Choking Economic Growth will not help INR
India’s GDP growth forecasts are being revised downwards across think tanks. Private economists are projecting growth at below decade low growth rate of 5% seen in fiscal 2012-13 while RBI and government have lowered projections by around 200bps to 300bps to 5.5% and 6% levels respectively. The outlook for growth is weak as RBI is tightening monetary conditions to fend off INR speculation while the government is fiscally constrained to spend. Global economic outlook is not very positive despite green shoots emerging in the Eurozone and US economy showing slow and steady growth. Weak global economy impacts domestic trade prospects leading to a negative impact on growth.
The Indian Rupee (INR) is deeply impacted by the falling growth prospects of the economy. India is seen as one of the high growth economies in the world and a growth slowdown can impact capital flows negatively. Weak capital flows lead to worries of financing a high CAD (Current Account Deficit) leading to more pressure on the INR. Policy makers actions to stem currency weakness leads to more growth pangs for the economy leading to fresh worries on capital flows that in turn leads to INR fall. A vicious cycle that has no end in sight.
The INR that touched all time lows of Rs 61.81 to the USD in the first week of August 2013 is compelling the RBI to tighten system liquidity to stave off currency speculation. RBI’s liquidity tightening policies has driven up yields across yield curves and has inverted the yield curves. Inverted yield curves have short maturity bond yields higher than long maturity bond yields and the reason for the inversion is due to the cost of liquidity becoming tight in the system.
The rise in yields at the short end of the curve is impacting the cost of funds for the banking system. Banks have been forced to park 4% of their NDTL (Net Demand and Time Liabilities) with the RBI at zero interest rates on a daily basis. Banks access to the RBI repo window for funds is restricted to 0.5% of their NDTL and banks are forced to borrow from the RBI at MSF (Marginal Standing Facility) rate of 10.25%. Banks are raising lending rates to pass on the higher cost of funds to borrowers.
Borrowing costs for corporates are high due to the stress levels in bank loans. SBI’s gross and net NPA (Non Performing Assets) stood at 5.56% and 2.83% respectively in first quarter of fiscal 2013-14 compared to 4.99% and 2.22% respectively seen in the same period last year. Economic growth at decade low levels of 5% is placing pressure on debt servicing by indebted corporates.
The economy is slowing down sharply. IIP (Index of Industrial Production) growth was negative 1.1% for the first quarter of fiscal 2013-14. Vehicle sales are falling with sales down year on year for the first four months of the fiscal. Tax collection at 10% levels for the April-July 2013 period is well below the budgeted growth of 17.5% for the full year. Bank credit has grown by just around 1% in the April-July period.
The government is under pressure to contain fiscal deficit as it is seen as one of the primary factors for a weak INR. Fiscal deficit is budgeted at 4.8% of GDP for this fiscal against levels of 4.9% of GDP seen in the last fiscal. The weak economy is slowing down revenue growth and the government has to curb expenditure to keep its fiscal deficit in check.
The government and the RBI are trying hard to bring down the Current Account Deficit (CAD) that was at record highs of 4.8% of GDP in fiscal 2012-13. The government has raised duties on non essential imports such as gold and silver while RBI has made financing of non essential imports costlier. The weak CAD is seen as the primary cause for the INR weakness.
Exports have grown by less than 1% in the first four months of fiscal 2013-14 despite a weak INR that is down by over 11% in the same period. Weak global economy is leading to anemic export growth. Imports are up by just 2.6% indicating weak domestic demand.
The US economy added 162,000 jobs in July 2013 against expectation of 185,000 job additions and against June 2013 additions of 188,000 jobs that were revised downwards from 195,000 job additions. Unemployment rate came off at 7.4% in July against June levels of 7.6%. US equity indices are trading at close to record highs on the back of rising home prices that rose by most in seven years in May, vehicle sales that touched five year highs in July and consumer confidence that is running at five year highs as of July. US economy is growing slowly and steadily.
China’s exports rose by 5.1% year on year in July against a 3.1% fall in June while imports rose 10.9% against a 0.7% fall. The country’s inflation was steady at 2.7% in July. Inflation was at 2.7% in June. China’s official figures showed improvement in the manufacturing index in July though private reports showed a decline. China’s economy faces many headwinds going forward and growth will be muted for the second largest economy in the world.
Eurozone economy is showing signs of stability. Manufacturing grew for the first time in two years in July. Eurozone economy is expected to show growth of 0.2% in the second quarter of calendar year 2013 against flat to negative growth seen in all the quarters since late 2011. The record low interest rates maintained by the ECB is helping the Eurozone come out of a recession. However the Eurozone economy has a long way to go given record unemployment, fiscal austerity in indebted countries and weak global economy.
Table 1: India Macroeconomic Data July 2013