The Gold Standard | Vignettes from RBI Annual Report 2010-11 – part 2

Export diversification and sustainable CAD

I.40 On the other hand, in the baseline scenario, the CAD would remain at a sustainable level in 2011-12. Estimates of sustainable CAD suggest a threshold of 2.7-3.0 per cent of GDP. Prospects for external sector for 2011-12 remain somewhat uncertain due to global uncertainties arising from the financial turmoil following the sovereign rating downgrade of the US, slowing pace of global recovery and the sovereign debt problems in the Euro area. These could impinge on commodity prices and exchange rate movements.

I.41 The continuance of robust performance of exports recorded in 2010-11 and 2011-12 so far faces downside risks. If these problems continue to simmer and do not turn into a full-blown crisis, the impact of growth slowdown in the advanced economies on India could partly be mitigated by continued diversification of exports. India’s exports have diversified notably in composition and destination in recent years. The impact could, nevertheless, turn material in case the slowdown in global growth is sharp and widespread.

ICOR of 4.5 and the need to raise savings rate

I.57 From the year 2000-01 onwards, gross domestic savings increased mainly on account of rise in private corporate savings and improved performance of public sector savings even as household sector savings remained almost stable as per cent of GDP. The public sector turned from being a net dissaver to a savings-generating sector largely due to fiscal consolidation under the Fiscal Responsibility and Budget Management (FRBM) Act regime. Private corporate savings improved in line with efficiency and profitability. The Planning Commission at the start of the process for formulating the Twelfth Five Year Plan (2012-17) envisaged a growth of 9.0-9.5 per cent. In the changed scenario, where advanced economies may go through a prolonged scenario of slow growth, this may be difficult target to pursue. In order to achieve even a 9.0 per cent growth, the investment rate of 40.5 per cent would be required if ICOR remains unchanged from 4.5 realised during the Eleventh Plan. The CAD that finances the saving-investment gap has averaged less than 1 per cent of GDP over past two decades.

Even assuming a higher a CAD/GDP ratio of 2 per cent, gross domestic saving (GDS) rate need to be raised by about 5 percentage points from 33.7 per cent in 2009-10. This underscores, the importance of augmenting saving as well as bringing about technological and institutional improvements to realize higher growth through higher investments and lower ICOR. Overall investment requirements and the need for continued sustainability on current account, thus underscore the need for attaining the highs of private corporate and public sector savings reached in the recent past and exploring the possibility of invoking an upward shift in household savings, which have remained stable for many years.

Global Monetary Accommodation, Commodities and domestic inflation

1.36 Given the fiscal limitations and growing signs of weakness in the US, the Fed has already indicated that it will pursue its near zero rate policy at least till mid-2013. It has also hinted at another dose of quantitative easing. This policy stance may keep the commodity prices elevated.

II.6.4 Global commodity prices firmed up during 2010, owing to rapid growth in EMDEs, strongerthan-expected growth of AEs and weather-related supply shocks. Low global interest rates and large surplus liquidity in the global economy fuelled global commodity prices with players taking long positions.

OPEC’s lower-than-expected output response during 2010 and unrest in the Middle East and North Africa (MENA) since January 2011 drove up oil prices. Commodity prices are expected to remain firm in 2011. If, however, monetary accommodation in AEs is progressively withdrawn, the consequent rise in interest rates could reduce leveraged position in commodity markets and deflate commodity prices. Commodity prices could also experience a decline if the pace of global recovery slackens further.

1.44 In the short run, if commodity prices soften and global crisis remains contained, the resultant benefit it may have in lowering inflation, fiscal and current account deficits could attract fresh investments. Therefore, the possibility of lumpy capital inflows cannot be ruled out.

Need to restore balance between consumption and investment

I.56 India is amongst the fast-growing emerging markets that have the right balance between consumption and investment in aggregate demand. It does not face the problems of over-investment or from excessive leveraged consumption. In the high growth phase, prior to the global financial crisis, leveraged consumption did increase, but from a rather low base. Investment, on the other hand, rose faster.

After the global financial crisis, government consumption rose on the back of large fiscal stimulus. In 2010-11, rebalancing took place away from government consumption to private consumption, but investment declined sharply in the second half of the year. There is now a need to maintain long-term balance between consumption and investment by rebalancing demand from consumption to investment. For this, there is a need to step up savings in the economy.

DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.