Macroeconomic conditions deteriorated during 2012-13: RBI
(Slowing growth, lingering inflation pressures and risks from persisting twin deficits)
The year 2012-13 was marked by slowing growth, lingering inflation pressures and risks from persisting twin deficits. Policy efforts helped contain fiscal deficits and moderate inflation towards the later part of the year. However, significant challenges remain ahead for reviving growth while maintaining macro-financial stability. In this context, it becomes important to address structural constraints to growth, improve governance, address asset quality concerns and correct external imbalances.
The Annual Report 2012-13 released by Reserve Bank of India states that the year 2012-13 was marked by slowing growth, lingering inflation, large fiscal and current account gaps and deteriorating asset quality. With growth decelerating further and staying below trend for the second consecutive year, ordinarily the policy response would have been an accommodative monetary policy. Persisting inflation was eroding the competitive efficiency of the economy and lowering the financial savings of households with its adverse consequences for the CAD, investment and long-term growth. Causes for economic slowdown – Growth decelerated further in 2012-13 to a 10-year low of 5%. The slowdown also became more pervasive across sectors, including services. Growth had averaged 8.8% during 2005-06 to 2010-11, despite a low of 6.7% in 2008-09 due to the external shock. Growth slowdowns are typically associated with cyclical or structural shocks that are often called real business cycle shocks in economics. The former are transitory, while the latter are more persistent because by nature they last until newer, lasting shocks take growth to a different level of output in either direction. Cyclical shocks are in the nature of upswings and downswings in growth or in terms of booms and busts. Permanent shocks are generally associated with real business cycle proponents, such as productivity changes, demographic changes, wars, natural calamities, structural deficits and other structural factors. Over the past two years, although part of the slowdown has been driven by cyclical factors, structural constraints have played a major role in the slowdown. The slack in manufacturing activity was largely due to poor investment on the back of structural issues facing the infrastructure sector. In addition, global factors played an important role in the current growth slowdown. Global growth decelerated to 3.1% in 2012, the lowest since the 2009 contraction that followed the global financial crisis. Likewise, global trade decelerated sharply to 2.5% from 6% in the preceding year and 12.5% a year ago. Consequently, external demand fell and revival was difficult. Persistence of Inflation – The year 2012-13 was marked by headline WPI inflation ruling at a lower level than in the previous two years. On an average basis, headline inflation came down to 7.4% from 8.9% in 2011-12 and 9.6% a year ago. Headline inflation, after receding in Q4 of 2011-12, exhibited persistence at that relatively lower level. This persistence mainly reflected high food and fuel inflation almost throughout the year. So, although non-food manufacturing inflation receded further during H2 of 2012-13 due to softer global commodity prices and a fall in demand-side pressures, the overall WPI inflation exhibited a fair degree of persistence. The year saw the negative output gap helping to moderate inflation, but encountering resistance amid supply-side constraints. Food inflation originated from an unusual spike in vegetable prices during February–April 2012, a rise in cereal prices later in the year due to the delayed monsoon and a significant increase in minimum support prices (MSPs). Fuel inflation largely reflected the impact of administered price changes during the year, with some of the suppressed inflation coming to the fore.Fiscal imbalances and the reversal – Fiscal developments during 2012-13 were split into two halves. The period H1 of 2012-13 was characterised by a fiscal slippage to a degree that it could have undermined macro-stability. However, H2 of 2012-13 was marked by an equally remarkable fiscal retrench, although in the face of a significant overshooting of subsidies from the budget estimate, the burden of adjustment fell disproportionately on plan revenue expenditure and on plan and non-plan capital expenditure. The fiscal correction in the second half of the year resulted in a significant reduction in the gross fiscal deficit (GFD) to 4.9% of GDP in 2012-13 from 5.7% in 2011-12.External sector vulnerabilities – External sector vulnerabilities came to the fore in 2012-13, as the CAD widened to a historic peak of 4.8% of GDP on top of an already high level of 4.2% in the previous year. The widening of the CAD was largely the result of high oil and gold imports and moderation in export growth. In order to contain gold imports, import duties on gold were doubled from 2% to 4% in March 2012, raised further to 6% in January 2013 and then hiked to 8% in June 2013. Further, in August 2013, custom duties on gold, platinum, refined gold bars and silver bars were hiked by 2% points each, taking the import duty on gold to 10%. With slowing growth over the past two years, external sector sustainability concerns came on the horizon. During 2012-13, India ’s external debt rose by about US$ 45 billion to US$ 390 billion. Prospects for the year 2013-14 – The year 2013-14 has begun with tumultuous changes. After early signs that growth was picking up in the US and Japan, the indication by the Fed that it would unwind part of the monetary stimulus earlier than anticipated, has led to tightening in financial conditions. Bond yields firmed up across the curve and across geographies, and brought further changes in other asset prices. Currencies of the Emerging Markets and Developing Economies (EMDEs) depreciated speedily, not just of the current account deficit economies but also for some current account surplus economies. This, in turn, led to a decline in equity prices as portfolio shifts occurred from EMDEs to US markets. Global commodity prices, which had exhibited a softer bias during February–April 2013, firmed up temporarily. Political unrest in parts of the Middle East also put upward pressure on global oil prices. These global spillovers affected India , like many other EMDEs. After the Fed Chairman’s comments on May 22, until July 15, 2013 foreign institutional investors (FIIs) on a net basis disinvested US$ 8.3 billion of their bond portfolio and US$ 2.1 billion of their equity portfolio in cash markets in India. The resultant net outflows brought the rupee under immense pressure. Considering the heightened exchange rate volatility, the Reserve Bank announced measures to stabilise the rupee on July 15, 2013 which were later modified in July 23, 2013. The emerging macroeconomic scenario for the year 2013-14 is challenging amid the wide CAD, risks to fiscal targets, persistence of high consumer price inflation, risk of exchange rate depreciation feeding into inflation, slowing growth and deteriorating asset quality. The Annual Monetary Policy Statement for 2013-14 of May 3, 2013 projected the baseline GDP growth for 2013-14 at 5.7% conditional upon a normal monsoon, revival in domestic investment and global growth and projected WPI inflation to be range-bound around 5.5% during 2013- 14, keeping in view the domestic demand-supply balance, the outlook for global commodity prices and the forecast of a normal monsoon. As such, macroeconomic and monetary policies need to be carefully calibrated to achieve the immediate objective of maintaining stability without compromising growth. Going forward – Indian economy is currently going through a difficult period. However, the problems are not unique to India . Growth has also slowed down in many other EMDEs. What is important at this stage is to preserve India ’s growth potential by arresting the downtrend and maintaining stable macroeconomic conditions. For this, the focus need to be on implementation of measures aimed at removing structural constraints so that production and investment activity could gather momentum. This is important, because spillovers from global growth and financial market conditions can only account for a part of the slowdown. Current slowdown has been accentuated by structural factors that have come in the way of smooth adjustment through pure demand management policies. With consumer price inflation, fiscal deficit and current account deficit being amongst the highest in EMDEs, the need to preserve macroeconomic stability has emerged as a binding constraint. As such the momentum of recovery could come from reengineering focus on unclogging the stalled investment projects, giving an impetus to investments in key infrastructure sectors, supporting productivity enhancements by technology enhancements, bringing in more managerial efficiencies and supporting research and development. Inherently, the Indian economy has several strengths including its natural endowment and demographic dividends. Simple institutional reforms such as better regulation of natural resources, improved harnessing of water resources, investing more in skill formation, digitalising land records, land consolidation, better integration of regional agricultural markets, freer labour markets and more competitive domestic markets can go a long way in improving India’s potential as well as actual growth. As such, efforts in the direction of macroeconomic stability and structural reforms can pave the way for the recovery. Warm regards, Dr. S P Sharma