The Prime Minister’s Economic Advisory Council recently revised its economic outlook for 2012-13, projecting a real GDP growth rate of 6.7% against 7.5% projected at the start of the fiscal. The council’s projection is still much more optimistic than those by private agencies. FE’s MK Venu discusses various aspects of the PMEAC’s latest report on the economy with its chairman C Rangarajan in an interview aired by Rajya Sabha TV recently.
How did you arrive at the growth estimates?
According to the Central Statistics Office (CSO), the Indian economy grew 6.5% last year. We believe that there could be some underestimation in this. When the final numbers come, there could be some increase in the growth rate for both the agriculture and industrial production for 2011-12. Nevertheless, we must accept the fact that growth has slowed down and, in 2011-12, the growth was perhaps one of the lowest in recent years.
As for 2012-13, we have looked at the projected performances in the various sectors and aggregated (them to arrive at the our estimates). Our estimate is composed of an improved performance in the industry, whereas, in agriculture, we project a growth of 0.5%. Even while predicting drought, the available data on behaviour of the monsoon indicate that we would be better off than we were in the drought year 2009, which nevertheless saw farm sector growth of 1%.
This year, the monsoon is not that bad and the actual growth rate can be better than 0.5% we have estimated. But we are also projecting a growth rate of 5.3 % for industry.
Last year it was 3.4 %. We are betting on improved performance of some sectors like mining, where we had negative growth last year as coal, iron ore and natural gas showed a decline because of various policy glitches.
Are you confident that these glitches are now being removed?
A lot more energy is being spent, for example, in increasing coal production. Therefore, the mining sector will likely report positive growth as against the negative growth last year. As far as the manufacturing sector is concerned, the first quarter numbers do not show a pick-up but we (expect momentum) coming in the second half. This is partly because of the effect of last year’s low base ? manufacturing grew fast in the first half of 2011-12 and all the decline happened in second half. Against that (low) base, we should see an improvement in the manufacturing sector.
I remember you telling me some four-to-five months ago that some key public sector driven investments can also push up manufacturing sector ? investments like coal, railways, ports and mining sectors, for example…
There are three areas (that were) mentioned in this context ? power, coal and natural gas. We are seeing a revival in the coal sector already and the power sector will automatically improve because of this. It is important to step up coal production. Not only the coal ministry and Coal India, but the PMO itself is also paying special attention to the sector. As coal production increases, it will have a favourable effect on capacity creation in the power sector, which depends upon firm and assured coal availability.
Are these things being monitored by some coordinating agency in the government?
I think there are two or three groups, which monitor what is happening in the key sectors of the economy. I’m sure the manufacturing sector will show (higher) growth than the last year. The available data show a pick-up in the steel and cement sectors, signalling increased construction activity. As far as the services sector is concerned, the growth will be the same in 2012-13 as last year (8.9%). In aggregate, we should be able to get 6.7% growth in the current year.
The twin deficits (current account deficit and fiscal deficit) are a matter of concern. Do we see a respite (on the deficit on) the current account and what could be its impact on the exchange rate?
Well, we are projecting a current account deficit of 3.6% of the GDP, which is lower than the last year, which was a historically high figure 4.2% of the GDP. But I must say the projection for this year is (also) a very high number. We should work towards a much lower level of current account deficit. I think the ideal would be 2.5% of the GDP. But certainly in the current year, the external situation won’t put as much strain as it did last year. The important point is how we finance the current account deficit. Last year, what we saw was that because of high current account deficit, (there was) pressure on the rupee whenever capital flows were not adequate.
What are your reasons for projecting a much higher net capital inflows this year of $72 billion?
I think (there will be) an increase in the capital flow as the banking capital (NRI deposits) would show an increase of $4-5 billion (over last year). This is because the rate of interest (in India) has become attractive for NRIs. Reduction in the current account deficit is itself putting less pressure on the system.
As of now, we shouldn?t expect the merchandise trade deficit this year to be much lower (than the council’s estimate of $181 million or 9.7% of the GDP) based on the assumption that crude oil prices will remain at the same level as (last year). There will be a decline in coal and gold imports because of an increase in domestic production of coal and measures to curb gold imports and promote financial savings. Then, there are net invisibles (which would be $114 billion or 6.1% of GDP).
So, the rupee could strengthen a bit?
Assuming that overall capital flows are just adequate to cover the current account deficit, the best projection one can make is that the rupee will remain more or less at the same level this year with some minor fluctuations. Indian businesses should get used to the idea that under normal times also, they should provide an appropriate hedge against the fluctuation in the currency.
Coming to the fiscal deficit, how do you think the consolidation in some substantive way can be effected? Do you think we?ll see a diesel price hike soon?
I think the revenue projections made in the Budget will be met because the nominal income growth implicit in the budget calculation (14%) will be fulfilled. We, ourselves, (the PMEAC) project real GDP growth of 6.7% and inflation of 7%. Therefore, the nominal growth rate in the GDP of 14%, which is implicit in the Budget, will be fulfilled and revenue calculations would be all right.
On the expenditure side, we need to ensure that the subsidy bill doesn?t go far beyond what has been indicated in the Budget. One area where policy action would be required to contain the subsidy at the budgeted level will be petroleum prices ? with respect to both diesel and LPG. If the fiscal deficit rises much beyond what is indicated in the Budget, it won’t be a good signal (to private investors, rating agencies).
The industry, by and large, feels this year, we may not get more than 5.5% GDP growth. All private research firms also put it at the same level. Why this pessimism?
Well, a number of factors have contributed to the weakening of investment sentiments. When growth slows down, it has an effect on investment decisions, which are based upon the future growth of the economy. There?s also the fact that we had high levels of inflation, which requires the monetary policy to be tight and that implicitly also has some impact on investment decisions.
Do we expect some reductions in interest rates in the coming months because there?s a feeling that the food situation may get worse because of the drought situation?
Well, our own expectation is that inflation will remain around 7% and, by the end of March 2013, it could be in the range of 6.5% to 7%. What the Reserve Bank (as the monetary authority) will be looking for is the tendency for inflation to decline. If (inflation shows reasonable signs of moderation), then the RBI will definitely have a larger space to operate.
What about the scenario when the headline inflation remains at 7% and growth declines? How would the monetary policy operate in such a situation?
You will have to decompose inflation. To some extent, if your food inflation remains high due to weak monsoon, then that has to be kept aside. Then, one looks at other dimensions, such as non-food manufacturing inflation, that could be a good indicator. I assume the monetary authority might look at the fact that some increase in the inflation is (due to factors) beyond its purview.
Coming back to the issue of investment pessimism. In the past, you have spoken of selective credit control. In an economy like ours, which is very heterogeneous in nature, high interest rates could be particularly problematic for smaller business.
I think the interest rate regime has been deregulated and it is for the banks to decide on what the appropriate rates would be, taking into account the risk attached to particular types of lending. Small and medium businesses will also benefit if space exists for the monetary authority to adjust the policy. The differential among interest rates is something banks have to decide based on risk perceptions.
Do you sometimes worry about the new threat that is looming, that India might be downgraded by international rating agencies who have issued warnings of late?
I think the grading done by these agencies have implications for the ability of Indian firms to borrow. This is because external lenders go by these rating agencies’ assessments. However, I must add that the rating agencies should look at several aspects of (the Indian economy). Despite the decline of growth rate, our economy is still one of the fastest-growing in the world.
The agencies are worried about the fiscal deficit and we also need to show that we are concerned and are working towards the plan of fiscal consolidation. The new finance minister has also indicated that he?ll have a roadmap for fiscal consolidation.
What is our philosophy on fiscal deficit today? The Prime Minister at the G20 summit went along with US President Obama?s formulation that this is not the right time for all countries to cut down expenditure. Countries that can increase productive expenditure should increasingly do so, he had said…
Some countries have fiscal space and some haven’t. I think we are in a sense a country, which depends on capital flows from outside, and we want high growth in a sustained way. And it is not possible when the fiscal deficit continues to be at a high level because the borrowing programme of the government has an impact on the interest rates and the borrowing ability of the private sector. After all, we do have the FRBM Act where we had taken a very firm decision that the central government’s fiscal deficit should be contained at 3% of GDP. I think we should move towards it. What is really required is not an abrupt way of controlling the fiscal deficit and moving to the level indicated in the FRBM Act, but treading the path of fiscal consolidation. We need to indicate in the roadmap that if not now, in another four years from now, we will bring down the deficit to a level that is appropriate. After all, much of our fiscal deficit is not attributable to the rise in capital expenditure, which props up investments and could lead to future growth.
