With RBI doing its bit by cutting repo rate 25 bps, indeed more if you keep in mind no one expected the 25 bps CRR cut, the focus is once again back to the government and what it plans to do to fix India’s growth prospects. RBI’s rate cuts, needless to say, were along expected lines given the slowing in core inflation and in economic growth—while FMCG firm HUL saw just a 5% volume growth in the latest quarter, commercial vehicles firm Ashok Leyland saw an 18% drop in net sales. Whether RBI continues to cut rates, even India’s growth prospects, depends on how the current account deficit (CAD) fares and what the supply response is—the Cabinet Committee on Investments meets today to clear hurdles in projects with bank lending of over R1,25,000 crore, and whether it succeeds will be a critical pointer to how investments grow. No one expects investments to rise just because RBI has cut rates, but as the rate cuts stimulate economic activity and this results in higher capacity utilisation—RBI says the current figure is just 73%—the investment cycle will turn.
Both investments as well as the CAD require the same thing: fixing of the fisc. And while that has a long way to go, as RBI indicated in its pre-policy macro review, the government seems a lot more serious about controlling expenditure—the extremely tight LAF of R91,000 crore this month is a result of government simply not spending. Subsidy payments, to cite one figure, rose just 6.4% in November over October and by just 4.3% the month before. The FM is looking at saving around R30,000 crore or more by way of cutting on Plan expenses and Citi has pencilled in a 0.5% of GDP saving coming from the monthly reduction plan for diesel subsidies. Were all this to happen, Citi is looking at another 50 bps of rate cuts during the year and Deutsche Bank/CLSA 75 bps. The competing forces here will be the UPA’s Food Security Bill and the government actually going ahead and making meaningful savings by transferring LPG and kerosene subsidies using Aadhaar.
Though RBI has said the CAD is fragile, how fragile is not well appreciated. Nor is the high 5.4% CAD due to high gold imports—indeed, CAD soared even while both gold imports as well as non-oil imports slowed. Apart from the exports and services contraction, the single-biggest factor was the sharp rise in repatriation of profits on investments and interest payments of FII/ECB debt. Given that all 3 added up to $7.8 billion in Q2 FY13, this means India needs so much FDI just to keep the FDI balance at zero. And with FDI inflows just financing a fourth of CAD, as compared to 100%-plus in just FY08, this makes India very vulnerable to external flows. Add to this the rise in corporate exposure to ECBs—$104 billion at the end of FY12 as compared to $41 billion at the end of FY07—and the rise in FII investment limits in the bond market, and the vulnerability gets magnified. That, of course, is the reason behind the FM’s global roadshows and it’s also the reason why GAAR was postponed and why, eventually, a solution will be found to the Vodafone retrospective tax amendment.