Inherited Problems for Modi's Economy Czars

After the Tsunami of celebrations, the time to address immediate economic problems for the yet-to-be sworn in Narendra Modi government, has probably started even before it takes office.
Top mandarins say the BJP will inherit not only the iconic red sandstone buildings on Raisina Hill, which stand at the heart of Delhi’s power corridors, but also the myriad economic `time-bombs’ which the Manmohan Singh Government will be leaving behind.


Gas Wars
Possibly the first challenging decision which the new BJP-led government will have to tackle will be  the gas pricing conundrum, which the Manmohan Singh regime will be leaving. Earlier this year, gas prices were sought to be hiked to over $ 8.40 a mmBtu, double the current rate.
The move which was stalled by the Election Commission as part of its code of conduct, will if accepted by the new Government, mean an immediate increases in the price of electricity, fertiliser, gas used by public transport, and plastics with its longer term knock-on effect on the price of almost every good and service in the country. 

For a government which would be trying to consolidate its recent massive mandate, any sudden price rises could translate into quick dampening of support and a reversal of voting trends in key state elections which would be coming up in the next two years.
However, not allowing any increase could damped investor sentiments in the oil and gas sector, which hasn’t seen any major discoveries in  recent past. Besides, the Reliance Industries Ltd, which was instrumental in seeking the rise in the first place, has sought arbitration proceedings on stalling of the price hike. The Government would have a legal fight on its hands which again would not exactly help build investor confidence, especially foreign investor confidence, something which the BJP-led government is believed keen on.
A possible way out would be to go in for staggered increase in the price of natural gas which could help keep prices under the lid and yet at the same time solve the possible legal tangle with the country’s largest industrial house, which many say is also close to both the new and former ruling parties.

Battle Over Money

The Yaksha & Yakshi Sculptures Guarding RBI
 

If India Inc., which so lustily cheered Narendra Modi’s victory on Friday, has any one demand they want fulfilled as of yesterday, it is a cut in interest rates. Their bitter complaint has been that high interest rates have locked out investment in new factories and projects and their one point demand in repeated meetings with finance ministry mandarins has been steps to reduce interest rates, to help drive back growth. India’s GDP grew by just 4.7 per cent last fiscal after falling to a decade low growth rate of 4.5 per cent in the year before.
However, with inflation still raging high, the country’s central banker, Raghuram Rajan favours continuing using interest rates to combat price rise. The country’s consumer-price inflation quickened in March for the first time in four months to 8.31 per cent from a year earlier, forcing Rajan to leave untouched key policy rates unchanged in the last review on  April 1, this year.
Speculation is already rife that this could lead to a battle royal between Rajan and the new Government.
In the run up to the elections, Rajan had told an audience in Switzerland that he “determine(s) the monetary policy. Ultimately, the interest rate that is set is set by me.” In response,  BJP leader Subramanian Swamy had reportedly lashed out at Rajan and his interest rate management and offered the advice : “We need to immediately drop interest rates.”
The BJP has however in recent days indicated that it would defend the RBI’s autonomy and Rajan’s job was not at risk.
How to manage the monetary policy to tweak growth and at the same time get Rajan to agree with the BJp's priorities, will be a concern for the Modi government. That could spell either the first public `war’ over economic policy-making or the first successful wooing of a `Congress’ econo-crat into the BJP fold.

Golden Goose

Raw Gold Bar

The government had increased the gold import duty and other curbs on the yellow metal to deal with the current account deficit, the difference between inflow and outflow of foreign currency, which had touched $88 billion during 2012-13. The curbs had brought down the yellow metal imports significantly to $32 billion in 2013-14. 
However, high duty of 10 per cent and insistence on minimum export before importing more gold has hit the gems and jewellery industry, which has been stridently seeking review of the policy. One of India's big ticket exports, this sector's sales to the world market have fallen 11 per cent in 2013-2014 to $ 34.79 billion after having grown at an average of 15 per cent over the last  5 years.
The BJP led government by Narendra Modi, coming from Gujarat, which is the epicentre of the gems and jewellery sector, is certain to seek changes in the policy. However, the government is expected to adopt a cautious approach and go in for a staggered duty cut.

Coal Bill

Open Cast Coal Mine
 

Part of India’s growth story dimming is because mines which feed India’s factories have been forced shut by environmental cases. While new mines have been stalled by red tape.
India, which has one of the largest coal reserves in the world, with some 293 billion tonnes of coal under its forests, farmlands and deserts. However, with the mining sector shrinking by nearly 3 per cent during the last two years, India has been forced to import coal worth $ 15 billion last year and is expected to import another $ 17 billion during the current year. Similarly, mining of iron ore, vital to India’s steel mills which seek to ratchet up output to 300 million tonnes over the next ten years, has been stalled in much of the country by environmental and legal activisim.
The Modi Model has long claimed that its problem solving capacity is far greater than the long drawn out consensus approach favoured by Manmohan Singh’s UPA Government. Many say the silent mines will be this Model of Governance’s real test.

Tug of War Over Interest Rates

In what promises to be one of the most crucial politico-economic tugs of war for the Manmohan Singh government, finance minister P. Chidambaram and bankers have locked horns over a rate cut.
Chidambaram who wants to spur a faltering economy, on Wednesday urged hesitant bankers to cut interest rates to borrowers.  “I have impressed upon banks the need to cut base rates. In my view, reduction of the base rate will be a powerful booster, will be a powerful stimulus to the credit growth.”
The Reserve Bank of India has cut repo rates, the key policy rate at which the central bank lends money to banks, by 125 basis points since January last year in a bid to spur growth which has slackened to 5 per cent for the year-gone-by, far lower than the average of 9 per cent which India was posting in the last decade.
In response to the RBI cuts, the country’s largest bank and trend-setter, SBI, has cut its base lending rate by just 30 basis points between August 2011 and February this year to 9.7 per cent. Actual lending rates to most businesses are at least 2 per cent higher and in case of less highly rated firms as high as 6 per cent over the base rate.
Chidambaram's exhortions led to another round of mild rate cuts by a quarter percent by state run banks, though not matched by private bankers.
Rates charged by state run banks either equal SBI rates or are slightly higher. Rates charged by private banks are usually higher, except to blue chip corporate clients for whose business, banks are willing to enter into fierce rate wars.

Though the chief executives of nationalised banks who met Chidambaram promised a review of their base rates, most privately say it would be tough to cut rates.
“Our Non-performing assets have shot up … this means higher provisioning norms, which gives us little room for cutting rates … nor can we show lower profits, we are after all answerable to shareholders,” said the chairman of a listed PSU bank on the sidelines of the meet, which Chidambaram held today. 
Gross non-performing assets of PSU banks have more than doubled from Rs 71,080 crore as on March 2011, to Rs 1.55 lakh crore as on December 2012. To compound the banks problems, economic slowdown has meant that credit grew slowed down from 17.8 per cent to 15.6 per cent, making it tougher to wipe out red blots on their report card with profits from new businesses.
The problem is that many of the big firms whose loans have gone bad have political `connections' and going after them is often extremely difficult. Repeated restructuring of several big loans including one to an airline which hasn't flown for some time, hasn't helped the banks cut down on their bad loan overhang.
On the other hand, India's banks remain flush with funds, as depositors unhappy with a jittery stock market continued to park money with banks, especially with state run ones, which they seem to feel are safer than privately held banks. Deposits with state run or PSU banks have grown by nearly 15 per cent in the last one year. 
Bankers said “North Block owns majority holding in all PSU banks  … we can’t  ignore it … but we have to answer to shareholders, auditors, Parliamentary panels ... don’t expect too much.”
The current Congress-led coalition government is supposed to demit office by early 2014, when fresh election are slated for a new parliament. Many bankers would like to ride out the pressure till then without taking too many tough decisions which affect their balance sheets.
However, for the government pushing the economic growth rate is crucial to poll prospects as an economic turnaround would be a better story to sell during polls. But bankers keen to keep protect balance sheets and stay away from auditors' querries and litigations by agrieved shareholders do not seem to share the same enthusiasm. 

 

Shrinking growth, weakening Rupee and RBI's plans

 

Indian industry contracted 5.1 per cent in the month of October, the first time industry contracted since June 2009, with rain-hit mines reporting production losses and a sharp over 25 per cent contraction in capital goods production.
October figures however, could well have been an aberration partly because capital goods had grown by a high of 21.1 per cent last October against which the figures are being calculated, and partly because October is a month with many holidays, which firms often use to produce less to bring down inventories.
Production of all kinds of goods – basic, intermediate (which go into making other goods), consumer durables like cars and television sets and consumer non durables like soap and tomato ketchup – contracted slightly varying from 0.1 per cent to 1.3 per cent. Mining which remained hit by heavy rains which held up production in August through October, also reported a 7.2 per cent contraction. 
However, as a number of economists with whom I spoke today pointed out, “the rate of moderation may be explained as an aberration but the fact that there is a moderation in the rate of growth of Indian industry cannot be denied.”
The seven month period from April to October 2011 told a story of marked slowdown – compared to a 8.7 per cent growth in industrial output last year, this year’s first half posted a 3.5 per cent growth in industry.  Consumer goods grew just 0.6 per cent during this period compared to a 8.6 per cent growth during the same period last year. Durables like TV and cars had grown 15.7 per cent April-October, last year, but this year  growth was a mere 4.5 per cent. 
To make things worse, the poor industry data, sparked off heavy sales on the Mumbai stock market. The Bombay Stock Exchange's Sensitive Index fell 343.11 points in one single day when the data was announced- December 12, 2011. A fall of some 2.1% .
This in turn saw the Indian rupee falling to a record low against the U.S. dollar as foreign institutional investors who were the biggest sellers on the stock market, converted their rupees into dollars to take out of the country.
India Inc., naturally hit panic buttons with a flurry of statements about `The Crisis' (no more looming crisis). The Congress-led government of course kept trying to cool down nerves by pointing out that the India growth story still remained valid, but few seemed to buy it.
ICICI Securities in a note said : “Industrial sector has suffered a series of supply side issues this year, which has seen the output decline sequentially in six out of the first seven months of the financial year. Over and above the supply factors, demand moderation which was sporadic at the beginning of the financial year has gathered momentum as the months passed.”
What that means in plain-speak is that industry has slowed down and that demand too is slowing down. The reason, many especially business leaders, say is the Reserve Bank of India policy of ratcheting up interest rates which has made it tough for buyers of cars, homes, other big ticket items like plasma TVs, refrigerators, air contioning etc., to borrow and buy. Just as it has made it tough for businessmen to borrow to set up factories or expand existing ones.
RBI has increased interest rates some 13 times since  March 2010 by the Reserve Bank of India in a bid to batter down rising prices. This in turn translated to actual lending rates to consumers and businesses of between 12-18 per cent.
However, the government does not seem for the time being inclined to reduce interest rates as its worried that speculators in the food market could borrow cheap and use the money to raise food prices, a politically sensitive issue ahead of key polls to states which include Uttar Pradesh. One way out could be for the RBI to cut Cash Reserve Ratio or the amount of money banks have to compulsorily keep with the central banker,  in order to release fresh money into the economy.
Despite the tight money policy followed by the RBI, the headline inflation stood at 9.73 percent in October, remaining above 9 percent for nearly one year. So many reason, that while interest rates can be kept high to sap up inflationary tendencies, at the same time more money can be released to industry which seems to be demanding finance or refinance. However, how wise this would be is something only time will tell. Much of that demand is coming from sick firms like Kingfisher who may or may not be able to pay back banks the money borrowed plus the accumulated interests.