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No beating about the bush.
Morgan Stanley isn’t exactly bullish on the Indian macro economic outlook due to stagflation and has drawn up three distinctive scenarios, none of which are too optimistic
In their new report titled ‘Where Are We in the Boom-Bust-Adjustment (BBA) Cycle?’, Morgan Stanley Asia/Pacific Research (MS) notes out that India is stuck in the threatening stagflation stage, caused due to weak productivity, high inflation and policy inaction. It also believes that the consolidation will take time as India is in the “early stages” of the readjustment cycle, which can only be helped by an “aggressive” actions whoever takes hold of the next government post-elections.
However, MS are also on a look out for external facts such as the US dollar and US 10-year yields. If the latter moves up, it could be trouble for India. The report said, “On the external front, we would be watchful of any sharp upward movement in the US dollar and US 10Y bond yields while we remain concerned about the potential negative effects of a sudden stop in capital flows.”
Reasons for stagflation and decline in GDP
According to Morgan Stanley, there are four reasons to explain for loss of productivity, resulting in stagflation, and weak productivity over the past three years.
Fiscal deficit: Firstly, India’s fiscal deficit remains in grave danger of breaching the double digit mark. If it does, it will put a severe dent to India’s growth prospects. According to MS, “the fiscal deficit was lifted from 4.8% of GDP in F2008 to 9.9% in F2009 and has remained above 7.5% for the past four years.” It is likely that double digit figures could be achieved if the National Food Security Bill is implemented.
Rural wages and NREGA: Secondly, there is a mismatch between rural wages and productivity. While rural wages have shot up, productivity hasn’t, thanks to the NREGA programme which has been beset with poor implementation and misuse. According to MS, “We believe the national rural employment scheme (NREGA) has been one of the key factors pushing rural wages without matching gains in productivity.”
Low capex: Thirdly, an “Unfavourable business environment resulting in deterioration in productivity of corporate sector, as well as, declining private investment to GDP” caused by global factors caused corporate confidence to decline, thereby reducing investments. This chart shows how capex has plummeted.
Negative real rates: Lastly, Morgan Stanley feels that negative real rates are the cause for India’s widening current account deficit which caused funding problems. The report said, “We believe that discouraging financial saving by maintaining negative real rates has only exacerbated the macro stability risks and has been instrumental in widening the current account deficit further, exposing India to external funding risks.”
All the four reasons collectively led to macro-economic stability issues, including persistently high inflation, widening current account deficit and a bad-loans crisis. The three graphs below are self explanatory:
Inflation: Even though inflation remains elevated, MS expects food inflation to worsen even as headline inflation hovers around the 8% levels, till April-May, during election time. The report said, “Even as we expect further deceleration in food prices, we expect CPI inflation to remain elevated around 8.5%-9% over the next 4-5 months.
Non-performing loans: Moneylife had predicted this way back in 2012, with a cover story on how the public sector squandered public resources leading to grave situation of bad debts. The same story can be accessed here: . MS expects bad loans to rise. “As per estimates from our Financials team, impaired loan ratio could rise to 11.1% by March 2014,” according to the MS team.
Current account deficit: Current account deficit widened from 2.7% of GDP in F2011 to 4.2% of GDP in F2012 and an all-time high of 4.8% of GDP in F2013.
Three possible scenarios
MS has drawn up three distinct scenarios: moderate, bad, and worse.
Benign scenario (medium): This would be helped by “strong policy actions” of the next government. MS believes that this could not only reduce fiscal deficit, but also moderate wages and keep headline inflation to 6.5%-7% levels by March 2015.
Sub-optimal (bad): Interestingly, MS thinks that if the government is unable to do anything (i.e. if the government is weak, without a mandate), then the RBI will do something. The report says, “if the outcome of the general election were to produce a weak coalition government, it could hamper the pace of implementing the required policy reforms... the central bank will have to tighten monetary policy further, potentially in an aggressive manner to bring about a more credible and quicker adjustment in inflation expectations.”
Disruptive (worse): The worse case scenario is forced market adjustment. Such a scenario is described as “the persistence of high inflation and inflation expectations keeps real rates in negative territory and brings about a widening in the current account deficit all over again, exacerbating the macro stability risks... the central bank would need to tighten monetary policy in a potentially disruptive manner... and could entail a sharper deceleration in growth rates.”
The key implication of this new CPI-based inflation targeting framework is that interest rates in India will remain higher for longer, says Nomura
The Urjit Patel Committee appointed by the Reserve Bank of India (RBI) has recommended that headline consumer price index (CPI) inflation should be the nominal anchor for monetary policy. The Committee says this is to revise and strengthen the monetary policy framework in India. Instead of the current multiple indicator approach, inflation should be the nominal anchor and this should be communicated without ambiguity, the Committee has said.
“The key implication of this new CPI-based inflation targeting framework is that interest rates in India will remain higher for longer,” says Nomura in a research report. "When inflation is above the nominal anchor, the real policy rate is expected, on average, to be positive," it said.
Nomura said, “Real policy rates in India are very negative and unless CPI inflation moderates, policy rates will move higher. While CPI inflation should moderate as vegetable prices ease, we expect headline CPI inflation to remain elevated at above 9% in 2014 as a result of the upswing in rural wages and elevated inflation expectations.”
Against this backdrop, Nomura sticks to its call of a cumulative 50bp hike in the repo rate in first half of 2014 including a 25bp hike at the 28th January monetary policy meeting.
The recommendations of the Urjit Patel Committee includes setting up of a five-member monetary policy committee (MPC) consisting of the RBI governor, deputy governor and executive director in charge of monetary policy and two external members chosen by the central bank. Each member will have one vote and the monetary policy outcome will be decided by majority vote. Further, the MPC will be accountable for any failure to establish and achieve the nominal anchor. Minutes of the proceedings of the MPC are to be released with a lag of two weeks. The RBI will also publish a bi-annual inflation report.
On inflation targets, the Urjit Patel Committee report has recommended that the ultimate target for CPI inflation should be set at 4% with a band of plus/ minus 2%. However, given the currently elevated inflation levels the committee recommends a transitional phase to the ultimate target zone, from the current level of 10% to 8% over a period not exceeding the next 12 months. Further, CPI inflation should reach 6% over a period not exceeding the next 24-month period before formally adopting the recommended target.
There are opportunities galore for both the countries in terms of Korean investment in India
India's single largest foreign direct investment (FDI) project, the $12 billion (estimated at Rs52,000 crore) POSCO steel plant in Odisha, got the necessary clearance before the arrival of Park Geun-hye, president of South Korea.
It may be recalled that the former environment and forests minister, Jayanthi Natarajan, had claimed, time and again, that there were "no pending issues" with her. The new minister, who took over her mantle, Veerappa Moily, gave the required clearance for the project.
The POSCO plant will initially produce eight million tonnes of steel, and when the fully required space is made available, they plan to increase the same to 12 million tonnes in the 2nd phase of the project
It is not that there are no hiccups in projects of this size and magnitude. Totally, around 2,700 acres of land has been acquired by the Odisha government, but approval for land (13%) is pending before the National Green Tribunal. In any case, all the land will not be required at the start, so the first phase work can commence, and, in due course, other areas can be covered.
Local villagers are planning protests, spearheaded by Kanchi Kohli of Kalpavriksh Environmental Action Group (KVEAG), and Posco Pratirodh Sangram Samity are likely file petition against the environment ministry for giving this clearance.
The Ministry of Environment and Forests (MoEF) clearance covers only the POSCO steel plant, while it excludes the port. This aspect has been questioned by the deputy director general of Centre for Science and Environment (CSE), who feels that the both the plant and port needs are interlinked and this has also been the view of government's own Appraisal Committee.
Now, let us take a look at the port issue, which has been "separated" from the POSCO steel plant itself, for the purpose of clearances. While Posco wants to set up its own captive port facilities, some ten kilometres from the existing port, the Paradip Port Trust (PPT) has made several proposals to Posco. The first covers PPT's willingness to build six new berths in its port to meet Posco's needs, some of which could be leased out on a long term basis to Posco, for their captive use; second covers a joint venture, between PPT and Posco, to take care of both imports and exports of Posco; and the third covers PPT's willingness to have a conveyor system linking the port to Posco plant, since the distance between the two is about 10 Kms only. It is hoped an amicable solution will be arrived at, as the major hurdle on environment has been overcome. It may be borne in mind that POSCO group are specialists in steel and have no port handling experience, as such.
As the plan stands today, iron ore is to be sourced locally, but coal will have to be imported, as Coal India are fully committed to meet commitments already made, even where they are failing to supply under fuel-supply agreements (FSAs). Unless Coal India is able to dramatically increase their production, coal imports will be a necessity for POSCO.
The Indian government had not favourably reacted to the proposal of Posco that they may be allowed to export iron mined by them, if and when a captive mine is offered. It may be a good idea for the central government to consider possibilities of offering captive coal and iron ore mines to POSCO, if such a scope exists in and around Odisha itself. This is an innovative area, which needs to be studied seriously.
Park Geun-hye, the South Korean President was accompanied by her Foreign Trade and Minister for Science and Technology, as the bilateral trade has amounted to over $18 billion in 2012, with a favourable balance for South Korea.
To offset this imbalance India needs to explore ways to increase its exports to South Korea in the field of pharmaceutical industry and through IT companies.
Between April 2000 and October 2013, South Korean investments in India amounted to $1.3 billion, as per data issued by the Department of Industrial Policy and Promotion. Recently Samsung Electronics have planned to invest $250 million in Haryana to manufacture mobile phones. As against this, Indian companies, such as Hindalco, Mahindra & Mahindra and Tata Motors have made investments in Korea to the tune of $1 billion, and the deficit stands out at $ 8.9 billion favouring Korea.
During this visit of President Park, both the countries have signed nine projects, and when they showed interest in Nuclear Power plants, India has conveyed that this could be taken up in phase II when they go in for larger nuclear plants. The civil nuclear agreement with South Korea was completed in just two rounds of negotiation, but before any allotment for the nuclear park to Korea Electric company, on similar lines extended to US, French and Russian companies, India favours a technology demonstrator unit, because the Department of Atomic Energy is unfamiliar with the Korean design. This is likely to take some more time to materialise.
On the whole, this visit of President Park has revived great interest in the development of all round relations between both the countries. Now South Korean nationals can obtain tourist visa on arrival in India; there are prospects for setting up Korean banks in India, though the state run India Infrastructure Finance Co Ltd (IIFCL) funds the Korean companies’ participation in India.
With the initial clearance of Posco, there is likelihood of many South Korean companies, such as Samsung, GS Engineering and Hyundai to invest in the near future in India's infrastructure developments.
(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce. He was also associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US.)