months of last year. Also, it has again become necessary this year to import five million tonnes of wheat but at prices over 75 per cent higher.
Despite a dearer rupee the outgo on imports of crude oil and food grains will be larger this time as the supply situation in these products has deteriorated. While there may not be any significant increase in the domestic output of crude latest reports suggest a lower food crop in the 2007-08 agricultural season at 206 million tonnes against the earlier estimate of 214 million tonnes. And, larger imports will only add to the subsidy burden as the landed cost of imports is higher than internal parity.
High oil prices
As the Petroleum and Natural Gas Ministry may be compelled to raise retail prices for petrol, diesel and aviation turbine fuel, inflationary pressures may be accentuated. World crude prices have been soaring once again and it is even feared that the U.S. and other developed economies may witness recessionary trends.
The OPEC will be raising crude output by 0.5 million barrels daily from the beginning of November, but this may not have noticeable impact on prices.
A heartening prospect for India is the likely commencement of production of natural gas from the Krishna - Godavari basin from the middle of next year .This may help moderate future oil imports to some extent. The controversy over the price formula for natural gas has ended with the Government accepting a satisfactory proposal in this regard.
CAD may remain high
However, for the current year, it will be difficult to avoid an increase in the current account deficit (CAD) for the whole year even with the prospect of a noticeable improvement in net invisible receipts.
This conclusion is borne out by the trends on foreign trade front in April-July. Export growth has been only 18.22 per cent against 20.9 per cent a year ago. The growth for the whole of 2006-07 also was 20.7 per cent as the impact of the dearer rupee had started in January – March. The increase was over pronounced at 23% in 2005-06.
Imports in the same quarter, on the other hand, surged by 30.65 per cent. As a result the trade deficit rose to $25.61 billion from $15.84 billion and $14.37 billion respectively in the two previous periods. The bridging of the larger CAD may not pose any problem as foreign exchange assets have been increasing steadily.
Capacity constraints
It is nevertheless anticipated that GDP growth will be 9 per cent, only slightly lower than the 9.4 per cent in 2006-07.The slump in Industrial output growth to 7.1 per cent in July against 13.2 per cent a year ago is explained by industry circles as mainly to capacity constraints and not the result of declining demand. This only stresses the need for quick capacity additions besides strengthening of the infrastructure sectors.
The services sector of course will remain buoyant with impressive forex earnings. Earnings of the software industry will be higher in forex terms but rupee profits will be hit by a dearer Indian currency. Other service segments will become costlier in forex terms as tariff rates are in rupees. The difficulties from rupee appreciation will be less where the external parities of other currencies also appreciate against the dollar as in the case of Chinese Yuan, Japanese yen and Thai baht.
The importance of the economy getting adjusted to a changing situation has been forcefully pointed out both by the Prime Minister and the RBI Governor.
This is probably in the expectation that the rupee will appreciate steadily in coming years with domestic efforts to increase crude and natural gas output and a serious bid to reduce the use of petroleum products for power generation, railway traction and so on. There will also be greater emphasis on power generation based on coal, hydel and non-conventional sources. The agricultural sector too will be aided to boost output tangibly for ensuring food security.
The new developments will however yield tangible results only in the Twelfth Plan. Meanwhile export Industries affected by a costlier rupee will have to be helped. This line of thinking has presumably compelled the Prime Minister to find solutions for the difficulties experienced by the textile, leather and leather products, plantation and small and medium industries.
The corporate and services sectors can improve their competitive ability with a more gradual appreciation of the rupee as happened until 2005.
Pragmatic approach
The monetary authorities are aware of the need to check further rise in external parity of the Indian currency with purchase of forex inflows in recent weeks. For averting a surge in liquidity of the financial sector the cash reserve ratio was raised by half percentage point recently by the RBI. However, in the light of developments in the U.S. and elsewhere, there is even scope for beating a retreat from dearer money when the credit policy comes up for review shortly.
Even when the economy gains balance with the strengthening of the external sector special problems of particular segments of the industrial and services sectors may have to be addressed. India has the advantage of a booming domestic market while foreign interests are keen to turn it into an export hub thanks to its lower costs in particular directions.
The happenings in the current and next year have therefore crucial significance.
P. A. SESHAN
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