The big news of the week is the change in rating on India by Standard & Poor's. Although the rating hasn't changed, the outlook is imbued with a negative bias which makes India a fence-sitter.
The country is a whisker from hitting junk status and experts have argued that India isn't anywhere near speculative rating. But India's comfortable foreign-exchange reserves and a 7% growth pace, are proof that there is no chance of will reneging on loans.
But both the quantum of reserves and the growth story are under threat. Fiscal deficit has been stubbornly close to 5% for four years in a row and the current account deficit which never went above 3% in the past two decades, will finish close to 4% in 2011-12.
C Rangarajan, former RBI governor and currently chairman to the Prime Minister's Economic Advisory Council (PMEAC) analyses these facets of the economy on CNBC-TV18.
Below is an edited transcript of the interview on CNBC-TV18. Also watch the accompanying videos.
Q: I don't want to start with S&P's observations. Let me start with the most recent data on the external front. Khullar has indicated from the DGFT (Directorate General of Foreign Trade) figures that trade deficit in FY12 is going to be USD 185 billion. Usually the final figures from RBI are about 5% higher because of items such as defence imports, so the trade deficit is USD 195 billion.
Invisible flows in the first nine months were USD 78 billion. Even if we add another USD 30 billion in the fourth quarter, that will be only USD 108 billion. The current account deficit looks like it will be nearly USD 85-90 billion and that works to, not 3.7%, but probably 4.25% of GDP. Would you agree with this calculation?
A: Your arithmetic is correct. But I don't think that that is how it is going to pan out. My own estimate is that it will be about 3.8% of the GDP but will be a little less than 4%.
I don't think the total trade deficit is going to be higher than what has been indicated in our review. Exports are also doing reasonably well. Therefore overall, I would say that the current account deficit could be around 3.8% of the GDP and not more than that.
Q: In FY13, between the PMEAC, the Reserve Bank and the government, the assumption was made for 7.3-7.5% growth. So imports will, if anything, be higher, isn't it?
Global markets are weak. Software companies are guiding for lower sales. So are you confident we can bring down current account deficit in FY13?
A: I think the current account deficit can come down on two factors. Gold imports in the current fiscal are almost about USD 56 billion. This is unusually very high and part of it is attributed to the high level of inflation in the country with gold serving as a hedge against inflation.
I believe that the amount of gold imports next year could fall by about
USD 10 billion or USD 12 billion.
The other factor is the extraordinarily large import of coal during the current year, because of inadequate growth in the coal sector. There has been a fairly large increase in the import of coal from. I believe that in the current fiscal the coal situation will improve.
We have seen it in the last three or four months of the previous fiscal and therefore I think that we need not linearly project from last year to say that the imports will be much higher.
On these two counts, I expect some reduction in imports and therefore the import level may more or less be the same order as this year.
Q: Even if we accept the coal and gold argument, crude is the single biggest component, whether it is current account or fiscal deficit. Crude imports grew by 47% in FY12.
Prices rose from sub-USD 90-per barrel levels in FY11 to over USD 100-per barrel in FY12. But even assuming stable prices, can we bring down crude imports when you expect the economy to grow faster in FY13?
A: We may not be able to bring it down but I don't see it rising too fast either. All indications are perhaps the crude prices internationally will settle down. Therefore on that assumption I think the crude imports may not necessarily go beyond reasonable limits.
I think the assumption that the demand for crude imports will pick up because of higher rate of growth is not justified because to some extent if you adjust petroleum prices during the current fiscal, it also may have some effect on the demand for petrol.
Q: But that assumes the government will be able to push diesel prices high enough. How much do you think the government can do politically and practically on diesel?
A: I think the government will take some action during the course of the year, both in relation to diesel as well as other petroleum products.
Petrol is already decontrolled, though there has been some delay in adjusting the price of petrol to international crude prices but that adjustment will also happen.
Since we have not adjusted these prices for a long time, to have the adjustment fully to the level demanded by international crude prices may be difficult in one go therefore we may have to do it in phases.
I would suggest that perhaps as the inflation rate comes down a little bit, we should really try to push, the prices up as far as the petroleum products are concerned, in stages.
Q: This government could not pass a 5%-10% rise in railway passenger fares that hadn’t been hiked for 10 years. Does this really give you much confidence that the government will succeed in hiking diesel prices?
A: The comparison is not identical. It became complicated in a number of other practical matters. Perhaps it could have even gone through if the political situation had been slightly different.
But I think the Budget has given a certain level of subsidies for petroleum products. If the level of subsidies is to be sustained and is not to be exceeded, then action is required.
The Prime Minister and the finance minister have said that the time had come to bite the bullet. I do expect action to be taken as the inflation shows some decline.
Q: Coming back to the worry of S&P on the current account. Are there any steps the government can take to tackle the widening current account deficit head-on in terms of export sops or wanton depreciation of the rupee? What are the tools available to tackle this deficit?
A: There is not much that can be done by way of policy tools except a few things that we talked about. Perhaps rise in the prices of petroleum products can have a dampening effect on demand. That’s one way of doing it and the reduction in the import of coal and gold through some mechanism is also possible.
As far as gold is concerned, as inflation rate comes down and the rate of return on the financial assets becomes attractive compared to holding gold, gold import can also come down.
In case of coal, it is essentially a managerial problem. If coal production is maintained, then it can come down. Therefore, to a very large extent the action is required on the real side in order to be able to bring down the imports.
The exchange rate can play a role but, the depreciated rupee is not always the answer to the problem. It also has other implications in terms of capital flows but as the current account deficit rises and if the capital flows are not adequate, there will be some decline in the value of rupee also.
Q: Can the RBI achieve a slow, stable depreciation and still accumulate reserves which are now beginning to fall as a percentage of our liabilities?
A: The reserves will depend upon the capital flows and there are a number of factors that contribute to the rise and fall of capital flows. If the investment climate is good and the growth rate is good, then I think money will automatically come.
I would also like to make a point that in today's world, 7% growth rate in the economy should not be taken lightly. I think it's a significant growth rate.
Therefore, investment will come in as we maintain and show that we can keep the inflation at a reasonable level and control the fiscal deficit. Reserves will be influenced largely by the capital flows because in India, it is not built by surpluses in the current account rather it is built as a result of the capital flows.
Q: Any other levers to increase capital flows? We have deregulated interest rate on NRI deposits, we have allowed USD 15 billion of FII money into government securities (G-Sec).
Now some people fear that short term data as a percentage of total external debt is over 40%. Do we have any more such levers to increase flows?
A: I think those levers have already been used effectively. Therefore, it is only the overall investment climate and the overall economic prospects that can act as stimulus for capital flows. After all everything is relative, it is not so much the absolute rate of growth. But, if India does better than others, we will get the flows.
Q: You earlier referred to inflation stabilising. But the last two CPI numbers that we have are quite scary, 7.4% in January, 8.8% in February and 9.5% in March. Can we afford any hubris on inflation?
A: The level of inflation will be lower than last year but that is not saying much because last year we had more than 9% for the better part of the year. Therefore, that is a very high rate of inflation.
But, one of the reasons why the consumer price inflation was very high was because of the high food inflation and food articles has much bigger weight in the consumer price index.
The fact is that the agricultural output has been good and procurement will also be good this year. Therefore, as more food grains come into the market, I believe the food inflation can also get somewhat moderated. On the whole I still think we can manage an inflation rate between 6.5 and 7 during the year.
Q: This has also been the Reserve Bank’s argument. Yet, given the CPI numbers and the wide current account deficit, is there enough room or any room at all for the Reserve Bank to cut rates further?
A: I think the guideline in the monetary policy statement is very clear on that. The scope for any rate cut is very narrow. We have to wait for inflation to come down significantly before we can think in terms of any further easing of the monetary policy.
Q: Without a rate-cut many will question even the current growth projections and that brings me to S&P. Would you justify the act itself, the action of lowering the outlook, do you think given our twin deficits we got what we deserved?
A: This is one perception and it is important to take note of it because it is an observation that comes from outside India. It emphasises some other factors that we all know and that we discussed a little while ago but, perhaps the view that they have taken is somewhat pessimistic.
As I mentioned a little while ago that a growth rate of 7% in today’s world cannot be brushed away as unimportant. I think we are still a high growth economy as far as the world is concerned and certainly the concern about current account deficit and the fiscal deficit are well-known.
These are areas in which we must act and if we act on both these fronts, particularly on the fiscal deficit, I am inclined to say that the rating agency may come back and upgrade rather than do anything to bring it down.
Q: The rating agency gives only 33% probability for a downgrade and that too in 24 months. But do you think the fear is greater in your assessment? Maybe we can foresee a situation where we could be downgraded?
A: I don't think so. I think we are determined that we are geared to take action and the fiscal deficit will be maintained. There are other sources of revenue as well which may push the tax collections a little more than what has been indicated in the budget and therefore, an all-out effort will have to be made to contain the fiscal deficit
They cannot continue to have fiscal deficit well above 5% for more than one year. I think that’s not justified and that cannot give credibility to us and we will take action.
Q: One factor affecting flows is surely the anti-avoidance rules in the Budget. There are some who argue that FIIs are like mutual funds, they are pass-through vehicles and therefore, they should not be taxed. Others say proprietary funds are also used by FIIs and they should be taxed.
What is the international experience? Do you think this is a justifiable tax and more importantly is this the right time to tax these flows considering that actually we are running short on dollars?
A: In general, I would say that we need to create an environment in which capital flows into the country. In fact, I very often think that there is too much talk about capital controls. We need more capital into the country and we should be very proactive in doing it.
We will get more clarification during the course of this Budget session, regarding what the various tax provisions will be and where we stand in relation to the financial flows.
You can wait for one-to-two weeks for more to get clarification on that and it will clear the position. It will prepare the ground for larger capital inflows into the country.
For the complete show, watch Indianomics at 11.00 am & 06.30 pm on Sunday 29, April 2012 on CNBC-TV18.