The Hindu Business Line : Prodding the economy into a trot

Taking a look at the economy at the end of the first quarter, G. Srinivasan says the Finance and Commerce Ministries have a task cut out in reviving retail investor interest in equity, finding ways to step up public investments, and ushering in a dual exchange rate regime to insulate exporters from the fallout of an appreciating rupee.

AS THE first quarter of the current fiscal draws to a close, the state of the economy and the policy inertia plaguing the Government, lest it should face any adverse notices in the elections to four major States before the year is over, present a hard case for dispassionate evaluation. Unlike the dream Budgets of the past few years of the NDA Government, the one presented on February 28, 2003 by the Finance Minister, Mr Jaswant Singh, was widely seen as a people-friendly exercise that did not affect any segment. There were not many harsh provisions and even the modest efforts at enhancing the revenue base by levying excise duty on powerloom were quickly rolled back, the hike in urea prices even before the Finance Bill was through Parliament.

Happily, the much-talked-about monsoon has set in, even if late by a few days, cheering the farming community and bringing relief from the heat wave that swept across much of the country. The market mood and sentiment also appear to be normal; a change from last year when an unprecedented drought had wrought havoc on the economy. The balance of payments position today is to use a cliché comfortable. That the economy is enjoying an exceptional combination of circumstances now than it had ever in the past is obvious.

Albeit the spurt in foreign exchange reserves since 1993, in the recent past the accretions have been mainly on capital account and non-debt receipts largely due to purchases of listed equity by foreign institutional investors (FIIs) and their backing of privately placed issues or other initial public offerings (IPOs). According to a recent IMF working paper by Mr James Gordon, Senior Resident Representative (India), and Ms Poonam Gupta, economist in the IMF Delhi Office, ever since the purchase of domestic securities by the FIIs was first allowed in September 1992, India has attracted portfolio inflows averaging about $1.5 billion per annum. At end-June 2002, FII investments in domestic equities totalled $14 billion, which constituted 11 per cent of the stock market capitalisation and 25 per cent of foreign reserves. They estimate that the total portfolio inflows into India (including equities, bonds and ADRs/GDRs) amounted to $18.5 billion during the 1990s.

Pertinent in the IMF study is that though portfolio investment is less than FDI in absolute terms, India receives a slightly higher proportion of portfolio investment going to emerging markets (3 per cent average between 1992-2000) compared with FDI (about 1.7 per cent) as a percentage of total flows of the respective investments to about 24 emerging markets for which annual data are available in the IMF's International Financial Statistics (IFS).

Yet another significant point made by Mr Gordon and Ms Gupta is that portfolio flows to India are less volatile than in other emerging markets and FII inflows into India also seem to be quite resilient. They contend that "lagged domestic stock market returns and other events such as credit rating downgrades or a depreciation of the exchange rate, affect FII flows negatively," as also domestic macro factors.

The IMF working paper is cited here only to establish that the domestic authorities have the key task of keeping the macroeconomic situation stable particularly at a time when the stock market remains caught in a bear hug, foreclosing the opportunity for retail investors to return in droves to pep up the market. It is a sad commentary on the state of the capital market that despite such watchdogs as the Securities and Exchange Board of India (SEBI), the Department of Company Affairs (DCA) and the RBI, the return of retail investors to stock exchanges still remains a distant dream with the number of IPOs declining by the year, ever since the securities scam hit the Indian bourses in 1993 and followed or accompanied by cases of vanishing companies, of share price rigging and other shenanigans entailing fixed deposits and mutual funds.

After the release of the Naresh Chandra Committee Report on Corporate Governance last year and the introduction of the Companies (Amendment) Bill 2003, one hopes things will mend. But as long as SEBI and the DCA do not beef up their investigation apparatus and come down on dubious companies, the confidence of retail investors in the equity culture will remain low. The time has come for the Finance Minister to show fresh initiatives on the investment front, particularly to make equity more attractive than fixed deposits even as bank rates have come down perceptibly.

There is a fear among the primary investors, particularly senior citizens who used to invest in reputed companies in the past, to subscribe to corporate equities. At a time when Indian companies need massive infusion of capital for expansion, modernisation and technological upgradation to stay alive and face competition, the small investor is turning his back on them as if their ability to make the equity earn reasonable returns is in grave doubt.

Apart from addressing this vital issue, there is the enigma of bulging foreign exchange reserves even as major sectors of the economy — particularly the infrastructure-related ones such as roads, railways, airports, shipping and ports — continue to be starved of funds; not to speak of private corporate sector in a range of industries.

India's forex reserves today stand at an incredible$81.33 billion (during the week ended May 30). Add to this, the country's current account surplus of $1.35 billion in 2001-02, against a deficit of $2.58 billion in 2000-01. In the nine-months of 2002-03, the current account surplus was sizeable at $2.82 billion. These twin developments have also been ascribed to the appreciation of the rupee vis-à-vis the dollar and its less marked depreciation against other major currencies. As much of India's export receipts are denominated in dollars, the exporting community appears apprehensive over the continuous appreciation of the rupee against the dollar by over 4.5 per cent since June last year.

It is rather unfortunate that save for purposes of sterilisation by the RBI periodically, there does not appear to be any strategy in place to deal with mounting forex reserves in tune with market sentiments.

Even as exports are doing plausibly well, exporters are apprehensive that they will be under pressure with the rupee becoming stronger. Is not the time ripe for putting in place a dual foreign exchange rate regime to offer a modicum of relief to harried exporters lest their earning should get eroded by the strengthening of the rupee against the world's major reserve currency on which they get their reward?

With the liberalisation era a decade old, it is unfortunate that the authorities should be casting about a touch-me-not policy approach that is neither good for the industry nor the economy. In the licensing Raj, the government was active in the direction of investment flows into different sectors and also undertook massive public investment with private investments complementing its efforts.

But the Government can no longer afford a hands-off approach and curb public investment on the plea of reining in fiscal deficit. As they say, form follows the function; if the Government sets the form, the private sector will follow its remit, enabling the public-private partnership Mr Jaswant Singh so eloquently suggested in his maiden Budget to unleash the animal spirits of entrepreneurial growth impulses in the economy.

In fine, on three specific issues of reviving retail investor sentiments in equity, finding ways and means to step up public investment, and ushering in a dual exchange rate regime to insulate exporters from the fallout of an appreciating rupee, Mr Jaswant Singh and the Commerce and Industry Minister, Mr Arun Jaitely, should hold discussions without any further loss of time so that a proper reflationary package is designed to sustain growth impulses.

But, unfortunately, the Finance and Commerce Ministry mandarins remain mired in needless controversy over suspension of DEPB rates or sops for this sector or that, losing sight of the larger picture. For macroeconomic stability, an unwritten understanding between the two functional ministries is crucial and it is time both the reform-inspired Ministers put their heads together to find a durable solution to a demand rebound in the economy that alone can underpin the high growth projection of the Tenth Plan.

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