Fine-print of RBI’s macroeconomic analysis

Fine-print of RBI’s macroeconomic analysis

The RBI Governor, Dr Y. V. Reddy…India’s liabilities to the rest of the world increase with every rise in the Sensex and appreciation of the rupee.

S. Venkitaramanan

Now that the RBI Governor, Dr Y.V. Reddy, has received richly deserved accolades from the Finance Minister for the contributions of his monetary management to inflation control, it maybe appropriate to look in detail at the fine-print of the Governor’s analysis of the macroeconomic fundamentals — the document ‘Macroeconomic and Monetary Developments,’ issued at the time of the monetary policy statement. The details of the analys is of the macro-economy, naturally, could not capture our attention to the extent they deserved in the midst of our concentration on more material aspects of policy change. But, the analysis by the RBI’s professional staff under the Governor’s leadership is well worth attention and it will be a pity if its analysis is ignored, both for what it states and does not.
Real economy

At the outset, the analysis goes into the profile of how the real economy performed and the financial markets behaved. It is also detailed in its explanation of the price situation with special reference to the impact on wholesale price index and consumer price index. It does take into account the critical impact of the looming rise in international crude oil prices. Its analysis of the external situation particularly bears evidence of skilful interpretation of critical facts and management based on that.
Credit distribution

As usual, the analysis gives details of the distribution of credit to different sectors of the Indian economy. The figures are particularly instructive. Gross bank credit to non-food segments increased year-on-year by 23.3 per cent in the period up to August 17, 2007. This was a decrease in rate of growth from the previous year of 34.8 per cent. Agriculture and allied activities drew loans, which grew at 24.4 per cent, as against the previous year’s 35 per cent. This is disturbing.
Housing, real estate loans

On housing loans, the increase year-on-year for the period ended August 17, 2007 was 16.6 per cent, as against an increase of 30.3 per cent in the period up to December 2006. There has been a decline in housing loans, if these figures are any guidance. To what extent it is due to rise in interest rates and to what extent to RBI’s active discouragement is not spelt out.

The analysis puts the figure for real estate loans in 2007-08 as increasing at a rate of 52 per cent in the period up to August 2007. For 2006-07, the corresponding figure was higher at 66.7 per cent. The Governor’s persuasion and pressure have obviously yielded results. Part of the real estate loans may be reflective of infrastructure investments and SEZ expansion.
Credit card loans

Loans against credit cards increased during the current year by 21.3 per cent as against an increase of 45 per cent in the previous year. The Governor’s advisory signals have been effective.
Excess caution

The absolute size of the loans for housing as on August 17, 2007 was only Rs 2,30,000 crore — a relatively small figure considering the population living in urban and semi-urban centres in India, leave alone rural areas.

While the Governor’s caution against indiscriminate housing loan disbursements gains traction from the recent US sub-prime experience, it remains obvious that one can be too cautious. Similarly, credit card loans in absolute terms are only Rs 15,200 crore on the reference date. It is too small for a country of India’s size, wealth and population. True, excessive use of credit cards can be obsessive and lead to disarray. But, credit cards are a necessary aspect of a liberalising credit economy. It enables an individual to access credit without passing through many procedural bottlenecks.
NBFC credit

The total credit to Non-banking Finance Companies (NBFCs) is only Rs 45,000 crore as on August 17, 2007. Considering the comprehensive service performed by NBFCs, this figure seems to indicate the prevalence of impediments in Bank’s disbursement to the NBFCs. They deserve to be removed.
Trade deficit

While the trade deficit continued to increase during the period, it was mainly offset by net invisible receipts. In fact, the receipts arising from remittances, export of software and business process outsourcing service offset nearly 75 per cent of the trade deficit.

The Governor has stated that the current account deficit is at around a tolerable level in relation to GDP. The fact, however, remains that we are in a position where our imports of goods, namwly fuel, food and consumer durables, are being supported by service exports.

What is left as current account deficit is financed by capital flows, both direct and portfolio. This is not a sustainable situation if India is to emerge as a world economic power. China’s strength in comparison is that it is able to maintain a flow of exports at reasonable prices to the rest of the world. We are not doing this.

This is a serious problem. We have, of course, to improve productivity by introducing technology and enhancing infrastructure, a task to which India must now turn.
Interest rates

An exhaustive analysis, such as the RBI’s macroeconomic developments, can be faulted, if at all for its absence of a section on real interest rates and real effective exchange rates. Our real interest rates have risen in recent years due to lower inflation and higher interest rates.

A comparison with the real interest rates in China, the US and the EU would be instructive both for the reader and the policy-makers. So too, our real effective exchange rates and their impact on export/import performance need to be focused.
Net investment position

I now turn to another important nugget of information revealed by the RBI’s analysis — the net investment position.

When we refer to our $250-billion plus reserve, we tend to forget that they are basically made up of foreign capital flows — both FDI and FII. Both these flows, in effect, leave foreigners owning assets in India. We are, to that extent, having an increase of liabilities. If we offset our foreign assets against our liabilities to foreigners, we get our net investment position.

Over the last few years, the net foreign investment position has remained around (-) $45 billion. In spite of our reserves of $250 billion plus, we have a net liability position to the rest of the world.

Both FDI and equity investments of the portfolio type will increase in market value, with the booming stock market and translation in terms of an appreciating rupee. The figures quoted by the RBI must be on a historical cost basis and will have to be raised upwards if converted to market value basis.

If the market valuation is taken into account, the net investment position will be a sharply increased one, more negative than RBI’s calculation.
Inflation

An analysis of the figures reveals that in our preoccupation with control of inflation and the size of foreign resources, besides rate of growth, we may be in a celebrating mood prematurely.

The size of our liabilities to the rest of the world increases with every rise in the Sensex and appreciation of the rupee.

Unless we turn our attention to trade and exchange rate fundamentals and improve our current account position, we will continue to be more and more in liabilities to the rest of the world.

A $250-billion plus reserve alone does not help. May the RBI turn its attention to this important conundrum that we are building our liabilities faster even as our stock markets rise and the rupee appreciates.

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