Financial Daily from THE HINDU group of publications
Monday, Feb 02, 2004
Time to give a thrust to growth policies
Rupa Rege Nitsure
The sharp turnaround in agriculture and its positive spin-offs on industry and services are fuelling an overall recovery by containing inflation.
A deeper analysis of the underlying macro currents suggests that India can look forward to a strong expansion in the months ahead. This is vindicated by the latest DSE-ECRI Indian Leading Index Report, prepared by Prof Pami Dua (Delhi School of Economics) and Dr Anirvan Banerji (Economic Cycles Research Institute, New York), which shows a sharp increase in the value of the index in March-September 2003.
In contrast to the global situation, India registered a robust performance accompanied by macroeconomic stability. The sharp turnaround in agriculture and its positive spin-offs on industry and services are fuelling an overall recovery by containing inflation. According to government estimates, the total foodgrains production in FY-04 will increase by 20 per cent to touch 220 million tonnes from 183 million tonnes in FY-03. The rise in oilseeds output during the kharif season of 2003-04 is 63.6 per cent and that of cotton, 40.9 per cent. Only sugar recorded negative growth, with the output declining by 6.2 per cent; adverse weather condition in some parts of Maharashtra is said to be the cause.
Backed by rising rural incomes and low interest rates, the industrial sector staged a healthy recovery, growing 6.2 per cent in April-November 2003. The recovery has been fuelled by the manufacturing sector, which grew at 6.8 per cent. This growth has been broad-based, with capital and consumer goods sectors logging 8.8 per cent and 8.1 per cent respectively. In the core sector, the growth impetus continues to come from steel and cement, recording production increases of 7 per cent and 5.1 per cent respectively during April-November 2003. This comes on top of corresponding year-on-year increases of 10.7 per cent and 8.9 per cent, respectively.
Similar buoyancy is observed for petro products output, with a 6.9 per cent growth in the first eight months of this fiscal. Backed by strengthening financial and IT-related activities and buoyant housing demand, the services sector grew by nearly 8 per cent in the first quarter of FY-04.
A CII survey expects the services sector to grow by at least 7.5 per cent in FY-04, as, in eight of the past 10 years (in good as well as bad years), the sector logged in excess of 7 per cent and often crossed even 8 per cent. And as per the latest CSO estimates, the sector has, on an average, grown at 8.6 per cent in the second quarter of 2003-04. Considering these sectoral trends, a real GDP growth of 7-7.5 per cent for the entire year cannot be ruled out.
Headline inflation (in WPI) has started moving up owing to rising oil and manufactured goods prices (thanks to increased capacity utilisation). But the Government has, to some extent, contained these pressures through increased edible oil imports and running down the foodgrain stocks. The total stocks were reduced from a record 63 million tonnes to 35 million tonnes in July 2003. Though inflation is expected to go up because of manufactured products' prices and the cascading effect of the fuel price hike (of December 31, 2003), the average annual inflation for 2004 is unlikely to exceed 5 per cent, thanks to the improved supplies of agricultural commodities.
On the monetary front, there is sufficient liquidity cushion to support an expansion in credit demand or investment in securities by banks without putting pressure on yields. As of December 2003, liquidity in the banking system is estimated at around Rs 3,45,965 crore. The accommodative stance of the RBI's Monetary Policy has been supported by strong capital inflows to sustain the soft interest-rate regime. This is apparent in the term structure of interest rates.
The yield on 91-day treasury bills declined to 4.2 per cent in mid-January 2004 from 5.6 per cent a year back, while yield on the 10-year bond declined to 5.26 per cent from 5.86 per cent. Commercial banks have cut their deposit rates for one-year maturity to 5-6 per cent from 6.5-7.5 per cent.
Also, effective January, banks have come out with new benchmark PLRs (prime lending rates), which are 25-75 basis points lower than their earlier levels. However, a third of the bank loans today are contracted at rates well below the prime rate. Yet, the pace of credit flow to the commercial sector is quite slow due to reduced dependence of companies on bank loans, through more efficient working capital management, increased retained earnings and direct borrowings from the capital market.
Monetary expansion is effectively controlled by the RBI through sterilisation. As a result, broad money supply grew by about 10.1 per cent during April to end-December this year against 12.3 per cent a year ago. Though the current point-to-point inflation rate at 6.1 per cent is higher than the 10-year benchmark yield of 5.26 per cent, it is unlikely that interest rates would reverse their trend till end-March, as inflationary expectations are still low (around 5 per cent for FY-04) and easy liquidity conditions are expected to continue, thanks to strong capital inflows.
The equity market is also on a high. The 2003-04 Budget gave the first boost by making dividends on mutual fund schemes tax free in the hands of investors.
Long-term capital gains on equities were waived to encourage long-term investments. This certainly became a "feel-good factor" for equity investors.
And, later, positive triggers came by way of plentiful rainfall, steadily rising corporate profitability, in the first two quarters of FY-2004, and foreign interest in common stocks. This helped the Sensex cross the 6,000 mark on January 2.
In the first nine months of this year, the net foreign purchases of common stocks exceeded $6 billion compared with $1 billion in the whole of FY 2003. While legal challenges have delayed the full privatisation of oil sector companies (Hindustan Petroleum and Bharat Petroleum, for instance), their low valuations vis-à-vis the private companies, and strong earnings have fuelled the rally. In the initial stages of recovery, the IT sector lagged because of margin pressures and an appreciating currency, while sectors such as steel, aluminium, cement, auto, auto-ancillaries, pharmaceuticals, engineering and power resurged and fuelled the run-up.
The PE ratio of the benchmark BSE Sensex companies moved from around 13.2 in April 2003 to 19.7 in January 2004. However, the consensus value for this ratio with respect to one-year forward earnings is around 13-14. This will help attract FII money into the bourses. Further, the earnings momentum of the corporate sector is expected to continue in the next two quarters as well. Even if there is some diversion of funds away from the emerging markets in Asia owing to a gradual recovery in the US and the Euro zone, domestic players are likely to make good the foreign capital.
The country's foreign exchange reserves have climbed consistently throughout the year. The rise has, to a significant extent, been because of buoyant FII inflows. In fact, this source accounted for 11.1 per cent of the accretion during April-Sept 2003. The RBI has been working at eliminating interest arbitrages. Yield differential on 10-year paper of the US and Indian government securities has narrowed, from 240 bps in November 2002 to about 100 bps now. But the prospects of the Indian economy are creating long-term demand for Indian paper and, as a result, inexorable flow of FII money. The rising rupee (vis-à-vis the dollar) on the back of strong inflows and uncertainty over the US economy have had a sobering impact on export figures. The cumulative figure for April-November has accordingly decelerated to 8.8 per cent. So far the central bank has effectively countered the upward pressures on the exchange rate to preserve external competitiveness.
The rupee, as a result, has appreciated only 5.1 per cent against the dollar (to over Rs 45.54/$1 on January 8, 2004, from Rs 48/$1, a year earlier). By end of fiscal 2004, the rupee is expected to remain between Rs 45 and 46, as there are factors working from both the sides.
As industrial activity accelerates, imports will necessarily rise further and would affect net trade inflows and result in rupee depreciation. But the increased economic activity will ensure that the targeted levels for tax collections are met, and this would keep a check on fiscal deficit.
And this, in turn, will check to some extent the downward pressure on the rupee. Similarly, current trends in forward premia rule out significant weakening of rupee vis-à-vis dollar. Also, continued inflows of foreign funds backed by strong fundamentals would keep upward pressure on rupee value.
This optimistic outlook has given policymakers another opportunity to push forward the pending structural reforms. While some progress has been made in indirect tax liberalisation, which has direct implications for productivity enhancement, the hitherto neglected sectors of agriculture (especially in areas such as irrigation, drainage, soil conservation, water management systems and rural roads) and infrastructure (mainly power) are still lagging well behind other South-East Asian countries. And if the fiscal deficit swells further, it could lead to insolvency.
The current macro situation should be looked upon as an opportunity to aggressively follow pro-growth policies.
(The author is Chief Economist, Bank of Baroda. The views are personal.)
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