Higher rate of inflation in food articles and currency depreciation are feeding generalised inflation. Hence, decline in the broader inflation rate may take some time, says Mr Benjamin Yeo , Head of Investment Strategy (Asia), Barclays. In an interview with Business Line , Mr Yeo explains how the widening consumption-investment gap and fiscal deficit can hurt the economy in the long run.
Excerpts:
Have interest rate cuts in India come a little ahead of time? Can this stoke inflation again?
Looking at the absolute level of inflation in India, it may appear as if the interest rate cut is a bit too early, as inflation has yet to be fully reined in. However, in view of the weak external and domestic demand situation, the cut in interest rate is certainly pre-emptive.
The third quarter GDP numbers were dismal — at a three-year low of 6.1 per cent. Hence, growth concerns have definitely come to the fore. Eurozone uncertainty is expected to prevail for some time. The overall impact on inflation is unlikely to be too negative in view of weak economic activities.
Where do you see (the rate of) inflation headed?
Although inflation has eased a bit, further decline may take some time, especially considering the sticky food inflation and the recent depreciation in the currency, which is feeding into inflation.
Should the current (rate of) inflation come down by another 1 percentage point or so, it should be a good number — good, in that inflation would be under control and policy-makers can afford to be more pro-growth in both monetary and fiscal policies.
Can the widening consumption-investment gap pose a threat to the economy?
India is a consumption-based economy. Based on Keynesian theory, you save to invest and so, in the short term, you consume less. However, with an already reasonable savings ratio in India at the national level, savings should be ploughed back effectively into the right investments, especially relating to long-term supply-side factors, such as infrastructure, labour training, etc.
Such a gap may be less threatening in the short term and should be rectified over time. However, in the long term, if no actions are taken, it bodes ill for the economy.
What do you think is the reason for the declining investments scenario ?
Investors always seek certainty in policies. The regulatory environment in India still has a fair element of uncertainty. For example, the case of foreign investments in the retail space has been debated time and again with little clarity on the real Government policy.
Hence, the lack of policy reforms has been one of the key factors affecting investment activity in the country. The return on investments is also affected by high inflation/interest rates and the ability to earn the right level of profitability if there are structural economic factors that are unsupportive of revenue growth.
Can you explain how fiscal deficit can hurt economic growth and also stoke inflation?
The government cannot, over time, spend more than what it collects, especially in the long term. If the fiscal deficit persists in the long term, it may lead to a situation not unlike the European crisis now. Europe accumulated debt and experienced budget deficits for more than a decade since the European Union was formed. Business and investor confidence will wane and investment in dollar will decline — and the vicious cycle goes on.
A persistently high fiscal deficit has a bearing on the domestic currency and a depreciating currency feeds into inflation for an import-dependent country like India.
India is now more dependent on capital flows to bridge the current account deficit. Does that make us more vulnerable?
India has relied on portfolio and capital flows to bridge the gap in the current account deficit, which in turn emanates from the high trade deficit.
So, in terms of sustainability, it does impart some vulnerability in the long term. The balance of import of goods and services relative to export of goods and services generally shows a country's competitive advantage.
There is talk of India being replaced by Indonesia in the BRICS. Do you believe India is losing out on the growth story?
It is too early to conclude this right now. If reforms in India are shelved permanently and the supply-side factors do not improve, no matter how much or how gradually, then India can potentially be replaced by Indonesia in the BRICS group. That said, it also depends on Indonesia's rate of reforms. Hence, these are two big moving parts which would have a bearing on this decision.