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March 10, 2012

What do the Indian numbers tell us

In the long run, the Indian Consumer Story will triumph

Economists can be a little fuzzy about numbers, and talk about animal spirits, or the role of expectations in inflationary pressures. In any case, their dismal science is made even more so by its proximity to that beast called politics. Nevertheless, numeracy is an essential tool for economists, too. For macro-economists, the two most important dipstick numbers of an economy – I believe – are bond yields, and currency rates.

What do the current Indian numbers tell us? Let’s look at bond yields first. In most economies, the 10-year bond yield is a cornerstone number; in our case, the benchmark bond is sometimes late in coming into the system, sometimes an 11 year bond gets more attention, so I have developed my own dipstick, which averages the two most traded bonds on any given day. By October 2011, this number had hit 8.9%, up from a January 2009 low of 4.7%. This was, on the one hand, high enough to dampen the ‘animal spirits’ of investment; on the other hand, it was still a negative number when measured against inflation, then being measured in the double digits.

While industrialists railed against the cost of borrowing money, and there was no one speaking for households who save, there was a third side to the dynamic, which was the government’s own need to borrow ever larger sums of money, to fund a growing imbalance between social sector programs and subsidies on the one hand, and slack tax revenues on the other. The RBI was persuaded to favour the borrowers, and it began printing money through the round-about route of Open Market Operations, or OMO, buying bonds off banks, so they could go out and buy more government paper. The amount has been staggering – over 1 lakh crore and counting; as a result, my latest number for bond-yields is down to 8.25%. 91-day bills return more. This inversion of the yield curve, with short-term yields higher than long-  traditionally foretells a recession – but the numbers do not reflect market reality, so I don’t know what you can take away from them.

The FX markets present a similar puzzle – we all know how the rupee plummeted from 44 to 54 between August and November. Enter – not a white knight, but Mr. Subbarao, selling 4.5 bn USD in November, and 9 bn of dollars in December. In the process, our much vaunted FX reserves are down to 293 bn, against borrowings of over USD 350. This is the lowest ratio in 5 years, and underlines our vulnerability.

Market interventions are, of course, the global fashion – whether by governments or central banks; in fact, it is getting rather difficult to find the gap between them – so much for the independent central bank, which is supposed to be one of the guarantors of monetary stability. This is probably not the place to debate the pros and cons of political economy, whether in India, Greece or Germany, so I will merely state that when the state sets prices, rather than the forces of demand and supply, economic actors lose their ability to read the signals. If there is one economic lesson from the grand Soviet experiment with centrally set prices, it is this.

There is, of course, a justification – many justifications, in fact – for the current state of affairs, chiefly that the world is trying to deal with the aftermath of a financial crisis. And, economic history teaches us that such massive disturbances are always followed by huge aftershocks; asset price swings of upto 50%  are common in the recovery process, which could take upto a decade!

In other words, the path ahead is difficult to read, extremely difficult.

Lest that sound as if I am evading the need to predict anything, let me say that I am an active investor, and my daily task is taking calls on asset price movements. Right, so how am I reading the leaves?

Firstly, I want to bat out the window the notion that India will return to double digit growth any time soon. Not 9%, or even 8%.
Why do I say this? We need to look at 2 numbers – numbers again! The savings rate, as the basic enabler of capital formation, and the incremental capital output ratio, or ICOR, which measures how much additional economic activity you are going to get for every rupee invested. Indian growth during the 2003-2007 period was a result of a savings rate of 37-38%. Add to this the influx of foreign funds, round it off to 40%, and an ICOR of 4, and a growth rate of 10% is simple arithmetic.

Since then, our savings rate has dropped, and the number we have for FY 11 is 32%. This was predictable – government dis-savings, as measured by its fiscal deficit, have been rising; and household savings are bound to drop when prices soar. Gross capital formation is now down to 30.4% of GDP. If you look at the figures a little more closely, you see that the drop in capital formation is even more significant for corporates, down from 14.4%  of GDP to 9.9%.

If we were to hypothesise that private sector investment is likely to be more productive than government investment ( though this is sometimes a difficult call, if we have to compare Vijay Mallya’s airplanes with Mayawati’s statues), we would have to conclude

  • Firstly, that gross capital formation has gone down;
  • Secondly that the more productive users of capital have stepped back,

Then we would be saying that both investment and the resultant economic growth have been hit. The work done by Ajay Shah (http://www.mayin.org/cycle.in/) to track the components of GDP growth on a seasonally adjusted basis, have a current GDP growth number of 6%. I know that sounds drastic, but the slowing is visible.

Staying for a bit with the theme of  savings, it seems unlikely that the government is going to turn conservative any time soon – the expanded food subsidy bill is a given, the NREGA budget will track the cost of living, and this in turn, will, at some time have to account for the huge surge in crude prices. Where these will head is anybody’s guess, though at this point, the shots are being called by Barak, and Barack and Ahmedinijad, none of whom I know well.

In July 2008, when crude hit 147 dollars a barrel, it was widely perceived as a crisis; today, granted its ‘only’ 124; but thanks to the weaker rupee, the Feb 23rd MCX quote for Brent, at Rs. 6105 per barrel, is less than 2% off the 2008 peak. This one number, alone, should be sending shivers up our spine.

A last word – and this is about foreign fund flows. Over the last 10 weeks, these have been positive, and in calendar 2012 alone, we have seen 5 bn come in to our equity markets, and 3 bn into our debt markets. I am sure it is a coincidence that the last time we saw this kind of fund flow was in May 2009, during our last general elections. If these flows were to subside, or even reverse, God Forbid, the rupee cost of oil, alone, could throw our macro-economic numbers completely out of gear.

In the long run, the Indian Consumer Story will triumph – just like the much abused spirit of Bombay. As a people, we have made a virtue of an imposition, that of bad governance. But it is a bad pivot for the outlook of what was – not so long ago touted as one of the world’s most vibrant major economies.


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