Out of control

Movement of crude oil, currency and real estate will support
or mar budget calculations

By Mohan Sule

The finance minister has made his calculations. Over the next 12 months, the economy could play out as per the bets in the budget or skid as revenue does not pan out as expected or expenses, planned or untold, overshoot estimates. This could be because of internal or external factors. Rollout of reforms could improve sentiments but paralysis in decision making due to compulsions of coalition politics could prove to be a setback. External factors that could cast a positive influence would include a bounceback in the developed economies. Flare-up of geo-political tensions in some hotspots of the world, however, might affect liquidity and inflow of capital. As such the finance minister may have played the best cards available but there is always a joker in the pack to spring up a nasty surprise. Among the three most visible factors that could make or mar the markets in the fiscal ending March 2013, the most important is the movement of crude oil. After crossing US$100 a barrel in 2008 on surge in demand due to the bullishness in global economy, crude is once again testing these levels but not solely in anticipation of global economy’s resurgence. Rather it is due to trade sanctions on Iran, one of the major suppliers of oil to India, China and Europe. How soon the tensions in this region ease will not only determine the speed of recovery worldwide but will also provide a trigger for another spurt in prices. For India, crude is going to play a spoilsport till it dismantles the subsidy regime. Otherwise, expansion will be accompanied by a ballooning fiscal deficit, thereby trapping the country into a periodic cycle of growth-inflation-slowdown.

Of late, the conventional linkage of oil prices to inflation and, in turn, to interest rates is being severely tested. One of the reasons is the world is no longer flat. The bipolar globe consists of the developed and emerging economies. The flow of liquidity favors yields over everything else. Till recently, oil prices were capped by the slowdown in the US and recession in the euro-zone. Yet, India was coping with inflation caused by factors such as increasing consumption of protein-rich food and surging commodities on China’s insatiable appetite. The biggest surprise was India’s inability to attract arbitrageurs despite high interest rates. The attack on the rupee primarily stemmed from the credit crunch in the euro zone and not only from slowdown in growth arising from high interest rates and lack of progress on economic liberalisation. Dollars are flowing once again despite absence of any reforms as the European Central Bank has pumped funds at very cheap rates to lenders in Europe. The US Federal Reserve, too, is determined to keep interest rates at rock bottom for another two years. Foreign direct investment in multi-brand retail, insurance and banks, thus, may not be the keys to open the floodgates for capital inflows. Levelling of economic growth around the world from the present lopsided situation of high-wire and turgid countries would map the movement of funds from one spot to another due to specific reasons and not because of interest-rate differentials. This may take some time to happen. Till then, even deft budgetary juggling will continue to be in the danger of being overshadowed by circumstances beyond the finance minister’s control.

The shock of the the real estate market’s crash in the US, for instance, was not restricted to homebuyers. The contagion spread to Europe and rest of the world quickly as there were many other stakeholders involved ranging from mortgage lenders to financial institutions with exposure to derivatives based on loans of different types and tenures. Earlier, the health of the automobile sector was viewed to determine the well being of the economy due to its capital- and labor-intensive characteristics. Eventually, the industry shrugged off its local flavor to achieve a dispersed personality as supply chains were spread out to the most cost-effective geographies. Ironically, real estate, which should be the most indigenous industry as domestic conditions are supposed to have a bearing on the price tag and availability, has become the most vulnerable component in the global value chain. A boom or a slump transmits benefits or setbacks to different export-oriented sectors including commodities and financial services. Increasingly, its outlook is decided not only by the country’s growth rate but also by the price of oil as it impacts inflation and lending rates. In its endeavor to boost the economy, the budget might fuel real asset prices. This could make the exercise of lowering interest rates tricky for the central bank as it would not want to create asset bubbles. The bottom line is for all the hype and hope pinned on the budget to give a big push to the economy, the exercise has its limitations and comes with an expiry date.

Mohan Sule