Governor's survey of macroeconomy India must be on guard

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The markets have taken in their stride the Credit Policy, which has been a non-event insofar as the economy is concerned, and corporates are not yet losing sleep over the tightening of the rates of interest, indicated by the reverse repo rate increase. S. Venkitaramanan examines the general contours of the policy, and the exhaustive survey of the economy that accompanied it.

S. Venkitaramanan

THE latest Credit Policy has surprised some, shocked a few, but, by and large, it has been a non-event insofar as the economy is concerned. The markets have taken it in their stride and corporates are not yet losing sleep over the tightening of the rates of interest, indicated by the reverse repo rate increase.

But, what survives is the general indications of policy revealed by the competent and exhaustive survey of the economy, which accompanied the Credit Policy. It is, in fact, a mini economic survey, recording the various features of the economy as they have evolved through the year. A look at a few significant aspects of the survey.

The survey of macroeconomic and monetary developments starts with an analysis of the farm situation. It remarks that kharif production in 2005-06 will be marginally higher in respect of foodgrains. In respect of commercial crops, the output of cotton, oil seeds and jute is expected to decline, while that of sugarcane is estimated to increase.

What is significant is that, through a combination of decreased procurement and higher PDS off-take, the foodgrains stock is quite close to the buffer stock norms, instead of being comfortably above, as in previous years. Thus, the stock of wheat as on November 1, 2005, was 9.1 million tonnes, compared to the buffer stock norms of 11 million tonnes.

Food stocks as a whole are lower by 28.1 per cent compared to the level at the corresponding time last year. There is need to take note of this trend when announcing generous programmes of public distribution.

The Government of India has to review its food stock management policy. Care has to be taken to ensure that its programmes of food distribution do not run ahead of its capacity to procure and supply foodgrains at reasonable prices. Delusions of populist grandeur should not result in collapse of the food security system as a whole.

Turning to industrial production, the survey points out that the period under review April-November 2005 saw a strong performance. Although there was loss of momentum in early 2005, cumulative growth during the first eight months stood at 9.4 per cent. However, critical sectors such as mining and electricity generation recorded a deceleration.

The reasons for the decline are the breakdown in the Mumbai High oil field due to fire on the rigs and the shortfall in mining consequent on heavy rains. It has to be stressed that the growth of the economy has to allow for such variations from the norms and seasonal problems. There has to be sufficient robustness in the production system to overcome such inherent bottlenecks. The problem is that our production systems are too sensitive to the least breakdowns. We have to build greater stability to the system, with failsafe security.

The Governor has cited a number of business expectations surveys in his report. They range from Dun and Bradstreet to NCAER, FICCI, CII and Crisil. By and large, the business confidence surveys record a strong expectation of growth in the remaining part of this year. Demand conditions are expected to strengthen. Of course, the survey results were showing a higher confidence index for non-manufacturing than manufacturing. That is to be expected, given the prospects for services, both domestic and export.

The growth in the services sector accelerated to 9.8 per cent during the second quarter from 9.6 per cent in the previous quarter as against 7.7 per cent a year ago. The services sector was boosted by growth in construction activity led by housing, besides rise in domestic and international tourism. No less significant was the growth of the communications industry.

The growth in expenditure on the revenue account of the Governments, both at the Centre and the States, also contributed. In the 1980s, critics had complained that one sure way to raise the GDP in the services sector was to increase Government employment. But, the services space has increased in India not only due to governmental expansion, but due to outsourcing of activities, both by external and domestic institutions giving rise to jobs and to incomes, which are palpable when we to go an IT-enabled centres of urban expansion as in Bangalore, Gurgaon or Noida, leave alone Chennai, Pune and Coimbatore.

The RBI's review surveys the fiscal developments in the economy in the April-December 2005-06 period. It essentially reiterates the conclusions of the Mid-term Review of the Government of India, released a few weeks ago by the Finance Minister. It points out that there is an improvement in the fiscal variables, thanks to the buoyancy in tax collections and containment of growth in non-Plan expenditure.

Revenue deficit, as a percentage of budget estimates, is lower in April-November 2005 compared to a year ago. If we adjust for the one-off item of debt swap, which took place last year, fiscal deficit in relation to budget estimates also was lower this year than the last.

Further, the Government of India has had higher cash balance with the RBI this year than the last. The tax revenue of the Government of India during April-November 2005, as a percentage of budget estimates, was higher than a year ago on account of higher collections of corporation tax, income tax, customs duties and service tax. Non-tax revenue has, however, been moderate on account of lower interest receipts. Significantly, capital outlays during the period declined.

In a comprehensive discussion of petro-product price rise in various countries, the RBI Governor's review points out that while international crude prices have risen by 71 per cent from April-December 2005, domestic mineral oil prices in the WPI basket rose 29 per cent over the same period petrol by 28.4 per cent, high speed diesel by 40.1 per cent. Different countries have absorbed the crude price increases in different proportions by fiscal adjustments. But the fact remains that, ultimately, the fiscal burden is also borne by the consumer, although not in the proportion that he uses the petroleum products.

Dr Y. V. Reddy has delicately referred to the policy dilemma faced by the Government in respect of petro-product price rise. Obviously, the time for a full pass-through of the crude price increases is politically determined. The fiscal costs of delay in petro-product price adjustment are high. Besides, the delay will encourage consumption of highly import-incentive products. It is unwise to continue the policy of subsidising consumption of imported commodities such as petro-fuels, whatever the populist compulsions.

This takes us to the Governor's discussion of the external situation. It is significant that India's current account deficit widened during the second quarter over its level in the first quarter. Capital flows, however, remained robust and in excess of the current account deficit. As a result of the capital flows, the overall balance of payments yielded a surplus. There was, however, a hit on the reserves due to redemption of the India Millennium Deposits on December 29, 2005. The Governor's survey cites various measures of reserve adequacy, such as the ratio of short-term debt to reserves to affirm its view that the reserves are adequate.

On the import bill of India, the survey points out how petro-product imports are significant. In the period April-October 2005, petroleum product imports accounted for $24 billion, up 41 per cent over 2004-05, coming on top of an increase of 56 per cent in that year. The import of petro-products and crude is nearly 33 per cent of the total import bill of $76 billion in the period. Capital goods account for only $15 billion. Gold takes up over $ 6.9 billion! This is, indeed, a wasteful use of forex, but the various devices thought of to divert the demand from the yellow metal, such as the issuance of gold units indicated by Government earlier in the year have not yet taken off.

It behoves the Government of India and the RBI to examine and rectify the prevailing flaws in the scheme so that it can minimise the urge to accumulate gold as a store of value. This, of course, involves a cultural change, but it is worth trying.

It is obvious from the data that an increasing share of the software receipts and remittances is consumed by the imports of petroleum products and gold and silver. While it is alright to pat ourselves on the back for increasing exports of software and growing remittances, it is also worth noting that the appetite for petro-products is outpacing their growth and absorbing them. A holistic policy for energy conservation to reduce our dependence on imported energy as well as device measures to wean the Indian public of their fascination for gold and silver are both necessary.

While the Governor himself does not sound any warnings, it is worth noting that the data his survey has produced has an unmistakable byline, which is that we should be on guard lest the good times end too soon!

(This article was published in the Business Line print edition dated January 30, 2006)
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