India's Golden Conundrum

Indian’s love for gold is spiritual where it is revered as God’s currency. It is only astronomically higher prices which can resist them to buy it. Falling prices are just what India wanted at a time when festival and wedding season is ensuing.

The king of metal Gold is again going south. It touched a 14-month low on September 20, 2014. Such a scenario induces people away from gold to flock into financial instruments. The metal will no longer lure Indians is what analysts believe but India’s thirst for gold will take eternity to be quenched.

Falling gold prices might lead people in other countries to ditch the yellow metal but Indian’s love for gold is spiritual where it is revered as God’s currency and people feel proud of owning it. It is only astronomically higher prices which can resist them to buy it. Gold demand slumped magically when import duty was hiked to 10% in order to control current account deficit. Now that prices are falling, it will be seen as an opportunity to purchase it on low in the hope of price-rise. Long-term return outlook of a common investor in India is always bullish on gold.

Current account deficit (CAD) narrowed sharply to $7.8 billion (1.7 per cent of gross domestic product) in the Apr-Jun quarter of FY 2014-15 from $21.8 billion (4.8 per cent of GDP) in the year ago period. The fall was strongly led by slowdown in gold imports which halved to $7 billion in the April-June quarter from $16.5 billion in the same quarter a year ago. However, the gold imports in the preceding quarter i.e. the Jan-Mar quarter of FY 2013-14 amounted to US$ 5.3 billion. 

To compare the two data, gold imports actually risen on quarterly basis. The reason is because RBI had eased some gold-import restrictions in the month of May which instantly drove the people to invest in gold. This uptick in demand is reflected in the gold import data of Apr-Jun 2014.

It is true that the gold investment at this juncture does not seem viable. Gold futures are trading lower. Improving global economy does not bode well for the metal, to boot. Stronger dollar is also contributing to Gold’s southward journey as gold is used as a hedge against movement in the US dollar, which means its prices will move inversely to change in value of dollar. Indian gold prices move in tandem with global prices depending on rupee’s value against dollar. Since India imports the yellow metal, a weaker rupee cushions a fall in gold price while a stronger local unit makes the metal cheaper. Given improving economic conditions, rupee may not depreciate much against dollar.

That said, why to invest in a declining metal when stock markets are doing well and lower inflation is making returns on savings schemes positive? The answer lies in a trend seen last year. Gold prices had fallen dramatically in Apr-Jun quarter of 2013. Questions were raised if it safe to invest in this yellow metal but coming true to the conscience of Indians, gold hit a record high of Rs.35,074 per 10 grams in August 2013. Hence, it is no hyperbole that Gold is the safest haven amongst all.

With the ensuing festival and wedding season, India’s gold buying binge is likely to be bumper. Low prices at this time are just what India wanted. Irrationally higher import duty had enforced them to stay away from the metal for long but now is the opportunity to buy it on dips. Thus, India’s golden problem is not yet resolved and it is too early to claim that the country’s CAD is normalized. India’s lure for gold can be suppressed but cannot be died in any case. 

Too early to bet big on markets

A reality check of current market conditions sparks good reasons to stay cautious while boarding the bus of current market rally.

Splendid times seem to have unleashed in Indian stock markets. Nifty touched a lifetime high of 8000 on 1 September and Sensex hit 27,225.85, an all-time high on 3 September. Nobody had the foresight to predict such levels for benchmark indices a year ago. But now, our fortune tellers aka technical analysts are certain that the bulls will ride faster and farther from these levels in the days to come.

For Navneet Munot, CIO, SBI Mutual Funds, Sensex hitting 10,000 in 10 years is not unrealistic if India Inc can deliver growth of around 15 per cent per annum, which, according to him, is not an unreasonable expectation over a long period.

However, taking these predictions with a pinch of salt is advisable for retail investors as their hard-earned money is involved. Their predictions might be true but a reality check of current market conditions sparks good reasons to stay cautious while boarding the bus of current market rally.

Needless to say domestic as well as foreign investors are betting on Prime Minister Narendra Modi-led NDA government which has successfully trumpeted its reform-oriented approach in every nook and corner of the world.

Now is the time to analyze whether the positive sentiment lurking around is hope driven or solid result driven. Looking at contracted July IIP data at 0.5% versus the 3.9% of June (revised higher from 3.4%) is enough to warrant that it is too early to stake bets on newly formed government. Though CPI inflation mildly cooled to 7.8 per cent against 7.96 per cent in the previous month but food inflation inched higher to 9.42% versus 9.36% m-o-m.

The week ahead is going to be eventful. First, markets will take stock of IIP and CPI data after opening bells tomorrow with simultaneously eying on WPI data expected to be out at noon. They will be taking note of advance tax payment by listed corporate, which is also due to be released tomorrow and will provide clues about Q2 September corporate earnings.

On Wednesday market mavens will eye crucial US Federal Reserve's monetary policy review. Woe betide the markets if Fed goes for an early rate cut as it will make Indian markets vulnerable to FII outflows leading to correction on Sensex and Nifty.

For investors who do not understand technicality of markets, it is sensible to wait for macro data of following months to come which does not reflect the overhang of UPA government’s tenure so that no confusion is felt whether the slowdown is of UPA’s making or NDA’s failure. Let the time confirm if the Modi-driven seemingly impactful India story is a fact or just the work of a fiction.   

Power Plight

The fruits of privatization must be savored by consumers. If CAG audit of discoms reveals otherwise, the bleak side of privatization will be re-affirmed. 

The power spat in the national capital has been temporarily avoided thanks to Supreme Court. On Friday it ordered Reliance Infrastructure owned BSES firms to pay 50 crores to NTPC, India’s largest power generation utility, within two weeks. NTPC had recently threatened BSES firms to stall power supply had they failed to pay their dues in the stipulated time. Collectively BSES-Rajdhani and BSES-Yamuna owe 300 crores to the NTPC. However, in a reprieve to them, SC has settled the matter at much lower payment till the next hearing due for March 26.

The modus operandi of power sector in Delhi is complex. Amid accusations and cross accusations of corruption and poor governance, it is being hard to identify the malady ailing the power sector. BSES firms assert that the Delhi government is required to pay them subsidy amount so that they can recover their operational costs. They also contend that once government pays them under-recoveries, they will make payments to NTPC. To this Aam Aadmi Party led Delhi goverment hits back stating that the distribution companies are not making losses. They just tamper with their balance sheets to show losses on paper but actually they are incurring profits. The Delhi government has also clarified that the subsidy amount due to discoms from it shall be adjusted against the receivables of government-owned Delhi Transco Ltd, the power transmission company, and the generation utilities, Indraprastha Power Generation Co. Ltd and Pragati Power Corporation Ltd.

Monetary activism

To douse the inflationary fire,the recommendation by the high level RBI committee must be worked upon with urgency and earnestness. 

India’s central bank, the Reserve Bank of India (RBI) is up with yet another concerted effort to combat the notoriously high inflation. A committee headed by RBI Deputy Governor Urjit Patel has recommended pegging monetary management with the Consumer Price Index (CPI) instead of the current practice of the Wholesale Price Index (WPI). Observers believe that the move is commendable since it is the CPI which directly affects the consumers, unlike the WPI. The recommendation, if accepted, will line the RBI in tune with the global central banks which target CPI as a nominal anchor.

However, there are reservations against this proposed step. Food and fuel inflation constitutes more than 50 per cent of the CPI. It is being pointed out that food and fuel price volatility will be difficult to accommodate in the policy decisions once CPI becomes the reference point of monetary policy. This seems a valid point. Nevertheless, instead of taking this into account what causes frequent variations in food and fuel prices in the first place is what one should look at.

Let’s first discuss the food prices. Though weather conditions have a role to play, government policies and supply side bottlenecks are the principle protagonists in the big picture. Without specifying how it would generate enough foodgrain to run, for instance, the Right to Food Security programme, the government chose to go ahead and implement it. Disregarding how it would meet the revved up demand due to increase in rural wages by MNEREGS on the ground, it is still choosing to run it. Also, no justification has been given as to why the Food Corporation of India (FCI) continues to hoard massive quantities of foodgrain, much of it is often left to rot and consumed by rats. Nor is there a grip on opportunist intermediaries either who hoard and block the food chain supply to inflate prices for purely vested interests driven by profit and greed. No legal action seems to follow in these cases of organised horading. Fluctuation in onion prices late last year is the best example of such deliberately manipulated price inflation. 

Coming to fuel prices, no government anywhere in the world can foresee fluctuation in international crude oil prices. The internal mechanism of setting up prices factors in such fluctuations. Unfortunately, India’s internal mechanism itself is faulty. There is no clarity on fuel prices which have been highly subsidized by government. Whether the benefits of subsidy reaches the needy or is enjoyed by the consumerist rich is a chronic debate. The case of subsidising diesel for swanky SUVs etc, is a glaring example.

That said, the food and fuel prices fluctuate due to the non visionary approach of the government. The failing of government should not be imputed as a hurdle on the progressive path of treating CPI inflation as the nominal anchor.

CPI inflation stood at 9.9 per cent in December. If it becomes the nominal anchor, it is feared that interest rates will have to be hiked dramatically to bring it under control. This is not something the government would like to hear at in the current phase since all it wants is to spur growth while an apparent economic slow-down stalks it relentlessly. It is true that the war against inflation is fought on the cost of growth. But, before citing this inflation-growth debate as a criticism, it is important to read the Urjit Patel committee report in-depth. The committee recommends targeting CPI at 4 per cent within the two years with the wiggle room of 2 per cent in either direction. It does not make a case to raise the repo rate in the next monetary policy review.  What the RBI panel is really looking at is to bring CPI inflation down to 8 per cent over the “next 12 months” and to 6 per cent the following year. Going by the Patel committee’s formula, a repo rate hike is therefore not in order at least until early 2015.

India’s Economic Affairs Secretary Arvind Mayaram has called the focus on CPI a “premature step” but there is a strong case for India’s monetary policy to be steered by CPI inflation. It is this inflationary trend which really impacts domestic households and influences their investment decisions. There has been much dispute between a government demanding growth and ‘inflation warrior’ RBI. It is high time to bring a decisive end to it.

Taming inflation is important even at the cost of growth because the virtuous cycle wheeled by a controlled inflation will spontaneously infuse growth in the economy; but the vice versa is not possible. Therefore, the recommendation by the high level RBI committee must be worked upon with urgency and earnestness without losing time.

Divestment Dilemma

Government will have to understand that   

diluting government control on PSUs by stake sales or getting them to divulge their profits as bonus is not the way to fund fiscal deficit.

With another fiscal year coming to an end in three months, the government is staggering hard to achieve its divestment target in public sector undertakings. Divestment in PSUs is important for maintaining the budgeted level of fiscal deficit but given the unfavorable market conditions at present and general elections looming in, a successful divestment program is highly unlikely. That government has 5,000 crore in its kitty with 40,000 crore to garner before the end of FY 14, is of ample proof how serious it has been to achieve this target.

Ideally the purpose behind divestment is to scale up the efficiency of firms by privatization. As per Anshuman Tiwari, the economic analyst and financial editor of Dainik Jagaran, “There is history of debates in India on purpose of PSU divestment. Divestment is the process to infuse efficiency in PSUs via reduction in government control and making them widely held but lately governments have been employing it to raise funds when they fall short of revenues to meet its fiscal deficit target.”

Taper proof

Thanks to RBI and FM, the specter of imminent fed taper couldn’t haunt markets as it did back in May. 

In what served as a nightmare for Indian economy back in May, when turned real was treated as a business as usual. The much discussed and feared US dollar tapering by Federal Reserve, first announcement of which shook the cores of rupee is finally set to begin from New Year.  Dollar inflows are to be narrowed down in the markets but thanks to the improved level of Current Account Deficit, the difference between outflow and inflow of the foreign exchange, rupee wouldn’t lose its stand against dollar. 

US Federal Reserve Chief Ben Bernanke on Thursday announced to cut down on its monthly dollar minting program by $10bn, bringing it to $75bn dollar. Fed, with an effort to spur growth, had been pumping in cheap money to the tune of $85bn in its economy on monthly basis which in turn also benefitted emerging market economies wherein US investors parked that cheaply acquired money for better returns. India was one of the beneficiaries of this program. However, Fed Chief announced to taper off liquidating dollars in May 2013. Mere his words were enough to scare the investors though final decision was yet to be taken. Foreign Institutional Investment (FIIs) began flocking out depreciating rupee’s value against dollar, which touched its all time low in August at Rs. 68.85 per dollar. It is only after drastic measures taken by Reserve Bank of India and Finance Ministry to attract dollars and cut down on imports that rupee could be strengthened.

In this background, it is surprising that panic-stricken response shown by markets back then didn’t come to pass now, now when taper is certain and just round the corner. To compare the current scenario from May, India is better placed at all fronts. First, the time and pace of taper was uncertain then which is not only clear but bearable at $10bn reduction a month. Secondly, India’s foreign reserve and CAD have improved a lot. The unprecedented surge in gold imports of earlier times could be controlled including few other non essential and expensive imports. CAD narrowed sharply to $5.2 billion, or 1.2 per cent of GDP, in the July-September quarter of 2013-14 which hovered around 4-5% in the previous quarters. In addition, RBI’s move taken in Sep 2013 to ease it for banks to run Foreign Currency Non-residents (banks) deposit scheme has also played out well. Under FCNR (B) scheme NRIs do not face currency risk; the currency risk is borne by banks. RBI had helped banks reduce this risk so that they attract more of NRIs to make use of this scheme and don’t stay away from offering it in the tight domestic currency scenario. 

These measures apart from turnaround in exports have made Indian economy resilient enough to face imminent outflows of dollars. Initially rupee might lose traction against dollar but that wouldn’t be severe and wouldn’t sustain for long. Considering US economy is back on growth trajectory, fed taper can instead be positive for India in a sense that demand boost in US will drive export growth of Indian export enterprises having business in US. That is double dose good news for them as lately they are already reaping benefits of surge in exports.

The specter of Fed Reserve taper is no more there to haunt. India’s external front is under control for now. It is time that all efforts are put to reduce notoriously high inflation, the pivot of economic growth cycle and thus boost industrial production bringing jobs and growth in the country.

Trinity Trick

While Rajan’s monetary policy review did ensure to handle two of the trinity trilemma i.e. sinking rupee and rising inflation but the last one i.e. meek growth demands Government action.

With US Federal Bank postponing quantitative easing withdrawal and with debutant RBI-Chief Raguram Rajan coming up with pragmatic monetary policy, positivity seems to have enthused in Indian economy. On one hand the breather given by Fed-Chief Ben Bernanke has ensured that Foreign Institutional Investments (FIIs) will remain intact till December, on the other, RBI-Chief’s move to hike repurchase (repo) rate has signaled that notorious inflation will also be guarded. Consequently with external and internal stability, the rupee-volatility will soon be the thing of passé.

RBI has raised repo rate i.e. the rate at which banks borrow from RBI for short-term credit to 7.5% from 7.25%. Simultaneously, it has reduced Marginal Standing Facility rate, a special and expensive borrowing window for banks, to 9.5% from 10.25%. Usually hike in repo rate translates into increased borrowing cost for banks but considering that MSF is the effective policy rate since July which has been lowered, cost of borrowing for banks has actually come down. The idea behind this move is to provide fresh air to banks currently suffocated with cash dearth but at the same time prepare them for the ensuing normalcy when repo rate will regain its position as effective policy rate. In that case, during normal circumstances, even if repo rate is increased from current level of 7.25%, it will be less than the present rate of MSF, thus there will not be any dramatic impact on banks’ cost of borrowing.

Another positive implication of repo-rate hike is that the subsequent arbitrage advantage in interest rates will attract more foreign investors, something which is needed to shore up foreign reserves. Increase in repo-rate also suggests RBI’s hawkish stand on inflation front. Fighting inflation through increased rates is justified as it is undoubtedly notoriously high inflation which fuels the vicious cycle of economic slowdown. Though it will hurt the already languishing growth with expensive loans and all but lower inflationary pressure is required even if it comes at the cost of short-term growth.

The so called impossible trinity trilemma of sinking rupee, rising inflation and meek growth has to be dealt with now. While Rajan’s monetary policy review did ensure to arrest sinking rupee and control rising inflation but meek growth cannot be strengthened solely by RBI. It does need policy-push and legislative reforms something which demands Government action. Effective monetary policy will come to a copper as long as it is not backed by prudent fiscal and legislative policies and expecting fiscal and legislative prudence on the part of Government in an election year is like asking for moon. Therefore, thumbs up to Rajan, a question-mark on Government’s intent!