Pain postponed

Whether the continuance of liquidity pumping by the US Fed will boost India’s growth is debatable. But it will intensify inflation

By Mohan Sule

There are four inferences to be drawn from the US Federal Reserve’s decision to extend its bond-buying program by another month or till early next year. One is that the US recovery is fragile as inflation is still below target. Second, the buoyancy on Wall Street cannot be mistaken for bounce-back of the home economy. Third, neither the finance minister nor the Reserve Bank of India can take credit for the return of foreign investors as there has been a worldwide rally. Fourth, the recent low of the rupee (below 68 a US dollar) and stocks (below 18,000) could be taken as the threshold for the market’s plunge when the liquidity tapering is announced as the benchmark indices may have crossed new milestones and the rupee appreciated significantly in the meantime. The central bank might also be in a hurry to wind up its costly subsidization of dollar deposits. The easing of FDI caps in some sensitive sectors, which has the power to lend support to the rupee when the Fed actually starts pulling out from the market, will take more time to percolate. What would see an immediate impact would be withdrawal of power, fertilizer and diesel subsidies. This is unlikely till the general election scheduled early next year. So while Ben Bernanke is hoping for inflation to rise, which would indicate the US economy is sprouting green shoots, Raghuram Rajan wants inflation to be tamed even at the cost of growth. The Fed is continuing with loose money policy, while the Reserve Bank of India is making money costly.

On the positive side, the rupee depreciation has helped narrow trade deficit. On the flip side, wholesale inflation remains high. The joker in the pack is food inflation, which rose near about 19% per annum in the month. Rural welfare schemes and the food security legislation will mean that surplus money will chase food items up the value chain. The paradox is slowing manufacturing but higher prices of foodgrains. The central bank now faces the challenges of moderating food credit and at the same time pushing up non-food credit. Food credit surged from a negative growth in FY 2008 to 18.6% annual increase last fiscal, while non-food credit slumped from 23% year on increase to 14% annual expansion in this period. Any which way, inflation is sure to get a fillip. Besides, compulsive focus on non-food credit could worsen the bad loan situation of banks. Gross non-performing assets have risen by 1.12% points to 3.42 % in the five years to FY 2013. Most of it was contributed by the infrastructure sector. The RBI’s new boss wants to free bank branch expansion from controls. How many banks will bite when treasury income supports profitability and the current trend is to shrink balance sheets after being burnt by aggressive expansion in consumer financing? Spread-out in rural areas has great potential, particularly since the launch of the rural employment guarantee scheme. However, there could be political pressure to waive off loans on eve of elections. The central bank instead should have spelled out a roadmap for mergers and acquisitions in the banking sector, which would have led to consolidation and strengthen the ability to withstand global and local shocks.

esides a surge in inflation due to the continuance of Fed’s loose money policy and other welfare programs of the UPA-2 government, real estate also could see the formation of bubbles. The weak rupee has increased the cost of construction. At the same time property prices have become attractive to overseas buyers. This means increased inflows into luxury projects, which could be in the danger of a bust when the Fed goes back to conventional monetary policy making. Developers were luring domestic buyers hit by inflation with 20% upfront payment and deferring the balance till possession. The clampdown on bank financing to such schemes will squeeze cash-flow. A slump in real estate could be dangerous as seen from the widespread fallout of the crash in the sub-prime category in the US in 2008. A host of ancillary industries will face decline in demand. Banks with exposure to these sectors will see a spurt in delinquencies. This would have a ripple effect on the economy. The tightening of credit against gold jewellery too is mis-timed. Rural and poor urban folks used the scheme for liquidity, particularly during times of distress. The RBI, thus, has limited the flow of these funds into sectors such as housing, education and healthcare. The relaxation in dollar borrowings by corporates and banks is meaningless unless policy paralysis is shaken off. Capital-intensive infra, power and telecom sectors are not seeing capital expenditure due to policy and regulatory issues and not because of lack of demand. The bottom line is three months is a short time for India to get its act together.