I have immense respect for Sanjeev's articles. They are well researched and give you a lot to think about. This one is definitely worth reading.
Source:
https://www.valueresearchonline.com/story/h2_storyview.asp?str=26870
The Titanic, accelerated to 22 knots, full speed ahead, just before
it hit the iceberg. Besides all the other factors, the speed at which it
was going, gave it little chance of avoiding disaster, and of surviving
the damage after it was hit.
This is a very appropriate metaphor for the dilemmas facing India just now. We have a 'Titanic' mentality, a flawed belief in our own invincibility. One part of this Modi Mania says, 'we have Modi', implying he will get us out of any hole, even change the Laws of Physics/ Economics.
To change the metaphor I have used above to describe macro-economic management just now, 'steering the economy' is very similar to driving a car. You don't accelerate a car as you drive through a crowded village, you slow down till you reach an empty stretch again. Or better still, you don't accelerate on a flat tyre, you wait for 'stability' before you try accelerating again.
The world economy is seeing great uncertainty and increased volatility in many markets. Some of the areas are as follows:
- Deflation/ depression possibilities in Europe, as the region nears its third recession in 6 years.
- Falling
oil prices, which will seriously affect major oil producers, including
major emerging markets. These economies will see sharp spending cuts, or
huge Budget Deficits and hence, falling currencies.
- A general commodity bust, consequent to a slowdown in China, which could tip into a serious crisis.
- A
rickety Japan, which has a number of problems, and has still to see the
after-effects of an unprecedented last ditch attempt at speeding up a
sputtering economy. This could end in a Greek-style blowout.
- A
potential currency war, which could be triggered by any of Japan, China
or Germany devaluing suddenly and trying to garner export
competitiveness. This triggers an upward Dollar spiral, with disastrous
consequences for everyone.
Hardly a time for a
still-stable Indian economy to try and wring out additional decimal
points in growth, by shifting Monetary Policy from its focus on
stability. Which makes me want to wade into this 'debate' between Mr.
Jaitley and the RBI on Interest Rates.
This chorus for an
Interest Rate drop is rather like a bunch of kids sitting in the
backseat of a car, screaming 'faster!!! Faster!!!', with no idea of what
the driver is dealing with. I don't understand this obsession with
growth, in an economy that is one of the fastest growing in the world
anyway.....it certainly has the highest growth momentum in the world.
It's not like we are teetering on the verge of recession, like Europe,
or trying to fight chronic deflation like Japan. I can understand an
obsession with growth in those economies.
India is the only major
economy still battling inflation. And we are just coming back from a
near Currency Crisis.....shouldn't we be focused on stability,
especially given the rocky seas clearly visible ahead. How have we
quickly created a consensus that all is well and we are ready to jump
off a cliff with an umbrella?
Most of the underlying factors are
still in the red zone. The fiscal deficit, for one: we are going to
overshoot yet again, a modest target that still brackets us with France,
that basket case of a no-hope economy that sits at the heart of the
Eurozone crisis. The CAD is back above the 2% red line, in an era when
the falling Euro and JPY is going to increase your trade deficit. If you
look at the trade-weighted REER in nominal terms, you will find the
Rupee has got overvalued, which is not going to be good news for your
CAD.
If the CAD also represents your savings deficit, then any
further uptick in the Investment Cycle will only bring more bad news on
that front. So why not keep high real interest rates to push up domestic
savings? A drop in the credit offtake could mean a cyclical
deleveraging effect. This can be made up with other reforms that improve
corporate profitability, like labour and land (acquisition) reforms,
which bring down the cost of other inputs. Tinkering with Monetary
Policy to bring down the cost of capital, is just lazy government,
taking the easy way out.
The steep drop in oil prices has been a
good stimulus for the economy, but this decline could have been used to
bring down the fiscal deficit with some temporary taxes. Such
initiatives could also cross-subsidise energy efficiency programmes and
VGF funding for Solar.
With all this talk about the Modi Wave,
real change of macro-fundamentals has been zero, and we are already
talking about going to 'loose money' again, even as liquidity is already
flooding in. This will only feed inflationary pressures, leading to a
two-steps-forward-and-one-step- back policy that will only promote
volatility in monetary policy.
I mean, why do we always to look
to Monetary Policy to bail us out of a slowdown? Is it because
everything else is more difficult, or is it because Markets are most
sensitive to money flows, and they have a disproportionate voice in the
mainstream media? Are the profit priorities of just a few rich and
influential individuals, going to be allowed to destabilise the
country's most important economic objective.....to provide stability
first, and then create the right environment for growth to find its
natural level.
Shouldn't the Govt's targets be first an inflation
target, a fiscal deficit target, a Public Debt target, a Primary
Surplus target.....and then a growth target, which follows as a result
of the enabling environment that is so created. A driver is first meant
to ensure that a car is stable, there are no accidents and the wheels
are not flying off, before he listens to the kids screaming in the
backseat. In India, you find very little debate on the rest of the
variables that drive stable growth, and all the conversation is just
about growth at all costs. This only promotes cyclicality and
volatility, with its own economic costs.....most important, these costs
(i.e. inflation, debt defaults, spikes in unemployment etc) are borne by
the poor and the middle class, while the short-term benefits of
incremental growth are eaten away by the elite.
A Modi government
that is looking at the long-term is better served by a sharper focus on
stability, and creating the right environment for sustainable growth,
rather than a blind rush for growth. I sincerely hope that a Raghuram
Rajan who has set himself the target for a 'bullet-proof' Balance Sheet,
will not be swayed by this cacophony of voices that are looking for
growth on steroids.
If at all interest costs need to be lowered,
the Govt can give an Interest Subvention of, say, 4% for Solar
investments. This will have the effect of reducing the cost of capital
for solar investments, helping promote investments. Except that the cost
wuld show up in the government's fiscal deficit, even if it is as a
capital subsidy. But at least it will discipline the government, which
will have to find other spending cuts. The net effect of a further solar
subsidy (over and above the VGF of `1 cr per MW), will be to reduce
imports (of coking coal and oil) and the cost of energy. Energy
independence will give a fillip to agriculture and water management,
which is just where growth momentum should be promoted.
To
summarise, the government should focus on promoting asset profitability,
rather than reduce the cost of liabilities. With rose-tinted profit
outlook being posted by every analyst worth his salt, why should we
resort to rate cuts: instead, keep real interest rates high, even as you
reduce the cost of other inputs, especially land, raw materials and
management value-add. This will bring in foreign investment, which will
help kick off your Investment Cycle with equity rather than debt. That
will kick off a virtuous cycle, bringing in FDI, besides promoting
domestic savings. It will also silence industry lobbies that are behind
this cacophony for lowering interest rates.
Lowering the cost of
capital often results in misallocation of investments, even as we are
suffering the after-effects of the rate-lowering spree and spraying of
cash, after 2008. The chorus for a rate cut could hardly be wanting to
go into another cycle of misallocation (of investments), even as we have
still to write of the NPAs of the last cycle.
The author teaches, trades and writes at spandiya.blogspot.com.
