Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Fall in GDP: The wages of sin - Outside View by S.S. TARAPORE

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

Fall in GDP: The wages of sin
Jul 1, 2013

It was felt by the government that the growth of the economy was all that mattered and once this was secured, all other things would fall in place. With lax monetary-fiscal policies in the past five years, inflation raised its ugly head and as savers were poorly remunerated, this resulted in a drop in overall savings, more particularly, savings in financial assets. With Indian inflation rates much higher than in the industrial countries, the rupee became increasingly overvalued and the balance of payments current account deficit (CAD) increased, culminating at 5% of the GDP in 2012-13. With falling growth and high retail inflation, as reflected in the Consumer Price Index (CPI), the adverse effects of these policies on the common person became more evident.

Preoccupation with low interest rates

The government and industry form a powerful combine and during the past five years, other than for very short periods, the Reserve Bank of India (RBI) has been forced to reduce interest rates and reserve requirements and also undertake open market purchases to keep security, yields low. With increased inflation and falling interest rates, bank depositors have been facing lower real rates of interest (i.e. the nominal rate of interest adjusted for inflation) and in the more recent period, these have been negative. Protagonists of low interest rates would point to the Wholesale Price Index (WPI), which now reflects an inflation rate of less than 5%. The more appropriate indicator is the Consumer Price Index (CPI), which is still over 9%.

The wages of sin

The permissive monetary-fiscal policies and the strong disincentives for savings have resulted in savings as a proportion of GDP falling by 5 percentage points. The current account deficit CAD of 5 per cent of the GDP is none other than the gap between savings and investments. The current problems of high retail inflation, low growth, a large CAD and an overvalued exchange rate of the rupee are all symptomatic of macroeconomic instability and are the wages of sin. I do not tire of repeating that if hurting the poor is a sin, the creators of inflation are the sinners of society.

If the government persists with its overbearing pressure on the RBI to keep reducing interest rates and making available easy accommodation from the RBI, there will be a further resurgence of domestic inflation, a fall in savings and a widening of the CAD. Needless to say, this could very quickly end up in a serious external sector crisis, which will ultimately further reduce the growth of the economy.

Low growth in the 12th Plan

The reputed think tank, the National Council of Applied Economic Research (NCAER), has come up with a sombre outlook for the economy. The study concludes that if the present policy logjam continues during the 12th Plan, the average annual rate of growth during the Plan will be a mere 4.8 per cent. Predictably, official policy honchos will find reasons for disagreeing with the study but the harsh realities are that unless expeditious remedial measures are taken, the economy will go into an uncontrolled tailspin.

External sector hazards

India's interface with the international economy has increased substantially since 1990-91 and now, current account payments are equivalent to 25 per cent of GDP. The weakness of the Indian economy is that it is excessively dependent on volatile Foreign Institutional Investors (FIIs) and furthermore, external debt has a preponderance of short-term debt (with a residual duration of less than one year) of as much as 40 per cent of total external debt.

Immediate monetary policy measures

While the next monetary policy review is due on July 30, 2013, the situation is turning critical. Top government officials are trying to assuage markets that things are under control and that knee-jerk reactions should be avoided. The fact of the matter is that it is already late and there is a need for immediate strong and unequivocal monetary policy action.

Without waiting for the scheduled monetary policy review of July 30, 2013, the RBI should immediately announce a package of measures which could include:

(i) An increase of the policy repo rate (i.e. the rate at which the RBI lends to banks against the collateral of securities) by 0.50 percentage points, from 7.25 per cent to 7.50 per cent.

(ii) An increase in the cash reserve ratio (the percentage of banks liabilities impounded by the RBI) by 0.50 percentage points, from 4.0 per cent to 4.50 per cent.

(iii) An immediate cessation of open market purchases of securities by RBI (which is monetary easing) and a gradual step-up in sales of securities (which is monetary tightening). These measures would be contrary to what the market expects, but the essence of central banking is to take away the punch bowl before the party gets rowdy.

RBI's forex intervention

In the absence of immediate measures, the RBI will find that it would have to support the rupee in the forex market by sales which would be throwing away scarce forex reserves. The RBI would be well advised to refrain from premature intervention in the forex market (there are already signs that the RBI has been supporting the exchange rate by forex sales).The rupee should be allowed to drift downward to US $ 1= Rs 70 before the RBI intervenes in the market (this is the rate which is warranted by the long-term inflation rate differentials between the US and India). Contrary to popular belief, the RBI's forex war chest is meagre in the context of the increased volume of transactions.

Fiscal measures

The government should immediately announce significant measures of tax exemptions to make savings more attractive and simultaneously impose taxes across-the-board to ensure that the overall impact is neutral to the budget.

The time has come for significant and visible measures. This is not the time for soul-stirring verbal morale building.

Please Note: This article was first published in The Free Press Journal on July 1, 2013. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Fall in GDP: The wages of sin". Click here!


More Views on News

Two Meetings That Nailed the Idea of Owning Brilliant Smallcaps Without Buying Them (The 5 Minute Wrapup)

Mar 22, 2018

Certain blue chips hold the potential of delivering returns comparable to small-cap stocks. With these stocks, you can get the best of both worlds.

What They Forgot to Tell You About Sensex at One Lakh (Profit Hunter)

Nov 29, 2017

Stocks that could beat Sensex returns in the long term.

Kotak Balanced Advantage Fund: Advantageous For Your Portfolio? (Outside View)

Jul 19, 2018

PersonalFN takes a look at Kotak Balanced Advantage Fund, a New Fund Offer (NFO) from Kotak Mahindra Mutual Fund.

How to Build Affordable Homes in India (Vivek Kaul's Diary)

Jul 19, 2018

Rajiv Talwar, the CEO of DLF, makes a few interesting points in a recent interview.

These Are the Best Stocks for the Next Decade (The 5 Minute Wrapup)

Jul 19, 2018

The start-up eco-system is disrupting each and every sector that we know of. How can Indian investors benefit from this?

More Views on News

Most Popular

How to Avoid a 90% Loss Suffered by This Super Investor(The 5 Minute Wrapup)

Jul 12, 2018

Blindly following super investors is a dangerous game to play. Here's how you can avoid such mistakes.

The Answer to Your Wealth Worries: Small Caps (Especially Now)(Profit Hunter)

Jul 10, 2018

If you're worried about the markets - you are on the wrong track. This is opportunity - put your wealth-building hat on, instead - Richa shows you how...

The Multiple Problems with the Minimum Support Price (MSP) System(Vivek Kaul's Diary)

Jul 11, 2018

The price signals that MSP sends out, creates its own set of problems.

New Fund Offer - ICICI Prudential Pharma Healthcare and Diagnostics Fund - Should You Invest?(Outside View)

Jul 6, 2018

ICICI AMC launches an open -ended equity fund following Pharma, Healthcare, Diagnostic and allied theme.

When Disappointment Panda is Around. Buy Quality Stock like This!(Chart Of The Day)

Jul 6, 2018

Buy Companies that can fight all kinds of Pandas and Bears in the long run.


Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms


Jul 19, 2018 (Close)