Vignettes from RBI Annual Report 2010-11 – part 2

Export diversification and sustainable CAD

I.40 On the other hand, in the baseline scenario, the CAD would remain at a sustainable level in 2011-12. Estimates of sustainable CAD suggest a threshold of 2.7-3.0 per cent of GDP. Prospects for external sector for 2011-12 remain somewhat uncertain due to global uncertainties arising from the financial turmoil following the sovereign rating downgrade of the US, slowing pace of global recovery and the sovereign debt problems in the Euro area. These could impinge on commodity prices and exchange rate movements.

I.41 The continuance of robust performance of exports recorded in 2010-11 and 2011-12 so far faces downside risks. If these problems continue to simmer and do not turn into a full-blown crisis, the impact of growth slowdown in the advanced economies on India could partly be mitigated by continued diversification of exports. India’s exports have diversified notably in composition and destination in recent years. The impact could, nevertheless, turn material in case the slowdown in global growth is sharp and widespread.

ICOR of 4.5 and the need to raise savings rate

I.57 From the year 2000-01 onwards, gross domestic savings increased mainly on account of rise in private corporate savings and improved performance of public sector savings even as household sector savings remained almost stable as per cent of GDP. The public sector turned from being a net dissaver to a savings-generating sector largely due to fiscal consolidation under the Fiscal Responsibility and Budget Management (FRBM) Act regime. Private corporate savings improved in line with efficiency and profitability. The Planning Commission at the start of the process for formulating the Twelfth Five Year Plan (2012-17) envisaged a growth of 9.0-9.5 per cent. In the changed scenario, where advanced economies may go through a prolonged scenario of slow growth, this may be difficult target to pursue. In order to achieve even a 9.0 per cent growth, the investment rate of 40.5 per cent would be required if ICOR remains unchanged from 4.5 realised during the Eleventh Plan. The CAD that finances the saving-investment gap has averaged less than 1 per cent of GDP over past two decades.

Even assuming a higher a CAD/GDP ratio of 2 per cent, gross domestic saving (GDS) rate need to be raised by about 5 percentage points from 33.7 per cent in 2009-10. This underscores, the importance of augmenting saving as well as bringing about technological and institutional improvements to realize higher growth through higher investments and lower ICOR. Overall investment requirements and the need for continued sustainability on current account, thus underscore the need for attaining the highs of private corporate and public sector savings reached in the recent past and exploring the possibility of invoking an upward shift in household savings, which have remained stable for many years.

Global Monetary Accommodation, Commodities and domestic inflation

1.36 Given the fiscal limitations and growing signs of weakness in the US, the Fed has already indicated that it will pursue its near zero rate policy at least till mid-2013. It has also hinted at another dose of quantitative easing. This policy stance may keep the commodity prices elevated.

II.6.4 Global commodity prices firmed up during 2010, owing to rapid growth in EMDEs, strongerthan-expected growth of AEs and weather-related supply shocks. Low global interest rates and large surplus liquidity in the global economy fuelled global commodity prices with players taking long positions.

OPEC’s lower-than-expected output response during 2010 and unrest in the Middle East and North Africa (MENA) since January 2011 drove up oil prices. Commodity prices are expected to remain firm in 2011. If, however, monetary accommodation in AEs is progressively withdrawn, the consequent rise in interest rates could reduce leveraged position in commodity markets and deflate commodity prices. Commodity prices could also experience a decline if the pace of global recovery slackens further.

1.44 In the short run, if commodity prices soften and global crisis remains contained, the resultant benefit it may have in lowering inflation, fiscal and current account deficits could attract fresh investments. Therefore, the possibility of lumpy capital inflows cannot be ruled out.

Need to restore balance between consumption and investment

I.56 India is amongst the fast-growing emerging markets that have the right balance between consumption and investment in aggregate demand. It does not face the problems of over-investment or from excessive leveraged consumption. In the high growth phase, prior to the global financial crisis, leveraged consumption did increase, but from a rather low base. Investment, on the other hand, rose faster.

After the global financial crisis, government consumption rose on the back of large fiscal stimulus. In 2010-11, rebalancing took place away from government consumption to private consumption, but investment declined sharply in the second half of the year. There is now a need to maintain long-term balance between consumption and investment by rebalancing demand from consumption to investment. For this, there is a need to step up savings in the economy.

Vignettes from RBI Annual Report 2010-11 – part 1

RBI is worried about fiscal consolidation at the Centre, or the lack of it. They do not mince too many words on it. The need to balance consumption and investment is stressed. Government fiscal multiplier is higher for capital expenditure than for government consumption expenditure. Not surprising. India’s inflation threshold is around 4% to 6%. RBI hopes for global growth slowdown but not a crisis. It hopes for a sustained correction in commodities. Otherwise, is concerned about monetary accommodation in advanced economies. Comes out batting for financial globalisation. Does not fret much about loss of monetary policy freedom. Declining agricultural yields over time and low yields compared to the rest of the world. The Central Bank wants to invoke a raise in household savings rate which has not gone up since the early years of the Millennium. But, how? Savings are a function of income and employment. So, more jobs and more income needed. So, more and better education and better health too. Presto, the entire gamut of government policy action is required to raise the household savings rate.

The Central Bank is quietly confident of managing the Current Account Deficit. It is taciturn on foreign exchange reserves and is mostly silent on China’s exchange rate.

The Incremental Capital-Output Ratio (ICOR) in the XI Plan Period was 4.5 while the target was 4.1. I doubt if this would be bettered in XII Plan. So, to get to 9% growth, the savings rate has to go up to 38%. Around 33% now. Assume current account deficit of 2%, we need the savings rate to go up by another 3% at least. I think if India achieves 8% real GDP growth in the XII Plan Period, that would be a good achievement. Real GDP would double in nine years and nominal in five years, assuming 6% GDP deflator.

Extension of the ban on mining in Karnataka to two more districts appears, on the face of it, appears to swing things to the other extreme. Livelihoods are affected either way. Posturings can be at the extremes. Solutions are always in the middle. These kinds of things won’t help India achieve the economic growth rate it needs, to generate employment. Coal, Iron ore, Steel and Power – they are the pillars of a modern economy that wants to grow at 10% and wants to double the contribution of its manufacturing sector to the national economic output.

I present below select paragraphs from the RBI Annual Report on different topics. This post deals with fiscal consolidation. The full annual report is here. Pl. note that RBI fiscal year runs from July to June.

Recent superficial fiscal consolidation and challenges ahead

I.14 Fiscal deficit ratios in 2010-11 turned out to be better than envisaged in the Union budget. Centre’s gross fiscal deficit (GFD) was 4.7 per cent of GDP against 5.5 per cent budgeted. Compared with a GFD of 6.4 per cent of GDP in 2009-10, this was a huge swing.

I.15 A qualitative assessment of fiscal correction during 2010-11, however, raises concerns. Not only did the correction in revenue account reflect more than-anticipated non-tax revenues from spectrum auctions, there has been a spillover of subsidy expenditure from the last quarter of 2010-11 to the current fiscal year. Although the share of capital expenditure in total expenditure increased in 2010-11 from 2009-10, it was marginally lower than the budget estimates. In particular, capital outlay-GDP ratio fell short of the budgeted ratio in 2010-11 and is still significantly lower than that achieved during pre-crisis period. Consequently, in outstanding terms, the Central government’s capital outlay (as ratio to GDP) as at end-March 2011 was lower at 12.9 per cent than 13.8 per cent a year ago.

I.16 Improved fiscal position had a large temporary component arising from a business cycle upswing and one-off revenue gains. This resulted in the improvement in headline deficit numbers. Not counting for the revenue proceeds of two main one-off items – spectrum auction and the disinvestment – the GFD/GDP ratio works out to be 6.3 per cent of GDP during 2010-11. Also, revenue buoyancy was supported by a cyclical upswing that led to above trend growth. So the one-off gains and higher growth in nominal GDP of 20 per cent against the budgeted 12.5 per cent contributed largely to lower deficits, while the permanent component of fiscal consolidation was rather weak.

I.17 Clearly, a more enduring fiscal consolidation strategy that focuses on expenditure compression by restraining subsidies as well as revenue enhancement by implementing Direct Taxes Code (DTC) and Goods and Services Tax (GST) needs to be put into place without any further delay.

I.39 In the context of weakening global economy and the likelihood of some spillovers to the domestic economy during 2011-12, the twin deficits require close monitoring. If the global crisis deepens and domestic economy slows down beyond what is currently anticipated, the fiscal slippage could turn out to be an issue of concern. It could potentially erode the fiscal consolidation achieved in the previous year.  On current assessment, the fiscal deficit in 2011-12 is likely to overshoot the budgeted projections. If the economy slows down beyond what is currently anticipated, the resultant revenue erosion could magnify the slippage. At the same time, the fiscal space to support any counter-cyclical policies is more limited than what existed at the time of the global crisis of 2008.

II.5.7 Expenditure growth remained higher than budgeted for 2010-11, thereby maintaining pressures on aggregate demand. The revised estimates of total expenditure on subsidies (mainly on food, fertiliser and petroleum) remained higher than the budget estimates reflecting the impact of higher international prices of these commodities. Capital expenditure, both plan and non-plan, remained higher than the budgeted levels in 2010-11. On the whole, expenditure growth not only turned out to be higher than that was budgeted for 2010-11 but also accelerated as compared with that of 2009-10.

II.5.17 While restraint on revenue expenditure growth not only ensures that the fiscal consolidation process is sustainable, it also creates a fiscal space for undertaking additional capital outlay, which is essential for infrastructure financing and to provide an enabling environment for sustained economic growth. Nonetheless, going forward, there are certain concerns with regard to fiscal consolidation. First, the ratio of revenue deficit to gross fiscal deficit, which is an important benchmark for assessment of the quality of fiscal consolidation, is expected to remain significantly higher at 74.4 percent in 2011-12 (BE) than 41.4 per cent in 2007-08. This indicates that a large portion of borrowings is used to finance the revenue deficit, thereby reducing the availability of resources to undertake capital outlays, which could have implications for potential growth. With the GFD-GDP ratio budgeted to be lower in 2011-12, higher RD-GFD ratio reflects that fiscal adjustment envisaged during 2011-12 will be mainly through compression in capital outlay. Accordingly, the quality of fiscal adjustment may have long-term implications for growth as fiscal multiplier is generally found to be higher in the case of capital expenditure (Box II.14).

From Box II.14: Fiscal Multiplier higher for capital expenditure

Based on quarterly data for 1996-97 to 2009-10, it was found that government consumption positively impacts GDP growth (both in real and nominal terms) in the short-term. Government consumption multiplier peaks within first three quarters (ranging between 0.11 and 0.20 under alternative specifications), after which the impact is found to peter out. Focusing on impact of Central government’s investment as reflected in annual capital outlays (in real terms), the cumulative multiplier works out to around 1.5 when the multiplier peaks. Thus, cross-country findings as well as the results for India show that government consumption leads to crowding out with size of multiplier being significantly lower than one while investment multiplier, working over the long-run, has crowding-in impact with its size more than unity. This calls for improving quality of public expenditure management by increasingly rationalising outlays towards investment as the Central and State governments revert to the rule-based fiscal consolidation path.

Jackson Hope

It is now clear that stock markets have taken heart from Mr. Bernanke’s speech even though pundits proclaimed the speech to be short on specifics in terms of what Mr. Bernanke could do near-term for the US economy. But, the markets are ‘right’ in a limited sense to be happy. Long-time readers of TGS or my columns in MINT would know that I do not think that any further round of asset purchases or money printing would help the US. But, that said, which part of Mr. Bernanke’s speech that stock markets have cottoned on to? My guess is that this is the paragraph:

Normally, monetary or fiscal policies aimed primarily at promoting a faster pace of economic recovery in the near term would not be expected to significantly affect the longer-term performance of the economy. However, current circumstances may be an exception to that standard view–the exception to which I alluded earlier. Our economy is suffering today from an extraordinarily high level of long-term unemployment, with nearly half of the unemployed having been out of work for more than six months. Under these unusual circumstances, policies that promote a stronger recovery in the near term may serve longer-term objectives as well. In the short term, putting people back to work reduces the hardships inflicted by difficult economic times and helps ensure that our economy is producing at its full potential rather than leaving productive resources fallow. In the longer term, minimizing the duration of unemployment supports a healthy economy by avoiding some of the erosion of skills and loss of attachment to the labor force that is often associated with long-term unemployment. [Full text of his speech here]

This coupled with the announcement that the next meeting has been extended to two days from one have kept stock markets drooling. In my latest MINT column, I equate this to the behaviour of druggies:

It is equivalent to a drug addict feeling happy at the prospect of his supplies being restored in the days to come. [Full column here]

Obsessions are blind

A good friend sent me two articles from the American press and asked for my comments. I thought it is a good opportunity to share both the articles and my comments. One is by the well-known Dr. Paul Krugman. The other is a community banker in the US. The article by the Community Banker is actually an answer to the piece by Krugman.

Paul Krugman’s prescriptions are nothing new. This bilateral email exchange gives me the freedom to call his proposals/suggestions NUTS.

Bernanke, the Fed Chairman, has already used some of the suggestions that has been made by BB, the Professor, to the Bank of Japan and now by PK to BB.  The Federal Reserve bought not just government securities. He bought all kinds of debt securities. He has now pre-announced interest rates for the next two years. what is missing? An inflation target. What is the US inflation rate now? It is already above 3%. It is not really missing.

When BB made these suggestions to BoJ in the 1990s, it was a different world:

1) Japan was not the US in the sense that its monetary policy actions and decisions do not impact the world as much as US actions do. The yen is not a global reserve currency.

2) Globalisation of trade, movement of commodities, global transmission of financial asset prices and correlation of asset prices across the world had not progressed to the degree that we witness now. So, America’s actions today will have far-reaching global consequences than America’s actions in the early 1990s

3) Resource constraint is a big issue, in my view, today. Saudi Arabia’s oil consumption has risen manifold. Climate change and climate volatility are playing havoc with harvests and yields. Plus, fnancialisation of commodities also means that low interest rates easily stoke speculation. That is what the article by the Community Banker also confirms.

4) There are global inflationary consequences of Fed actions. Switzerland’s desperation with its currency strength clearly illustrates that.

The absence of even a cursory acknowledgement of the costs and of the scope for the law of unintended consequences to become operational is almost a criminal omission.

I have commented on this irresponsibility of the ‘neo-Keynesians’ on several occasions in my blog and in my MINT columns. Most recently here.

Check out these two blog posts by Tyler Cowen (‘Marginal Revolution’) on Irish bond yields, the growth in the Irish economy and the silence of the Keynesians. As to how the Irish economy achieved this growth rate, read this good piece in Wall Street Journal. ‘Marginal Revolution’ thinks that this piece in FT was one of the best in documetning Ireland’s recovery. I think this post is long on rhetoric and short on specifics. The Wall Street Journal piece is better in that respect.

Yes, the answer is simple: Austerity, some debt reduction, a decline in real wages and a competitive exchange rate would go a long way towards restoring growth in peripheral Europe. Who is holding up the Euro from weakening? Is it the ECB or China or the Federal Reserve? The answer is: ALL THREE

Steve Jobs

I did not think that I would do a blog post on Steve Jobs simply because I did not think I knew him well enough to do a post. Quite imperceptibly though, most of the gadgets in my house are now Apple-made. That apart, I have not followed technology that closely and I am a late adopter. Thanks to Jayakrishnan Nair (JK), fellow INI blogger, I happened to read (for the most part, that is) the very long interview that Steve Jobs had given to Playboy magazine in 1985.

Reading it a full quarter-century and longer later, it makes for incredibly insightful reading. He comes across as a true visionary and largely, a well-grounded human being, even at that age.

His comment about thinking about Western rational intellectual trait after returning from India is a rather interesting remark. Many follow-up questions arise in our heads on reading that.

Further, many people think that the Sixties was a lost decade for the US. After reading this, I wonder whether the US would have become a hardware and software innovation leader but for the spirit of the Sixties?

So, what do we know what is the ideal preparation for the world – world of business, world of life, world of being a husband, father, friend, sibling, etc.?

We know very very little.

It is extremely long but it is well worth the time spent. You can read the full text of that interview here. Strangely, Singapore Media Development Authority has blocked access to Playboy site!

Inequality is the system

The visit of an old-time pal from Madurai with his mother to Singapore, my pre-occuption with the message of Dr. Arun Shourie’s ‘Does He know a Mother’s Heart? – I shall post my personal review of the book here (a long one) – and the Jan LokPal agitation have kept me away from commenting on global developments.

There has been no dearth of them:

(1) Just as the Philadelphia Federal Reserve Manufacturing Index was a ‘shocker’ for its steep decline, the German Economic Sentiment Index (it is a survey of economic forecasters) dropped like a stone. Interesting that a Google search on this news does not reveal its coverage by any major news agencies or news wires.

(2) We will come to Mr. Bernanke’s speech at Jackson Hope (Hole, that is) soon.

(3) Steve Jobs has resigned. Many would and have noted this with sadness. I am not a technology buff nor a tech. watcher. But, slowly and imperceptibly, most of the gadgets in my house have now become Apple products. We do not complain. My daughter – 12 years old – said that this would mean that Apple innovations would stop now. She did not mean it seriously, I guess. I doubt if she would be right, though.

(4) Warren Buffett’s investment in Bank of America. By and large, my respect for the veteran investor has been declining steadily since the global crisis occurred in 2008.  For great comments on his investment, one should simply doff one’s hat in the direction of Barry Ritholtz and ‘Tyler Durden’ (nom de plume) of ZeroHedge. See here, here and here.

(5) On the sudden departure of the President of S&P, the best comment was made by ZeroHedge. Read it here.

(6) Sometimes, the most revealing piece of information does not come from economic data or from any official or political declarations, announcements, etc. They come from ‘friendly’ basketball matches. This one is indeed a revelation and holds the best pointer to how China would behave when threatened by ‘failure’. You may need to be a subscriber to read the full article (I hope not). This is a great piece of news. (ht: Anirudha Dutta)

(7) A very good piece in Der Spiegel (in English) flagged by ‘Naked Capitalism’ on the meaning of riots in England. My good friend Dr. Vidyasagar liked this particular sentence as I did:

Wealth disparity is no accident of the capitalist system — it is the system. [Read the full article here]

(8) I ‘follow’ good friends Rajesh Sundaresan and Subba Iyer on Google reader. Thanks to Rajesh, these two posts at ‘www.ritholtz.com’ came to my attention. One post is on James Montier’s reading list. I particularly am fascinated by the book, ‘The psychology of intelligence analysis’. To a somewhat lesser extent, ‘Margin of Safety’ by Seth Klarman also piques my interest.

Thanks to this post, I also came across ‘Memos from our Chairman’ on the website of Oaktree Capital.

The post on ‘Incredible science discoveries’ also by Barry Ritholtz is fascinatingly positive. The link on the design of a new drug that could cure any viral infection by scientists at the MIT should gladden the hearts of billions. Wishing Godspeed to the final arrival of that drug.

(9) As this post of Barry Ritholtz suggests, its contents are indeed the ‘Heart of the matter’. It appears to be a question of WHEN and not IF there would be a social revolution or unrest or the latter leading to the former.

Now that this post has become long already, I shall post my comments on Mr. Bernanke’s piece separately.

The post-LokPal world

I have refrained from joining the chorus of discussions because, in times such as this, there is more noise than information or substance. But, when learned friends who ought to know more start talking in binary terms – either you are with Hazare or with the UPA – then it is time to make a few things clear. There is no expectation or arrogance that these views are the right ones. Just exercising my right to belt out a few words. The right to delete or ignore or castigate is very much yours.

Those of us who have been expressing light or deep concerns with both the Hazare camp tactics and goals have missed out one thing. We have consistently under-estimated the groundswell of public opinion against politicians and, especially, the Congress and its coalition partners. In the absence of a credible Opposition party that could tap into this sentiment, Mr. Hazare and his team have stepped in to harness this anti-politician sentiment. They have done well in giving a form and outlet for the frustration of the Middle-Class India. Merely because some one is against Indian politicians, they cannot and should not be placed above criticism or scrutiny.

Also, it is very unfortunate that if you questioned a proposed solution, then you are branded as being indifferent to the problem or that you are part of the problem-creators.

For instance, the US economy is deficient in demand. The proposed solutions are either to print more money or to spend more government money. I have expressed doubts on the efficacy of both and pointed out the costs of both these proposed solutions. So has Raghuram Rajan, among many others. That does not mean we do not recognise the problem of unemployment in the US or weak economic growth or that something could be done about it. But, it does not need rabble-rousing to come up with patient solutions. As Raghuram Rajan wrote in one of his recent columns in FT, patience might be a key ingredient of any solution.

Our experience tells us that most things in life are never black or white. Yet, any criticism of Mr. Hazare, his methods and his goals invites such venom that one wonders what is the difference between the disdain shown by politicians towards rules and norms of behaviour and conduct expected of them and the disdain shown by Anna’s internet and on-the-street followers for any alternate point of view?

Why even otherwise sensible Indians should suspect the critics of the methods and goals of team Hazare to be lacking in integrity, to be agents of the Congress Party or that of the UPA or to be applicants to replace Digvijay Singh?

Yes, TGS concedes readily – again – that the issue of corruption has never before been brought to the front burner in India as has been now done by Mr. Hazare. He has unleashed tremendous energy and has aroused expectations sky-high. Unless properly harnessed and channelized constructively, these forces could turn against the idea and integrity of India and could become the Basmasura to Mr. Hazare.

Mr. Hazare has called the politicians traitors – technically, he is right. Any one who betrays the trust reposed in them is a traitor. That is true, by definition.

Is it possible that a situation could arise that today’s followers of Anna Hazare and his team would call them traitors down the road? Yes, it is possible because they (Team Hazare) have given rise to the expectation that they (Team Hazare) have all the answers to the problems of corruption and governance. That is the trust they (the Middle Class) have reposed in these people (Team Hazare) and tomorrow, if they (Team Hazare) fall short for want of acumen or competence or good intentions or a combination of all three, they (Team Hazare) too will have betrayed the trust of the people who followed them.

It should be apparent to a High school student that where there is discretionary power, it is abused. Power corrupts and absolute power corrupts absolutely. Two off-shoots of this well-known fact are: (1) If you wish to eliminate corruption or reduce its incidence and impact, you reduce discretionary power and (2) if, in the process of eliminating such corruption, you create some other structures with absolute power, you are ignoring this fact that absolute power corrupts absolutely.

Hence, the logic of de-centralisation and elimination of discretionary powers in reducing or eliminating corruption is unassailable. The logic of information being used as a sunlight/disinfectant to eliminate the abuse and the virus of discretionary power is equally powerful.

To give credit where credit is due, the Jan Lok Pal Bill Draft 2.3 available on the website of www.indiaagainstcorruption.org is a considerable improvement over the drafts formulated last year. The powers of the LokPal are less draconian than before and there are more provisions for accountability. I do not know wish to go into details. Little bit of homework  – as I did – would make many readers arrive at the same conclusion.

But, if there are three features of the anti-corruption agitation – the LokPal Bill, the tactics and the post-Lok Pal governance agenda – what the draft 2.3 conveys is that Team Hazare has listened to public feedback on some of the most draconian provisions of the original Lok Pal draft. But, concerns over the other two elements of their agitation remain and have become deeper. Their tactics have become more arbitrary and unconstitutional at the same time and their governance agenda is deeply worrying.

It is the middle class – that is frustrated deeply by bribes paid to get driving license, to get a seat in an educational institution of choice, to be able to buy a property at affordable prices by paying out of their savings in a bank account rather than by cash, by having to pay a bribe to collect their income-tax refunds, etc. – that now backs Mr. Hazare to the hilt. But, the frustration of the middle class with the reform process is not that it was undertaken but it has not been completed.

But, they should remember that the agenda of Team Hazare is – intentionally or otherwise – roll back reforms, concentrate power in State hands and have a Lok Pal to check that abuse of expanded State power!

Prashant Bhushan’s remarks made in May against economic and policy reforms are most troubling. That those remarks were made in May flanked by Ms. Arundati Roy should be deeply worrying to all the right-thinking Indians. See the blog post at TGS of April 30th.  The Middle Class camp followers of Team Hazare should read the excellent blog posts by ‘Offstumped’ here and here.

Further, the remark by Kiran Bedi that Anna is India and India is Anna should not be ignored. It is a reflection of the mindset that pervades Indians, in general. It is just that the cast and the crew of the drama are different. But, the drama is the same – power and hubris.

The world is in the midst of unprecedented uncertainty, strife and potential conflicts. India is likely to be whipsawed by these developments in the coming months. What is the worldview of team-Hazare?

Prime Minister Manmohan Singh and his two governments since 2004 have done many things that are going to hurt India in the years to come. I sincerely hope that the Hazare phenomenon does not join that list.