India faces serious economic challenges including perhaps the carry trade and should cut interest-rates now

3rd February 2012 by Shaun Richards

Today will give us an opportunity to find out some more about the employment/unemployment situation in the United States as the monthly figures will be released at 1:30 UK time. I would caution against knee-jerk responses to them as there is more and more concern about how accurately the seasonal adjustments work particularly around the turn of the year. To my mind the most revealing number is the widest measure of unemployment or U-6 which stood at 15.2% in December.

However today I wish to spread the net geographically wider so to speak and take a look at developments in the Indian economy. Back on the 12th of December 2011 I offered this advice to the Reserve Bank of India.

It is perhaps one  the hardest decisions for a central banker to reverse course but let me offer my guide which is to look forwards over the likely time period for it to take full effect which is around 18 months. If the economy sets on a weakening path then it needs to respond now and should it be on such a path then waiting will be a mistake. Also if a small cut is made of say 0.25% India’s interest-rate policy will still be contractionary but a signal will have been sent.

The Indian economy

If we look at inflation the Ministry of Commerce and Industry produced these figures recently.

The annual rate of inflation, based on monthly WPI (Wholesale Price Index), stood at 7.47% (Provisional) for the month of December, 2011 (over December, 2010) as compared to 9.11% (Provisional) for the previous month and 9.45% during the corresponding month of the previous year. Build up inflation in the financial year so far was 4.95% compared to a build up of 7.12% in the corresponding period of the previous year.

In case you were wondering build up inflation is measured from the previous March.

If we look at the figures we see a solid month on month drop and also a reassuring fall from a year ago. Looking at the last four months shows this trend 10%,9.87%,9.11% and now 7.47% which seems fairly clear. Another hopeful sign is that the wholesale price index itself was unchanged in December at 156.9.

If we look at the detail we see some hopeful signs too as food price inflation has dropped substantially. This matters very much in a country like India with so many poor people to whom food will be a much higher proportion of their expenditure than we would consider usual in the western world. Of course food price inflation was a trigger for the so-called “Arab Spring” which if developments in Syria and Egypt continue looks like it will reach spring 2012. Looking at the detail of this we see that the “Food Articles” index fell from 196.9 to 190.9 giving a month on month fall of 3.1%. this meant that the annual rate of inflation for “Food Articles” has fallen from 15.7% to 0.74% over the past 12 months.

Now I do not expect the prices of vegetables,potatoes and onions to fall forever as harvests and rainfall pattern changes lead to price swings both ways but as we stand it looks hopeful. However I am reminded again that I look at the situation differently to many central banks who exclude food and energy from inflation indices to create core measures which I feel are anything but.

The Rupee has strengthened too

After a sustained period where it fell the Indian rupee has strengthened recently against the US dollar. This is important as many commodities such as oil and basic foodstuffs are priced in US dollars so that a rising currency against it makes them cheaper all other things being equal. After a sustained fall from 44 to above 53 versus the US dollar from late summer to late December the rupee has turned around and rallied to 48.78 as I type this.

Accordingly the recent rise in the rupee represents a tightening of monetary conditions. As some of the thirteen interest-rate rises were likely to have been in response to the rupees fall they should reverse such a move in response to a rise particularly if it continues. Interestingly as long as they believe in symmetry then whoever wrote this Royal bank of India working paper agrees with me in principle.

The exchange rate pass-through coefficient is found to be modest, but nonetheless sharp depreciation in a short period of time, as it occurred during July-September 2011, can fuel inflationary pressures.

Actually they also if we continue the same assumption of symmetry show signs of agreeing with me about the importance of food prices in the inflation chain.


Finally, structural food inflation emanating from protein-rich items and fruits and vegetables has emerged as a key driver of domestic inflation.

Indian economic growth

It looks as though economic growth is slowing too in India as this quote from her Prime Minister Manmohan Singh indicates

Growth in the current fiscal year is likely to be lower, between 7 and 7.5, in a large measure due to the continuing uncertainty in the global economic environment

This is lower than the 8.4% reported for 2010/11 and the previously expected acceleration to 9% growth for this year. Whilst this may seem an extraordinary rate of growth for readers in Europe or the United States for India it represents a slowdown.

 Balance of payments

As ever in economics matters are never entirely clear-cut as India has a persistent trade deficit and it appears to be worsening.


The trade deficit for April-December, 2011-12 was estimated at US$ 133272.03 million which was higher than the deficit of US$ 96210.22 million during April-December, 2010-11.

Virtually all of this can be accounted for by rising oil and fuel prices (just over US $30 billion) but nonetheless it is a deficit.

What has the Reserve Bank of India done?

It has kept its repurchase rate at the 8.5% it raised it to in October last year which was the thirteenth rise in sequence. However it has eased policy in terms of reducing the cash reserve ratio to 5.5% which if we look at the theory means that banks can lend more as they need to hold fewer reserves at the central bank. Sadly in practice the resulting extra lending is hard to predict and if UK economic history is any guide has a habit of arriving so late that you no longer want it!

In addition the Reserve Bank of India has been buying Indian government debt and plans to buy 100 billion rupees today which will mean it has purchased some 719 billion rupees since November 2011. This frankly seems odd on several levels. Central banks often buy government debt (in the UK we called it over-funding) at times of high inflation as a way of attempting to restrict money supply growth and eventual inflation. Also it is odd to buy government debt when you have a policy interest-rate rate of 8.5%! Such purchases or Quantitative Easing type policies are associated with much lower interest-rates and indeed ones near or at zero.

The RBI may well be monetising debt here and may well think that it is clever by buying government bonds into a slowdown and a likely bond price rise. The “rub” with demonstrating that you are a skilled “insider” trader comes when you try to sell……….

It is not impossible that we are seeing signs of the credit crunch spreading to India. As extraordinary monetary measures have proved to be weak tools in the countries that have tried them I remain of the view that I expressed on January 12th that 8.5% official interest-rates now look too high.

The Oil Price: what is it?

Regular readers will be aware that I consider that economic growth in India and China has helped support the oil price over a period where the United States and Europe have struggled to grow much. I am reminded of that debate today by looking at India.

However if we look at the fact that the spread between the two oil benchmarks is widening again to over US $15 (West Texas Intermediate US $96.97, Brent US $112.56). So what is the price of oil?

Also as we see an increase in Quantitative Easing type policies in the Euro zone or what I call Queasy policies is it a coincidence that the oil market looks disturbed again? The cash has to end up somewhere…..

The Carry Trade

Speaking of cash finding a home, we have a world where many interest-rates are very low. But you can get 8.15% on ten-year Indian government bonds. Have they and the rupee been rallying because of borrowing in low interest-rate areas to invest in higher ones?

11 thoughts on “India faces serious economic challenges including perhaps the carry trade and should cut interest-rates now”

  1. JW says:

    Hi Shaun
    Nice to see another part of the world under your microscope.
    As we discussed several weeks ago the QE money slushes around in carry trade and also ‘dark matter’ trades , especially oil and commodities. With the BDI still falling, China looking softer as well as India , the ‘real’ world economy looks like its struggling outside the zombie western/Japanese states. The commodity prices underlying much of India’s inflation could fall as sharply as they increased , your suggested interest rate easing may need to be accelerated to reduce the possibility of a hard landing. 

    1. Anonymous says:

      Hi JW

      If there has been a type one error in the use of interest-rates over economic history it has been that responses have been too slow. This has then often led to over-tightening or over-loosening. In many ways the timing of what you do is much more important than recognised by conventional theory.

      Accordingly India should have already started to ease interest-rates rather than meddling with reserve ratios and QE.

  2. JW says:

    Hi Shaun
    US numbers reminded me of ‘lies, more lies and statistics’.
    NFP numbers rose by more than expected 243k, unemployment rate fell to 8.3%, stock market jumped with joy, the US economy has turned the corner, just in time for the election.
    However there lurks other statistics; broad unemployment is still above 15%; no fewer than 1.2 million fell off the workforce stats completely in one month, and the overall workforce participation rate fell to 63.7% the lowest in 30 years.
    Its just how you tell ’em.

    1. JW says:

       More on these dubious numbers. Actual jobs were no less than 2.9m DOWN in the 2 months Dec and Jan , somehow they have been manipulated to be positive after seasonal adjustment. Now I used to use X11 the father of X12 and its very easy to ‘manipulate’ the data, which is why ‘factor analysis’ is used by physical scientists to smooth data , rather than X12.

    2. William Amofah says:

      Sorry to burst pessimists bubble but:

      “The steep jump in the number of those not seeking work came entirely
      from the census adjustment, which added 1.25 million people to that
      group. If you take out the census adjustment, the labor force numbers
      stayed essentially the same.”  – Massimo Calsbresi

      1. JW says:

         Hi William
        Please see attached
        Its not pessimism its just reality, not massaged stats.
        One figure sums up the real situation. U-6 for January 2012 ( not seasonally adjusted, ie ‘real’) is 16.2% that is a whopping 1% higher than U-6 for December.
        Remember the unemployment rates are from a Household Survey, the actual payroll numbers show out of a population increase in 2012 of 3.65m, 66% of these were not in the labour force, ie not counted for unemployment. Perhaps they have gone to Mars!

    3. Anonymous says:

      Hi JW

      I was in a meeting when they came out but when I took a look at the U-6 number later I saw this and tweeted accordingly.

      “Take care everyone the widest measure of US unemployment or U-6 rose in January from 15.2% to 16.2% without seasonal adjustment”

      If you recall it rose last month too without seasonal adjustment and fell with so there is a lot of pressure on statistical adjustment just as there is a debate over whether it works well over the year end….

      If we add the last 2 months together then the bare U-6 measure has risen by 1.2% but the the seasonally adjusted one has fallen by 0.5%.

      If we look back over the past year we see that U-6 bare numbers have fallen by 1.1% and at that rate the US may not get back to “normal” this decade.

      So in many ways we have the same message which is that it is improving but very slowly and that year-end figures may be subject to distortion!

      If this is to be #carboncopy2012 then we will see disappointment in the spring/summer.

  3. Space Man says:

    India’s domestic oil production is expected to double due to various discoveries over the past few years, so I’m sure that will help but they will still be importing large quantities of oil. 

    Also I’m sure I read that Iran is it’s major oil supplier to India, and that India pays Iran for it’s oil in rupees rather than dollars.

    1. Anonymous says:

      I think india have agreed to pay Iran in gold for its oil.

      1. Anonymous says:

        Hi Sue

        In these times of high and indeed rising gold prices there is strength to be found in India’s propensity to hold gold. From the flashes of news that come up they seem to have continued buying it too.

    2. Anonymous says:

      Hi Space Man

      Good point and one I should have added on reflection. Indeed India has also looked at using both the rupee and the Chinese Yuan more in trade deals with China rather than the US dollar.

      So another front in the “currency wars” is opening up.

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