For India, the key risks to growth are industries that are more export oriented than the ones that predominantly depend on domestic demand. Industries such as leather goods, textiles, gems and jewellery, etc would be perfect examples of export-oriented sectors that have seen large output losses and also a large rise in unemployment.
However, even as global demand continues to erode, Indias domestic demand seems to be buffered by increases in disposable income in the hands of public sector workers and farmers. Rural demand is reportedly strong and a good monsoon will hopefully sustain this. Expenditures under the NREGA programme have also helped. Sectors that cater mainly to domestic demand such as the cement, steel and auto have seen a turnaround in fortunes recently, especially in the January-March 2009 period. And this gels well with the trends seen in the ABN Amro PMI.
RBI started its aggressive monetary easing at a time when the contagion effects of the bust of Lehman Brothers had opened up the possibility of destabilisation of the domestic financial markets and a sharply weakening demand. While financial market stability was sought to be achieved with CRR cuts and other liquidity enhancing measures, the objective of stabilising demand was attempted through interest rate reductions alongside the fiscal stimulus packages of the government. Rupee liquidity now is extremely comfortable with the LAF surplus running at above Rs 1,00,000 crore which, in turn, has led to a sharp reduction in the interest rates at the shorter end of the yield curve. Three-month T-bill rates are now down to 3.65% from around 5.00% at end March 2009 while the 12-month T-bill rates are lower at 4.05% now from 5.00% at end- March.
The common complaint is that the transmission mechanism is not working fast enough to reduce the economys pains. Both the government and RBI had been trying to nudge the banking segment to reduce lending rates to mirror the sharp decline in policy rates. But this is taking time as the banking segment is still saddled with high-cost deposits raised in higher interest rate period. However, now the force of domestic rupee liquidity has led to a lowering of interest rates on the deposit side too. The significant easing on the lending side will happen with time after the banks retire high cost deposits. On the other hand, signs of stability could also help reduce NPL fears that had restricted banks from increasing lending.
RBI may yet be tempted not to reduce rates any further than it already has. Higher prices globally, as a result of the lagged impact of the large monetary and fiscal accommodations, are being discussed now. For instance, Alex Weber of the ECB sees no strong deflation risk and is critical of cutting the refinance rate below 1%.
In India, headline WPI inflation is likely to go down to a negative territory. But over the last few weeks the headline index number has not declined as much as was being expected. There has also been an increase in the Index for manufactured items over the last month. And with money supply growth still robust at 18%, there are no real fears of deflation in India. RBI is bound to keep this in mind.
The author is chief economist, Kotak Mahindra Bank. These are his personal views