India might as well be in the midst of a volatile, uncertain, complex and ambiguous (VUCA) economic situation. We need to comprehend that adequately and put in place some tough, hard core reforms and programs.
Are we now in the midst of a VUCA [volatile, uncertain, complex and ambiguous] economic environment? Given the intensively competitive and globalizing milieu, the response to this question has inevitably to be in the context of evolving global and domestic economic developments. Let me begin by outlining the current global narrative.
Evidently, there are three key distinctively disturbing trends: first, the looming Chinese ‘hard’ landing; second, the continued US Fed dilemma about the rate hike andthird,the prolonged commodities prices deflation syndrome.
All these together have serious implications for global economic and trade growth. I strongly believe that Indian policy makers cannot be oblivious to such distressing developments. Now let us turn to the more specifics.
1. The Chinese Challenge
China has now officially scaled down, albeit marginally, its real GDP growth estimates to 7.3% for 2014 from 7.4% earlier – the weakest performance over the last quarter century. The latest Moody’s forecast pegs its estimated growth rate to be lower at 6.3% in 2016. Some experts believe that the likely growth rate may turn out to be even lower than 6%.
China’s export engine – the main driver of its accelerated growth profile for the past many years – isslowing down sharply in recent months; in fact, its overseas shipments have contracted by 5.5% in dollar terms in August after a 13.8% fall in July 2015.
Alongside, China has witnessed the substantial loss of its forex reserves – as much as US$444 bn. [about 1.3 times India’s current forex reserves of US$352 bn.] in a span of just last 15 months. Admittedly, even its current size of depleted forex reserves of US$3.56 trillion is still very massive – equivalent of such reserves of next top six forex reserves holding countries put together.
The collapse of stock markets in China has, no doubt, been causing acute pains not only for the Chinese investors and policy-makers but also to foreign investors and to global stock exchanges at large.
For many emerging market economies like India, the challenges are two-fold: [a] how to penetrate shrinking export markets of China?; and [b] how to protect domestic industries from likely aggressive pursuit by the Chinese exporters to dump their excess production in their markets?
Competitive devaluation of currencies is no solution – it would turn out to be like a Pyrrhic victory, if at all! So, also would be the strategy of building up trade barriers, especially the indiscriminate use of anti-dumping duties.
2. The US Challenge
The second source of VUCA environment would emerge from the impending US Fed monetary policy action. The US Federal Open Market Committee[FOMC]meeting is scheduled on September 16 and 17 – and it is expected to provide the direction of the rate hikes.
The recently released Q2 [April-June] 2015 national accounts results show acceleration of US real GDP growth rate to 3.7% as compared to 0.6% growth rate in the previous quarter. Q2 2015 results reflect widespread positive contributions from personal consumption expenditures, exports, state and local government spending, non-residential and residential fixed investment and private inventory investment.
Besides, its unemployment rate has dropped to 5.1% in August 2015 –the lowest unemployment rate since April 2008.But the dilemma on interest rate policy is due tothe US inflation rate still remaining well below the Fed’s own 2% target and is attributable largely to wage stagnation and the strong dollar.
From India’s monetary policy perspective, the US Fed move is being anxiously awaited by the RBI, and the reason is quite clear.
If the US Fed finally raises its key policy rate by 25 basis points and the RBI were to take a contrarian move of reducing the repo rate by 25 basis points in the forthcoming fourth bi-monthly monetary policy on September 29, in accordance with the expectations of the market, as well as pressures emanating from the Finance Ministry and business and industry, then there would be substantial narrowing down of the real interest rate differential between two countries.
In turn, this would lead to some flight of capital – both from debt and equity markets of India. This could inevitably cause some volatility in the exchange rate of the rupee in the coming months.
3. The Commodities Deflation Challenge
Continuously falling trend in global commodity prices is generally perceived to be a blessing in disguise, especially from the viewpoint of commodities importing countries, including India. But, doubtless, it is something to be seriously concerned about.
The closely watched composite Bloomberg Commodity Index [BCI], which tracks 20 commodity prices, has been on a downward drift – both in a short-term to a longer-term viewpoint. Thus, BCI Spot [comprising of energy, agriculture, metals, livestock, etc.] is down by 9.3% over the last three-month period; by 24.3% over the last year; and 33.1% over the last three-year period.
Likewise, international crude oil [Brent] prices for the past few weeks are hovering in the range of USD$47 to US$49 per barrel as against US$112 to US$115 during mid-June 2014.
All this has predominantly helped our policy makers in better inflation management and has conferred substantial fiscal bonanza for the Govt. of India.
While contracting commodity prices does provide substantial relief to the importing countries, including India, in their cost of inputs and, therefore, in improving cost competitiveness of their manufacturing industries, they cause huge erosion in real incomes of the exporting countries.
A prolonged phase of deflation may have many adverse consequences – it could feed on itself and trigger another Great Recession – the reminiscent of 2008-2009. Most of the major economies have limited monetary and fiscal space now to counteract such a predicament.
India will have the formidable task in sustaining its exports of merchandise, and also of services. In turn, this would have serious implications for growth momentum, which now would have to be incrementally generated through restoring the buoyancy of domestic markets.
The Domestic Scenario
How does the Indian narrative read in this global contextual framework?
Obviously, it has become somewhat more complex and ambiguous in the last few months, and more so following two key recent developments, namely, [a] the Central Govt. finally deciding to request the President to prorogue the monsoon session of the Parliament, thereby giving a goby to the immediate passing of GST Bill. In turn, this would most likely to derail the roll-outof this important game-changing fiscal policy initiative by April 1, 2016; and [b]the announcement of the state assembly elections in Bihar – whose first phase would start on October 12 and end with the last phase to be completed on November 5, 2015.
Thus, for all practical purposes, there would be a virtual standstill for at least next couple of months; and there would be no major policy reforms on considerations of code of conduct, which now becomes operational.
In the meantime, the government seems to be becoming more proactive with several administrative/ executive efforts. The recently held PM’s high-powered meeting with the top captains of business and industry along with the RBI Governor, NITI Ayog Chief, various senior bureaucrats reflects in a sense the serious concerns about current state of the economy – impacted, as it is, by
[a] growing global uncertainty, as described earlier; [b] severity of the south-west monsoon failure, and a looming specter of widespread drought; the IMD’s latest data reveals 15% rainfall deficiency during the current monsoon season till September 10, 2015; [c] volatility in stock markets and exchange rate behavior of Indian rupee; and [d] widespread despondency that key reforms are not moving, and the implementation various promising programs – “Make in India”; “Digital India”; “Start-up India; Stand up India”, etc. – have not progressed beyond being mere slogans.
Much of the over three hours long interactions in this meeting were on familiar lines – the spokesperson of business and industry, once again, making a pitch for
- Reducing the cost of capital – the RBI needs to cut back key policy rates quickly;
- Improving the ease of doing business;
- Expediting infrastructure development and public spending thereon;
- Tax incentives for the upcoming new entrepreneurs; etc.
In turn, the PM has exhorted the business and industry to take the risk and step up investment, thereby contribute to nation-building through investment and jobs. Further, the FM has either promised or expressed govt.’s intentions to do the following:
- Taking steps to strengthen the Indian economy through investment in infrastructure, irrigation, etc.and attracting more global investment and generating private investment; and
- Improving the flow of credit, de-risking and de-stressing the balance sheets of public sector banks and improving the overall lendable resources of the banking system.
Incidentally, there are pressures building up on the RBI to ease the key policy rates – a virtual consensus is emerging that in the fourth bi-monthly monetary policy the repo rate needs to be reduced by 25 basis points from present 7.25% to 7% come September 29, 2015. I believe that marginal softening of interest rate policy per se would hardly cause any noticeable positive impact on the cost of capital. In any case, the share of interest cost in total manufacturing cost (barring the capital goods industries), of both corporate and non-corporate businesses, is just around is less than 5%. What are more crucial are the costs of raw materials, energy, salaries and wages, etc. and other structural rigidities hampering the growth of production, distribution and investments.
The other worrisome development on the macro front is the increased fiscal burden arising from implementation of “one-rank, one-pension [OROP]” schemefor the retired defence personnel [servicemen] – the actual quantum so far remains not fully comprehensible [ranging from Rs.8,000 to 10,000 crores annually and another Rs.10,000 to Rs.12,000 crores by way of arrears]. Even more burdensome would bethe impending 7th Pay Commission Awardfor the Central Govt. employees, which would become operational next FY – its burden could be equivalent of ~0.5% of GDP, if not more. In effect, the fiscal bonanza that is currently accruing through falling international crude oil and commodities prices may be more than fully neutralized by the rising burden of pay and pensions of the government employees in next year or so.
In substance, for India, the VUCA economic environment is for real. Mere brave proclamations that the economy is resilient and would still grow at 7.5% to 8% would be not of much avail. Mere exhortations to the business community to go and invest in one-off meeting with their top leaders would neither deliver investment nor growth. Mere reduction in the repo rate by 25 basis points would just wither away as the previous three attempts to reduce the interest rates cumulatively by 75 basis points have so far been.
I genuinely believe that gravity of the challenge is not adequately comprehended, and hence it is important to sound the warning bells so that tough, hard core reforms and programs get started soon.