Economic data send out contradictory signals
A combination of good fortune and the policy of curbing gold imports has clearly paid off with the government able to rein in the current account deficit (CAD) for Q2FY14 at $5.2 billion or just 1.2% of GDP compared with 4.9% in Q1FY14. But, more than anything else, it is the continued collapse in GDP that has ensured CAD remains under control, implying that the situation can once again get out of control as GDP picks up—with no policy on opening up of the coal sector, for instance, coal imports will pick up once again as GDP rises; similarly, till the ban on iron ore mining is lifted, exports will remain limited. In the immediate short run, though, with H1FY14 CAD at $27 billion—versus $38 billion in the same period last year—the full year’s CAD is well on track to be around $50 billion which is around 2.7% of GDP compared to FY13’s 4.8% of GDP. Though the contraction in Q2 CAD was accompanied by outflows of $5.4 billion versus inflows of $20.5 billion in Q1, India is a lot better prepared for the taper, likely in March or April next year. Not only was RBI exceptionally adroit in the swap mechanism that helped bring in $34 billion of inflows, the move to keep the oil demand away from the market while not drawing down reserves gives the country much-needed flexibility to tackle any post-taper outflows in foreign investment. Removing ceilings on FII investment in government debt—to become part of a global bond index—will help shore up foreign inflows further, but the chances of the government doing this soon look low.
The critical question is whether the stronger CAD and GDP situation will sustain. While a likely CAD of 2.7% of GDP is something to feel good about, this is in a sub-5% GDP growth scenario. And while the GDP data as well as the PMI—after 3 months of contraction, it was 51.3 in November—suggest there is some bottoming out, much of Q2FY14 growth has been due to the spurt in agriculture growth, not because of any structural change. So, thanks to rural incomes growing, firms like Hero MotoCorp with a strong rural base have seen November volumes rising 5.6% yoy. Overall demand, however, remains muted—while private consumption grew a bit faster at 2.2% in Q2FY14, government consumption contracted and will contract further since nearly 85% of the year’s fiscal deficit target has already been exhausted by October. In such a situation, few are investing—a recent study by Kotak Institutional Equities shows how sanctions for fresh projects have been tapering off from R1,13,900 crore in Q1FY11 to R74,900 crore in Q1FY12, R41,300 crore in Q1FY13 and to just R22,000 crore in Q1FY14. Both Tata Motors and Ashok Leyland reported another month of sharp decline in sales volumes of commercial vehicles in November and that too on a low base—37% and 27% yoy, respectively. This coupled with the weak core sector data—the index contracted in November possibly due to a combination on weak demand and supply-side constraints—suggests the recovery is still a weak one, prone to large volatility.