CAUGHT HIGH & DRY

CAUGHT HIGH & DRY
The Economic Times, August 12, 2009, Page 13

Two weeks ago, RBI anticipated growth to be better-than-expected. A fortnightlong dry spell, when the monsoon is at its peak, has changed all that. The situation no longer gives RBI leeway to tweak interest rates, says Mayur Shetty


TURNING the country’s official measure of price rise — the wholesale price index (WPI) into a joke, retail prices of several pulses and even vegetables look set to touch the Rs 100-per kg level even as the WPI continues to be in negative territory. Tur dal, the basic ingredient of the humble dal-chawal meal, has seen the highest price rice in recent times. It is estimated that retail food prices have risen by a third in the past three months.

The failure of the monsoon is expected to push up already high food prices even further. With deficient rainfall for all of August so far, forecasts are that there will be a sharp drop in agricultural output of pulses and cereals. Even if the rains revive in the coming days, it will be too little too late. Although future trading in tur dal has been banned, the prices of other pulses and sugar in commodity exchanges show that they are going to be in short supply. According to Crisil, “The distorted monsoon pattern has translated into lower sowing during the kharif season. At the all-India level, area sown till 31st July was 6.0% lower than the area sown during the corresponding period last year.”

The cumulative rainfall deficiency has now risen to 25% from 19% over the week, according to a Kotak equities report. Though it was less than 54% as on June 24, the fact that the peak monsoon season will soon be over, leaves the country with the prospect of a deficiency of 20-25% even with some subsequent improvement in rain.

To make things worse on the price front, international oil continues to quote close to its eight-month high of $70 per barrel. Although this is less than half of the peak levels of last year, a sustained rise will mean that some of the increase would have to be passed on to consumers in the form of a petrol and diesel hike. If fuel prices do go up further, they would have a cascading effect on other consumer prices. With the government increasing coal prices, there could be an upward revision in power tariffs as well. While the monsoon has hit food supply, the recent outbreak of swine flu across the country is likely to effect productivity, as several businesses and offices may have to closed down as part of precautionary measures and also because of cancelled events and travel plans.

While all of this is extremely negative news for the economy, curiously the BSE Sensex appears to have been unaffected. The Sensex touched this year’s high of 15924, which was much higher than the pre-crisis levels.

With so much liquidity eased by central banks across the world, funds are flowing into the Indian market which continues to be the second best in the world. The fallout can be witnessed in real-estate prices, which are showing signs of hardening.

It is now very clear that expectations of growth in August are far more tempered than they were in June. Research houses have lowered growth expectations for the current fiscal. Citibank has revised its growth forecast for India down to 5.8% from 6.8% before the monsoon. Most other research houses expect growth to be at least half a percentage point below what they had expected it to be before the monsoon.

The forecasts present a dramatic change in sentiment from what was prevailing last month. In July, Reserve Bank of India (RBI) governor said that he was leaving rates unchanged and he expected growth could be higher than the 6.5% originally estimated at the beginning of the fiscal. Indeed, the views of economists as presented in the macroeconomic report showed that the mood in July was that growth would be higher than expected.

If July’s status-quoist policy was designed for better-than-expected growth, RBI may soon have to take measures to tackle a slowdown coupled with double-digit consumer price inflation. RBI’s dilemma is similar to the one faced by all central bankers when confronted with a stagflation situation. The drop in growth will mean that RBI cannot hike rates, but at the same time raging food price inflation will make it difficult for the central bank to ease monetary policy.

The food situation will require the government to take policy measures through subsidies for irrigation and release of buffer stock. Some of these measures will put further pressure on the fiscal situation, pushing up government borrowing and yields on government securities could rise. What this means for banks is that they will no longer be able to generate profits by selling government bonds to each other or by writing back higher provisions for depreciation made in the past.

With growth under strain, banks will also be under continued pressure to keep interest rates low. In a Citibank report, Rohini Malkani and Anushka Shah have said: “We maintain our view that though the enhanced borrowing programme could result in yields firming up, surplus liquidity conditions, still-muted credit growth coupled with RBI’s role in the borrowing programme, would cap yields at 7.5% levels.”