If the growth rates of emerging markets continue to be substantially higher than those of developed world economies, then the former must be ready for higher capital flows, and its consequences such as appreciating currencies and overheated capital markets. The developing economies will have to bear the onus of this round of global rebalancing.
As for India, it may have to tighten some of the already existing controls on capital flows. A tax on capital flows will only be a measure of last resort, says Abheek Barua, chief economist, HDFC Bank, in a wide-ranging interview with Sanjay Kumar Singh.
Why are we seeing such high volatility in IIP (index of industrial production) numbers from one month to another? It was 5.6 per cent y-o-y in August, much lower than the 15.2 per cent figure for July.
The volatility is principally due to the capital goods component. This component has been extremely volatile without there being any fundamental reason for this behaviour. The consensus now is that there is a problem of data collection and data flow that has to be resolved. The rest of the components put together have been more or less stable and have been signalling a couple of fairly important things. One, the non-durable goods component of the index has been very sluggish, which suggests that there is a problem of purchasing power, especially among the lower-income categories, possibly induced by high food inflation. So that's something that needs to be carefully monitored. Basic goods, which often maps into the construction sector, has been doing reasonably well, which points to the fact that the real estate sector has picked up. There is some bit of investment-related construction activity happening, particularly in the infrastructure sector.
I think the headline IIP numbers have to be viewed cautiously and it would be dangerous to arrive at too many conclusions based on it.
Is there a need to revamp the IIP index?
Absolutely. I think the revamping has to be done at various levels. One is, of course, that the index has to be recast to include certain things, given the changing profile of consumption and that of industry. That's one bit which is being done. You will see a revamped IIP come out by the end of the year.
The other thing is revamping data collection. This is a daunting issue since there is no legal commitment on the part of any firm to give this data. Consequently only some of the public-sector firms feel obligated to provide the data. Data is not sent on time and that leads to bunching up of data entry during a particular month. So the entire data collection and processing mechanism will have to be revamped completely.
Some of this work has been outsourced, as I understand, to the private sector. But outsourcing to the private sector has not meant more comprehensive coverage and inclusion of more entities. I think that serious effort has to be made, which perhaps has to include the Ministry of Corporate Affairs, to make sure that more companies report their sales or volume numbers regularly. One of the ironies is that if you take, for instance, the non-durable segment of the index, which is broadly FMCG, hardly any of the major FMCG companies contribute data for the IIP number, which is really strange. So what are we really picking up? So my limited point is that there is a need to recast the basket of goods that is included as well as the entire data collection and processing activity.
What are your expectations from the monetary policy review scheduled for early November? Do you expect the Reserve Bank of India (RBI) to continue to raise rates or is it likely to pause? And what are the major factors that are likely to influence its decision making?
The problem faced by most emerging markets is not principally the growth-inflation trade off but the huge upward pressure on their currencies. What is likely to happen at the time when the RBI releases its monetary policy is that the US Fed might announce its quantitative easing programme. So you would potentially have very large flows coming in from that source. The bottomline is that the RBI will have to consider the impact of an interest-rate move on the exchange rate as well, given the fact that the Indian currency is getting overvalued.
On the inflation front, I think there are bits of good news. Although food inflation remains stubbornly high, but core inflation, which is largely manufacturing inflation, seems to have stabilised on a sequential basis. Within a couple of months, because of the benign base effect, inflation should come down quite sharply. The RBI has done quite a bit and the next two or three months will see banks go in for lending-rate hikes. So on that front the RBI should be more comfortable than in the past.
Growth shows signs of moderating a little. Even apart from the IIP, if you look at the other indicators, there seems to be some consolidation or moderation in growth. So given all this I would expect a pause. And the principal reason for the pause would be the potential impact on the currency.
The price of crude oil has started rising once again. From $77 last month, it is now around $83-84 per barrel. What is driving it upward?
I think it's once again the huge refinancialisation of the commodity market that is responsible. For some time the commodity markets were driven by fundamental demand and supply related factors. But I think it has come full circle again and it is now essentially driven by liquidity and perceptions of future liquidity.
Also at the margin, I think the fact that the US is unlikely to go into a double-dip recession, the fact that China has stabilised - all that seems to have helped in sustaining positive expectations about global demand. But I think the main factor has been liquidity, and the speculative element in price determination of commodities in general, which has increased a lot.
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