Originally Published 2010-10-22 00:00:00 Published on Oct 22, 2010
India may have to apply capital controls in the future like Brazil has done to regulate the inflow of FIIs, and there could be more effective intervention in the currency market by the RBI to stabilise the rupee to promote export growth.
Control inflation by non-monetary means
RECENTLY, there was much hype about Washington-based International Monetary Fund’ s forecast of 9.5 per cent growth rate for India next year. But the news of an unusually low industrial growth rate in August 2010 has dampened the spirits of the market and the government. The BSE Sensex, after reaching 20,000, quickly shed 225 points after the report of industrial slowdown surfaced in the market.

Industrial output in August grew at the slowest pace in 15 months at 5.6 per cent, casting doubt on the IMF forecast that was based on India’ s high manufacturing growth. In India’s Industrial Production Index (IPI), the manufacturing sector, which accounts for 80 per cent of the factory output and is the key indicator of the consumer demand, grew only at 5.9 per cent in August as compared to 10.6 per cent a year ago and 16.7 per cent in July.

The problem with slow manufacturing growth indicates that there has been an impact of the government’ s tight monetary policy that has manifested itself in the Reserve Bank of India raising interest rates five times in the last one year. Due to the high interest rates, factories have been reluctant to increase capacity or undertake new projects. A slowdown in manufacturing growth also indicates that the demand for manufactures is not rising rapidly. The growth in the demand for non-consumer durables or fast moving consumer goods (FMCG) has declined from 1.4 per cent in July to minus 1.2 per cent in August even though the demand for automobiles and consumer durables has been rising rapidly. The 8.5 per cent general inflation and over 16 per cent food inflation are obviously causing people to spend less on some types of manufactured goods.

Actually, low manufacturing and capital goods growth can keep industrial growth low for quite sometime, and if the latter is low, GDP growth will also be lower than the government forecast of 9 per cent. Manufacturing growth, however, can pick up if export growth is high in the future. Around 72.3 per cent manufactured goods are exported.

Export growth was quite high at 22.5 per cent in August and total exports amounted to $16.2 billion. For export growth to remain high, there would have to be some way of preventing the rise of the rupee against the dollar. The rupee has risen because of a heavy inflow of FII (foreign institutional investment) dollars that caused it to appreciate by 6.2 per cent against the dollar since September 1, 2010.

The high rupee is bound to have an adverse effect on exports because exporters have to quote their prices in dollars and euros, and a high rupee means higher international prices. They would have to compete with the exporters from other countries which are manipulating their currencies in order to remain competitive.

The high rupee will further increase imports into the country that will offer tough and often unfair competition to Indian products, denting the demand. In August, imports grew faster than exports at 32.2 per cent, amounting to $29.7 billion. The trade deficit ballooned to $13 billion and in a few months could reach $135 billion for the entire fiscal year. The current account deficit could be 4 per cent of the GDP, which may prove to be unsustainable.

The other important component of IPI is the capital goods industries’ growth which indicates the scale and level of investments taking place in the economy. Capital goods aid manufacturing processes to gain efficiency that reduces costs. As compared to the growth of capital goods industries in July 2010, its growth in August 2010 has been very disappointing. There was a negative 2.6 per cent growth in August as compared to 9.2 per cent rise in the sector’ s output in 2009 in the same period and a rise of 72 per cent in July. Some doubts have already been cast on the July figures by various economists and they have questioned the surprise growth of insulated cables and its disproportionate contribution to capital goods industries’ growth.

Some other indicators are also portraying a gloomy picture about the robustness of industrial growth underlying the July figures. The indicators such as cargo traffic at ports, railway freight traffic and non-food credit offtake and the HSBC’s PMI (Market Purchasing Managers’ Index) show that investment cycles have not picked up and there has only been an increase in investment in infrastructure.

There has been a slowing down of order book expansion in some construction companies and a slowdown in the cargo handled in ports and in railway freight traffic which grew at 1.3 per cent in July as compared to an average growth of 4.8 per cent from June 2008 to June 2009. Non-food credit offtake has also not picked up.

There has been a moderate growth of 3.7 per cent in the core sector (crude oil, petroleum refining products, coal, electricity, cement and finished steel) in August which contributes 26.7 per cent to the Industrial Production Index. It was also responsible in pulling down industrial growth.

All these underscore the problems underlying industrial production, especially when slower export growth in the future due to the hardening of the rupee looms large in the horizon.

India may have to apply capital controls in the future like Brazil has done to regulate the inflow of FIIs, and there could be more effective intervention in the currency market by the RBI to stabilise the rupee to promote export growth. FII inflows have amounted to $20.34 billion this year. Any reversal could have an adverse effect on the market. In today’ s world of currency wars, India cannot be a passive watcher. It would definitely help the exporters if the rupee is not so high.

The surge in the FII inflows will continue as long as the US has a low interest rate regime to stimulate its economy, hit by the financial crisis that began in 2008. India was insulated considerably from the crisis because of its own huge domestic market, but clearly the demand is falling with rising interest rates and inflation.

The most important item in the agenda for remedying the situation seems to be inflation control by non-monetary means like having a better distribution of essential commodities and stepping up agricultural growth. Even though agricultural growth is going to be higher than that of last year because of a good monsoon, there are doubts about the self-sufficiency in pulses and oilseeds. Industrial growth also depends on the demand coming from agriculture.

Next in importance would be to control the unabated FII inflows. Otherwise we would have high inflation and low industrial growth. We ought to aim at high industrial growth fuelled by higher export growth to achieve what the IMF has predicted.

(The author is a Senior Fellow with Observer Research Foundation)

Courtesy: The Tribune

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David Rusnok

David Rusnok

David Rusnok Researcher Strengthening National Climate Policy Implementation (SNAPFI) project DIW Germany

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