Opinion No escaping the basics

At an official press briefing in Washington DC,a questioner asked Gerry Rice,director of the communications department,IMF,whether the Fund had had any discussion with India about supporting its economy or offered any advice. Rice said,“Well,I wouldn’t want to speculate on any support or programme needs. But…” If nothing else,his answer only raised curiosity. Why didn’t Rice respond with a resolute “no”? That would have quashed doubts,if any,among analysts tracking emerging markets. But he chose to say he didn’t want to speculate,and added quite a bit about the prevalent economic scenario in the country. “The combination of large fiscal and current account deficits,high and persistent inflation,sizeable unhedged corporate foreign borrowing and reliance on portfolio inflows are long-standing vulnerabilities that have now been elevated as global liquidity conditions tighten,and this clearly has affected market confidence,” Rice pointed out.

A few days ago,addressing central bankers in Jackson Hole,Wyoming,Christine Lagarde,the IMF’s managing director,said first the US financial crisis had brought the world economy to its knees in 2008. Then came the eurozone troubles. The worry today is the risk of a slowdown in emerging markets pulling back growth in the rest of the world. She was referring,perhaps,to China,Brazil and Thailand,and not India. But clearly,our growth rate has taken a serious beating. For the April-June quarter,India’s GDP grew at 4.4 per cent,a sharp deterioration since the heady quarters of almost double-digit growth rates during 2004-09. India benefited from the G-20’s plan of a coordinated stimulus programme,post the US financial crisis. But once India had managed the crisis and its economy had rebounded,did the government pursue policies that would help it face the brunt of an unwinding of the stimulus? When the going was really good in the last decade and the world financial system was flush with funds,domestic policies allowed companies easy access to foreign borrowings. As on March-end this year,the outstanding stock of external commercial borrowing stood at a whopping $120 billion. Out of this,borrowings worth $21 billion are scheduled to mature this year. This,together with the monies that public sector banks in India have lent to a handful of corporate groups,raises valid concerns of private sector defaults on PSU bank loans. Even in the current equity markets meltdown,the banking index plunged the most — a whopping 32 per cent — between May 20,when it was at its 52-week high,and August 30. During the same period,the Bombay Stock Exchange’s 30-scrip benchmark index Sensex fell by less than 8 per cent. The stock markets have noticed the risks in the bank stocks and priced them accordingly.

Coming back to what the IMF would prescribe for India. Undoubtedly,it will ask the government to put its head down and return to basics. First,the price of petroleum products — kerosene,cooking gas,diesel and petrol — in the pumps and other shops must reflect global crude oil prices,factoring in the sharp rupee fall. These subsidies look so extravagant,especially when the government has moved ahead with the food security legislation,which will substantially add to expenditure in the coming years. Assuming global crude oil prices at an average of $115 a barrel during 2013-14,the petroleum ministry has estimated the under-recoveries of oil PSUs to be Rs 1,81,000 crore for the year. If petroleum products are market-priced,it will dramatically cut government expenditure and create resources for a social safety net. This one measure will address the fiscal deficit — the indicator global investors are most in love with.

Such pricing will naturally have an impact on inflation,which is already beyond the comfort zone. The IMF would want the Reserve Bank of India to adopt an orthodox approach,hike interest rates to keep inflationary expectations under control. As it is,real interest rates (the difference between the 10-year bond yield and consumer price index-based inflation) are negative in India. That being so,maintaining the current monetary stance and raising interest rates based on the inflation outlook would be correct,according to the IMF. Low inflation and fiscal rectitude are prerequisites to set the stage for foreign investment. Of course,what will really turn the tide are measures to improve the investment climate,from bringing certainty into policy to identifying and removing supply bottlenecks,where the government has failed miserably. Last but not least,given the rising bad assets of banks and the poor state of corporate balance sheets,it would only be prudent for the government to start substantially recapitalising public sector banks,the backbone of the economy. Short-term foreign borrowings of the private sector and the huge concentration of lending by Indian banks in infrastructure sectors pose a big risk to public sector banks,as is reflected in the movement of the S&P BSE Bankex vis-à-vis the Sensex. The IMF will be ready to help with its own instruments. But if India doesn’t require that,it has the advantage of having brought the IMF’s former chief economist home for good advice.

The writer is editor,Mumbai pv.iyer@expressindia.com