X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 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.
No easy path to higher growth - Outside View by S.S. TARAPORE
 
 
No easy path to higher growth

The RBI Annual Report rightly points out that even to grow at 7 per cent, inflation needs to fall sharply

It is important that government, policymakers, opinion-makers, industry and other stakeholders give serious attention to the Reserve Bank of India's Annual Report 2013-14, especially as it provides a goldmine of ideas for improved overall macroeconomic policy.

With greater political stability, the move towards fiscal consolidation and strengthening of the monetary policy framework, GDP growth in 2014-15 would be around 5.5 per cent.

Risks to growth as also upside risks to inflation arise from the sub-optimal monsoon and the geopolitical situation in West Asia.

Preconditions for growth

There are always aspirations for a quick return to the halcyon days of 9 per cent growth. But the RBI does well to caution that for a medium-term growth of even 7 per cent per annum, it is imperative to have better microeconomic policies to improve activity and productivity; this should go along with a conducive macroeconomic environment with reasonable, positive rates of interest, low inflation, moderate balance of payments and current account deficit, (CAD) and a low fiscal deficit.

Higher growth does not come easy. The Government has been responsible in not generating expectations of an early acceleration of growth.

Even to have a sustained growth of 7 per cent per annum in the medium term will require considerable effort in terms of a better macroeconomic balance.

A major prerequisite is lower inflation. It is for this reason the RBI stresses the need to contain inflation to 8 per cent by January 2015 and 6 per cent by January 2016.

At the present time, 8 per cent inflation for January 2015 appears reasonably secure, but a lot more needs to be done to contain inflation to 6 per cent by January 2016.

Caution on interest rates

There is an asymmetry in that when inflation falls there are pressures to reduce policy interest rates, but there is no support for higher policy rates when inflation rises.

Hence, it is best to leave the RBI to take a considered call on when it is appropriate to reduce interest rates. It is gratifying that the new government has reduced the sabre-rattling, urging lowering of interest rates. It would strengthen macroeconomic policy if the Government were to refrain from expressing a hope for lower policy rates.

It is often not appreciated that a small reduction in interest rates has very little impact on reducing the cost of production.

On the contrary, excessively low real rates of interest can easily generate a resurgence of inflation.

According to the RBI, gross domestic savings have declined from an average of 35 per cent of GDP from 2005-06 to 2007-08 to a nine-year low of 30.1 per cent in 2012-13. Household sector savings have fallen from 25.2 per cent of GDP in 2009-10 to 21.9 per cent of GDP in 2012-13.

What is alarming is that household sector net financial savings have fallen from 12 per cent of GDP in 2009-10 to 7.1 per cent in 2012-13. In contract, gross savings in physical assets rose from 13.2 per cent of GDP in 2009-10 to 14.8 per cent in 2012-13.

These numbers provide a telling message that financial savings are not attractive and savers prefer physical assets. This is not surprising as inflation has eaten into real financial savings and nominal interest rates are low given current inflation levels.

As such, much of the clamour for lower interest rates is misplaced. Bringing down inflation should be the topmost policy priority.

The RBI is optimistic that the gross fiscal deficit (GFD) and the CAD in 2014-15 would moderate. According to the RBI, the reduction in the GFD to 3.6 per cent in 2015-16 and further to 3.0 in 2016-17 is feasible, but requires further expenditure reduction and better targeting of subsidies.

Medium-term challenges

The RBI advocates a quick pass-through of global crude oil prices and also early measures for more flexible diesel, LPG and fertiliser prices.

There is a need for better appreciation of the impact of increased administered prices. Illustratively, in the case of imported crude petroleum, India would have already paid the international price. By holding down administered prices, sectoral prices are kept down, but such measures cannot keep down overall inflation.

On the external front, in 2014-15, there are upside risks to oil prices due to geopolitical developments as improved domestic demand could increase imports.

Again, a faster monetary policy tightening by the industrial countries could put pressure on India's CAD.

While higher exports are important, it is essential that the exchange rate be competitive. In particular, the macho spirits pushing for an appreciation of the rupee exchange rate should be resisted. An appreciation of the rupee vis-a-vis the major currencies is totally unwarranted as India's inflation rate has been persistently way above inflation in major industrial countries.

The RBI has aptly set out the key challenges for the ensuing period. First is the need for lowering food inflation through supply side measures. Second, strengthening the monetary policy framework and improving the transmission process. Third, fiscal consolidation through better targeting of subsidies and revenue augmentation. The revenue to GDP ratio in India is significantly lower than in industrial countries.

There is a need for direct tax reforms taking into account the principles of efficiency, equity and effectiveness. The direct tax structure reflects gross inequity, in that some individuals with very large incomes and assets are free from direct taxes while some with moderate incomes are subject to relatively high direct taxes. (to be continued)

Please Note: This article was first published in The Hindu Business Line on September 05, 2014.

This column, Maverick View 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 Freepress Journal, is titled Common Voice.

Disclaimer:
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 "No easy path to higher growth". Click here!

  
 

More Views on News

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

How To Read Your Mutual Fund Account Statement Correctly (Outside View)

Aug 17, 2017

PersonalFN simplifies the mutual fund account statement for you.

This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process) (The 5 Minute Wrapup)

Aug 17, 2017

A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

Which Gods Will Bring Down the US Empire? (Vivek Kaul's Diary)

Aug 17, 2017

Mr Trump is in the White House and the gods are in their heavens; what's not to like?

Will They Haul Off Trump's Statue, Too? (Vivek Kaul's Diary)

Aug 16, 2017

All across the country, the old gods become devils. New, gluten-free gods take their places...

More Views on News

Most Popular

Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

Aug 7, 2017

The data tells us quite a different story from the one the government is trying to project.

Proxy Plays: A Smart Way to Bet on 'Off Limits' Companies(The 5 Minute Wrapup)

Aug 4, 2017

The small-cap space is full of small players that are clear proxies to great growth stories and Indian megatrends.

Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

Aug 8, 2017

Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

Signs of Life in the India VIX(Daily Profit Hunter)

Aug 12, 2017

The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

Aug 7, 2017

Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

More
 

Become A Smarter Investor In
Just 5 Minutes

Multibagger Stocks Guide 2017
Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Aug 17, 2017 (Close)

MARKET STATS