Current Account And Inflation In India

Posted in Finance Articles, Total Reads: 3522 , Published on 30 August 2012
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Recently Reserve Bank Of India governor Dr. Subbarao had refused to succumb under the pressure of the industry to reduce the Repo rate and Reverse Repo rate, citing the current level of the inflation unacceptable and ensuring sustainable growth by monetary tightening.

The WPI index rose to 7.55 percent in May while the GDP of the country plunging to the nine year low of 6.5 percent. The below figure shows the GDP and the Inflation of India over the year.


 As can be inferred from the above chart the annual change in the Consumer Price index (CPI) inflation rate has seen a decrease from the high’s of 16% in July 2009 to the present lows of the 7 percentage as recent as July 2012, due to constant rate hikes by the Reserve Bank of India (RBI) during these years.


The effect of the rate hikes by the Reserve Bank of India (RBI) has considerable effect on the growth rate of the country witnessing a constant decrease in the growth rates from 9.3 in 2010 to 5.3 in recent years.

Hence now it’s becomes important to analyze how we have reached this position. How India has blown away the chance of continuing the exceptional growth rate and how the Inflation Rate and current account has played an important role in reaching to a stage in which we are a witness.

Current Account Deficit

Current Account Deficit representing the net flow of the income out of the country barring the capital movement has surged. It represents the country’s investment saving gap in simple terms. While the India’s Current Account Deficit on 29th June stands at highest ever level to 4.5% of GDP at USD 21.7 billion in January –March period of 2011-12 due to higher imports of oil and Gold. The graph below shows the trends current account deficit of India taken from the RBI data base.


The graph shows the grim situation of the present state of the country, with current account deficit increasing in the coming years.

The current account deficit is expected to increase in the coming years due to the crude oil imports which is the main import constituent of our country and whose prices are increasing over the years. India has dependent heavily on the foreign money coming through the stock market route but with the depreciation in the rupee, the FII are pulling their money causing the further depreciation in the rupee.

There is need for country today to build exports encouraging the domestic players to invest in the markets rather than relying on the FII.

Inflation In India: Present Situation

As seen above the graph shows the India’s inflation rate, annual change in Consumer Price Index(CPI), the figure below shows the change in the Wholesale Price Index(WPI) over the years

Year

WPI (%)

April 2003

5.12%

April 2004

2.23%

April 2005

4.96%

April 2006

4.65%

April 2007

6.67%

April 2008

7.81%

April 2009

8.70%

April 2010

13.33%

April 2011

9.41%

The recent data collected by Bloomberg, reveals that vegetable prices have increased by 49% compared to 2011 and the fuel expenses have increased by 11.5%. Increase in the prices of non-food manufactured i.e the IIP data shows the increase in the rate from 4.86 % in April 2012 over the previous year, this is when the rupee has depreciated considerably.

Now we are analyzing certain factors which can be attributed to the present condition of Inflation and Current Account are as follows:-

Rupee Depreciation

As seen in the table below the Rupee to INR conversion rate, rupee has depreciated by approx 14% over the last 9 years. The depreciation in the Rupee has affected the benchmark indices considerably also the stocks of the companies who have taken the FCCB route for growth has now knocking on the doors of creditors for CDR, though it has brought smiles on the faces of the exporters but the present market condition has not helped in increasing the exports.

Year

Exchange Rate

Jan 2004

45.59

Jan 2005

43.39

Jan 2006

45.07

Jan 2007

44.17

Jan 2008

39.30

Jan 2009

48.12

Jan 2010

46.30

Jan 2011

44.95

Jan 2012

53.06


There is wide spread expectation by the Indian Industry of decreasing the rates but inflation is a big hurdle in doing so.

Government Policies

Subsidies

At the time when our fiscal deficit is estimated to touch INR 5.22 trillion, it gives little sense to provide subsidy on the oil and fertilizers, but due to the political conditions prevailing it is very difficult to completely remove the subsidy being provided by the central government. The revised estimates show that total subsidy expenditures for the fiscal year 2012 ending in March rose by 24.7% to reach INR 2.2 trillion, versus INR 1.7 trillion and 22.7% year-on-year (YoY) growth recorded in fiscal year 2011. However, the budget estimates for the upcoming fiscal year reveal a 12.2% cut to INR 1.9 trillion.


                                       Chart provided by: CEIC

The subsidy provided by the government has grown over the years due to the increase in the international crude oil prices and the prices of the oil remaining same in the domestic market, the government has used the price increase as a tool for fulfilling its political ambitions, who increase the prices during the favourable conditions and letting the oil prices remain stable in the adverse conditions. This has resulted in the increase in our fiscal deficit, while the petrol prices has been deregulated, but the oil companies still needs the permission of the central government before increase in the petrol prices

There is a need for finding a permanent solution for this, while there can be many solutions one of the solution could be to maintain a constant price difference between the International Oil prices and the domestic oil prices which can be revised on the fortnight basis. This constant difference can be reduced over the period of time hence reducing the fiscal deficit and making the decoupling the oil prices with the politics.

Policies

At the time when the present government is accused of the present policy paralysis, it is actually some of the prior policies and bills presented by the government which is responsible for the present current account deficit and the inflation rate. One can be attributed to the NREGA (National Rural Employment Guarantee Act, 2005.

According to the Act any adult who is willing to do unskilled manual work at the minimum wage is entitled to being employed on local public works within 15 days of applying, while it can be said that the act being the right  step towards the right to work, as an aspect of the fundamental right to live with dignity, it has helped in pushing the inflation rate and current account deficit, the people in rural areas which were previously not able to earn enough and pay for higher food bills are now buying the same which have pushed the prices of the vegetable. This is due to the short sightedness and money spending of the which the government cannot afford now. While such acts are a positive step towards curbing the poverty in India but we have still not reached the stage where these can be afforded by India.

The recent development in the corruption and the policy paralysis is not helping the in reducing the Inflation rate and the current account deficit either.

Demand Of Forex

India being a net Oil Importing company, the oil importing burden is hurting the rupee. With the liberalization the energy demand has also sky rocketed, with major contributor towards energy production being the Oil followed by coal.


Indian having few oil reserves has no option but to import the crude oil, but India could have during the past years increased E&P of oil over other countries, like OVL (ONGC Videsh Limited) having stake in the foreign blocks in Russia, Vietnam etc. This is nothing as compared to the Chinese oil companies having stake in the other countries, hence India should from now on over the period of time try to increase stake in the oil resources in other countries.

Also the oil being a limited resource the price will only be increasing over the period of time hence we should look to switch over to alternative energy sources like Shale Gas which is an upcoming source of energy slow adoption to these new technologies could increase the price of shale gas over the period of time.

India being a coal rich country can still cover its need of the Power producing companies by mining of coal but to bridge the domestic shortfall in the production of coal India is now importing coal and is now expected to cross 100 million tonnes in 2012-13, with 95.8 million tonnes being imported in 2011-12, this is due to the use of the traditional methods of mining and lack of competition in this sector. Opening of the sector to private companies could help increase in the coal production.

Foreign Funds Inflow

With the turn of recent events and the free fall in the value of rupee, it seems as if the rupee is totally dependent on the investments from the foreign funds. Foreign funds had poured about $9 billion into stocks and debts between January 1 and March 15; but with the announcement of the budget and the market expecting reforms, government came up with the controversial tax proposal of GAAR which has spooked the FII’s and are now pulling their funds out of the Indian Markets.

In India there is uncertainty when you start a project, getting environmental clearance, going through all the red tape in the bureaucracy; there is uncertainty about how laws will be interpreted, classic case is of Vodafone India; even Indian entrepreneurs think that doing business in India involves business risks. There is a need to reduce the red tape and streamline all the processes.

Indian economy being always compared to Elephant cause it always take times for an Elephant to gain speed once it has slowed down and looking at the present situation of the economy it has certainly slowed down. The reforms done now can bring effects only in the later years. Hence steps taken today in reviving the economy will only bear fruit till three to five years down the line.

This article has been authored by Rajiv Tripathi and Ashish Kumar from NMIMS.

Image: FreeDigitalPhotos.net


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