State of the health

Recession or recovery, drought or normal monsoon, India has to live with inflation

The certificate of health given to the Indian economy by Standard & Poor’s was the trigger the market was waiting for to spring back into action. What were tentative moves, influenced by the woes of the European economy and the still weak US economy, into the trading ring after the presentation of the Union Budget 2010-11 have become bolder forays. The budget represents an opportunity to the government to translate its vision into concrete ground level action. Yet, the scope is restricted, mindful of the fiscal imbalance that could be the spin-off of going overboard: inflation, drying of investment, and decline in revenue. In India, along with the budget, foreign investors also watch policies on foreign direct and portfolio investment. Achieving a semblance of stability in managing conflicting interests is considered a feat that needs to be acknowledged. Political stability, efforts to pull back fiscal deficit, important reforms to be initiated in direct and indirect tax codes, restoration of foreign capital inflow, a range-bound currency, kicking off of PSU divestment and 3G spectrum auction, and hints of opening the financial services sector probably satisfied S&P that India is on the right course of inclusive growth. The market has responded to the rating agency’s approval with vigor, unmindful of the rising inflation and indications that the Reserve Bank of India may have to clamp down on money supply sooner than later. A few days after S&P upgraded India’s rating, the RBI raised the repo and the reverse repo rates at which it lends and borrows short-term funds. The central bank’s hesitant moves arise from the crossroads facing Indian markets.

On one side is the promising growth story set to take the markets to new heights. On the other is the accompanying inflation, fuelled by external and internal factors. Earlier, crude oil was a major contributor. The irony is that despite consumption growing manifold on the expansion of the automobile, aviation and petroleum-based product sectors, rise in prices of oil is being absorbed by the economy much better than when the economy was closed. This is despite the government subsidising the usage of petroleum products by urban and rural poor. The answer lies in the increasing prosperity of rural areas, stemming from the minimum support prices for food grains. It is a vicious circle: government supports prices during scanty rainfall to help farmers and also during bumper crop to put a floor to declining prices. The resultant demand from rural areas spurs companies to compete for capital as well as for commodities and capital goods to undertake expansion. Consequently, India is faced with a perpetual problem of inflation as surplus cash finds its way to automobiles, consumer goods and real estate, while infrastructure sectors have to scramble to raise funds. The spin-off is pressure on interest rates. Higher interest rates strengthen the rupee. The monetary authority, therefore, is always in conflict with market forces to tame money supply without capping growth. The banking sector captures the dilemma of the policy makers of meeting liquidity requirement without creating asset bubbles.

Emerging sectors like telecom and aviation are as likely to ground India’s flight as can credit crunch in the infrastructure sectors. Frequent changes in rules and delays in taking decisions have been a bane of the telecom sector just as restrictive guidelines on foreign investment and volatility in aviation turbine fuel have been for the aviation sector. It is important that the two poster boys of reforms remain in good health. The aviation sector is only now emerging from the cutthroat competition even as the telecom sector is in the midst of a shakeout. Transparent allocation of 3G spectrum is vital for its healthy growth just as easing the crushing taxes on ATF. The government’s procrastination and opaqueness in the initial round of bids when mobile telephony was introduced, stemmed partly from the desperation to bridge fiscal deficit, ballooning from subsidisation of the festiliser and petroleum product sectors. Implementation of the Kirit Parikh Committee report on the deregulation of the petroleum sector will temper the need to take recourse to other channels like telecom auctions with stiffling norms and high-priced divestment to make up for the diversion of resources to socially sensitive sectors. But for these compulsions, there would not have been the need to experiment with the French auction method in the sale of shares of NTPC and REC with unsatisfactory results or stiff rules so as to perpetuate by default the control over the telecom market of the top three to four players by virtue of bagging 3G spectrum for all circles.