LAST week, one had written about the Ind-ian economy being at crossroads. With a choice between moving straight along the co-urse that had been set over the previous few years and the momentum that had built up in both private and government sectors. Or of taking a diversion, about which the only certain thing was uncertainty. The electorate has chosen the diversion and the po- litical circus brought to your living rooms by 24-hour TV channels give you a flavour of things to come. We can only hope that things will turn out better than the cynic might be inclined to conclude. I shall not dilate any longer on the vivid colours of the political season and move on to issues that provide far less infotainment, but govern the conduct of our working lives nevertheless.
It has been sometimes said that much of India?s economic success has been despite, rat-her than because of, government policy. That, one thinks, is overly extreme. There have been periods when the conduct and execution of public policy has been in tandem with the effervescence in the private sector ? from farm to factory and software estab- lishments. But there have been less happy periods when the Indian economy had mostly one hand to clap with. In the worse case scenario, that would indeed be the situation in the days to come. Undoub-tedly, it would be delightful if it turns out for the better.
Tomorrow, the Reserve Bank of India (RBI) will release its Annual Policy Statement for 2004-05. The postponement from end-April is no doubt because of the ongoing elections, the model code of conduct and so on. Normally, the April Policy Statement comes a few months after the Union Budget. This time round, it is going to be the other way round. And with the new government not in sight, the RBI will surely have some difficulty in articulating things in a way that will avoid collision with any reasonable official policy down the line. Unreasonable policies, of course, can neither be anticipated nor accommodated in the rational structure of monetary policy.
Globally, markets are gearing themselves to generalised monetary tightening. As crude oil prices soar, energy costs are rising across the world. Prices of non-energy items are also not quiescent. In the US, both consu-mer and producer prices rose sharply in April after big in-creases earlier as well. The seasonally adjusted three-month compoun- ded annualised in-flation rate (which gives us the picture in the immediate past) rose at the rate of 3.9%. Even if energy and food (whose prices have also been rising) are excluded, the figure is 3.3%. Producer prices also showed signs of accelerating inflation. Although the most recent meeting of the US Federal Reserve kept rates unchanged, markets are factoring in an increase later this year.
Through April 2004, the yield on 10-year US government securities has risen by over 50 basis points (bps) and had gone up by another 35 bps till last week ? an increase of 85 bps over the past one-and-a-half months. At the end of last week, the yield on 10-year US treasury was at 4.85%. The increase further along the yield curve was even sharper. 20-year US treasury has gone up by 100 bps since April and closed last week at 5.6%. Part of the increase was a fall-out of the rising US federal deficit and the prospective increase in supply of treasuries. The imp-roved position of corporates was reflected in the continued decline in the spread between US treasuries and corporate bonds. The spread between yields on 10-year treasury and Moody?s Aaa-rated seasoned corporate bonds fell to 133 bps in May 2004, from 165 bps in May 2003. More interestingly, corporate improvement was evident in the continued dec-line of the spread between Aaa and Baa-rated papers, which was down to 70 bps, from over 90 bps in January 2004 and 115bps in May 2003. To get a sense of perspective, this spread had ranged bet-ween 60-70 bps in the boom months from mid-1999 to mid-2000.
As interest rate expectations have changed and the economic news coming out of the US are consistently better than that emerging from Europe, exchange rates have changed course. Against the euro, the US dollar has gained some 8 cents since mid-January 2004. Current rates are much below the 200-day moving average and are approaching the 300-day moving average. The Indian rupee has rapidly dropped 5% against the US dollar since the closing days of March. Economic and financial news coming out of India has helped push the rupee down, as indicated by the fact that the rupee has also lost 1% against the euro over the same period. The rising rupee is at least one front on which the elections have lifted a burden off the RBI?s shoulders. A weaker rupee will also mean higher rupee costs of crude and therefore higher product prices or subsidies, or both.
Business has been lifting credit from the banking system at a rising pace. Non-food credit has risen by 21% on year-on-year basis in the first two fortnights of April. Although on a year-on-year basis food credit shows a decline, as wheat procurement begins, additional food credit is being drawn upon. The fundamentals of the economy remain strong, and the pace of economic activity and the concurrent demand for funds continues to rise. An investment cycle has been gathering momentum, which might not hit the funds market with the same strength if public policy does not provide the other hand to clap with, but much of it will materialise. As Indian corporate issuance of paper overseas increases, the premium on scarcity is declining and the rates on offer are not turning out as attractive as in the past. With the rupee not looking like the certain one-way bet that many had un-wisely believed, the cost of overseas issuance has further risen. Which means that there may be greater demand pressure on the domestic funds market than might otherwise have been.
In addition, the government?s borrowing programme will rise more than expected as a consequence of the combination of possibly higher subsidy accommodation accompanied by near zero disinvestment flows. The impact on domestic interest rates because of purely domestic factors plus global development is self-evident. Expect rates to rise faster than you had expected.
The author is economic adviser, ICRA, New Delhi