Getting the macro right PDF Print E-mail
Tuesday, 18 September 2012 00:00
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That means more disinvestment in the case of India, and higher German wages and a looser monetary policy in the case of Europe

What a fortnight it’s been! From a time when no government across the world seemed to be able to get it right to one where Europe seems to have got back some of its mojo with the European Central Bank (ECB) bond buying and the European Stability Mechanism (ESM) finally getting a kickstart, to the US where QE3 has been announced (it must be said this was weakened by the complete absence of coherent action on the fiscal front) and to India where the government has finally taken some tough decisions on diesel pricing to announcing reforms like allowing FDI in multi-brand retail and genuine FDI in aviation.

Though these measures, across the world, have got both currency and equity markets upbeat, it’s important to keep some perspective. In India, while the diesel price hike and the capping of subsidies on LPG will lower petroleum product under-recoveries by R22,000 crore, the long delay in hiking prices has meant we’re probably back to the same levels of overall petroleum under-recoveries today—in March, they were R486 crore a day, R562 crore in April, R509 crore in May, R446 crore in June, R358 crore in July, R402 crore in August, R551 crore on September 1 and R496 crore after the diesel price hike. In other words, though bold, the diesel and LPG “bullet” the government has bitten isn’t quite as big as is made out.

Given that the budget has put aside only R43,580 crore for the petroleum subsidy as compared to a possible R1,80,000 crore under-recovery (based on current levels for all fuels), it’s obvious the diesel hike and LPG cap will do little, if anything, to cut the fiscal deficit. Which is why yesterday’s RBI statement says getting the economy to a higher sustainable growth trajectory “requires concerted policy action across a range of domains”.

The key to high growth in India remains getting savings back on track—high GDP growth in the past was largely driven by government savings rising, from minus 2% of GDP in FY02 to plus 5% in FY08. Since any surge in investments without a corresponding movement in savings means the current account deficit swells up, this leaves India vulnerable on the capital account front. Given the slowing economy means the government cannot possibly meet the budget’s tax targets and the telecom auctions are unlikely to fetch anywhere near the budgeted amount, raising overall government savings from around 0% of GDP at the moment is going to be impossible—overall government savings include not just the fiscal deficit, but also the profit/losses of PSUs. It doesn’t help that the FM has already said the subsidy bill for the year is likely to exceed the budget target by around 0.5% of GDP.

In which case, the government’s best bet to achieve a fiscal deficit of below 6% of GDP—and this is critical from the point of view of rating agencies who are threatening to push India to junk levels—is to go in for aggressive disinvestment. Two easy targets that come to mind are the residual stakes in Balco and Hindustan Zinc for which Anil Agarwal has already promised R17,000 crore, and SUUTI whose L&T/ITC shares are probably worth upwards of R40,000 crore.

In the case of Europe, as EFSF/ESM chief Klaus Regling has pointed out (http://goo.gl/tNdYR), there has been steady progress in the case of countries like Ireland and Portugal (disclosure: this author met Regling as part of a 5-day European programme sponsored by the Konrad Adenauer Stiftung, a think tank affiliated with the CDU, Chancellor Angela Merkel’s party).

In the case of Portugal, the budget deficit more than halved between 2010 and 2011, and a successful adjustment in Ireland resulted in it being able to tap the bond markets again, at half the interest rates compared to a year ago. Each country has a different problem but, as Regling pointed out, the key lies in getting their competitiveness (real wages) back on track. The picture here has been mixed (see graphic). Greece’s wages rose around 40% between 2000 and 2010 while Germany’s rose only 5%—the difference has more than halved in the last couple of years (see third graphic). That creditors still feel not enough has been done by Greece only underscores the length of the journey ahead.

Had these countries been independent ones, a depreciation would have speeded up the adjustment process, but this is not a possibility in the eurozone—ironically, the bond-purchase plan of the ECB has strengthened the euro. Printing more money is not an option either, leaving driving down wages as the only viable option. This has happened in several cases (as the graphic on labour costs shows, Italy is still not quite there as Italian labour costs continue to rise), which is why current account imbalances are getting better (see second graphic). But with unemployment already very high in the periphery countries, there is just that much that wages can be driven down, more so since it will take at least a decade for the periphery to get back to pre-crisis per capita income levels.

Another solution, a more palatable one, is to share some of this burden with Germany raising its wage rates. This would make the periphery relatively more attractive and increase its exports while lowering Germany’s. Indeed, while the current account balances of the periphery (see second graphic) are looking better, the 5%-plus levels for Germany mean there is a ceiling to this adjustment process unless German surpluses reduce. In any case, since Germany spent large parts of its earlier surplus to buy sub-prime debt—in 2008, the German government had to set up a 480 billion euro stabilisation fund to bail out the German landesbanks which bought truckloads of such paper—and is now using the current surpluses to fund the periphery, why not opt for a more suitable and direct strategy which would also benefit the German public? Chancellor Merkel is absolutely right in asking the PIIGS to promise to a plan to get their act together before they get any money, she needs to cut them some slack including discussing with the ECB ways to weaken the euro. Otherwise, the plan’s not going to work. And let’s not forget that, with around 750 billion euro in debt due (through the ECB) from the periphery and another 200 billion of Spanish and Italian debt held by its banks, the risk for Germany isn’t small either.

In the final analysis, in the US, Europe and India, there’s no substitute for getting the macro right.


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