The XFactors

Jun 08 2014 : The Economic Times (Kolkata) The XFactors Avinash Celestine   GDP growth seems to have bottomed out, the external deficit has shrunk and even industry seems optimistic after a long time. But risks remain. And some of them are beyond the government's control. So what could derail the good mood, as the NDA government prepares its first budget? ET Magazine looks at four wild cards There's good news on the inflation front. But it remains the key economic challenge Earlier this week, the Reserve Bank of India (RBI) seemed to signal a pause in its rate hikes and adopted a wait and-watch attitude toward inflation which has remained stubbornly high. However, good news finally seems to be filtering through -food prices for instance, have weakened in the last month or so. Even under-recoveries on fuels like diesel have dipped, giving the government some potential respite from having to hike administered prices. The RBI hopes to see inflation at about 8% by next January and if it remains within that limit there are unlikely to be any rate hikes. In fact, the main issue facing the government and industry is at what point the RBI could begin to lower rates -this would be a major boost to sentiment and the possibility of economic revival. However, actual rate cuts still seem some time away.The biggest X factor is the monsoon. Lower rainfall could easily derail an economic revival The monsoon is already shaping up to be the bad news in the economic revival. The Met department has forecast that the monsoon could be 95% of the long period average, or below what would be considered normal. Further, chances of the El Nino weather phenomenon affecting the evolution of the monsoon are currently pegged at about 60% -the phenomenon has, in the past, led to weak rainfall and drought-like conditions in parts of the country. A weak monsoon or an adverse distribution of monsoon rains across the country could affect prices of food and agri-commodities, leading to higher inflation. In turn, this could affect the RBI's willingness to cut rates. FDI fell sharply in the last quarter of 2013-14 -will this be reversed? In the last quarter of the 2013-14, the current account deficit declined that was the good news. The bad news was declining net FDI inflows (to less than $1 billion), though FII flows remained strong. With a new and stable government at the helm and committed to further liberalization, FDI inflows could easily pick up. But the main risk to FDI and portfolio flows may not be internal to India, but external. A sudden shock to the world economy or a new global crisis could lead to sharp reversals in flows, irrespective of new policy reforms introduced by the government. Banks' NPAs have been rising and could affect increased lending needed to support an industrial recovery A key support to any economic recovery will be banks' willingness to lend to industry. On that front, the news isn't so great -bank loans to industry as a proportion of incremental credit growth have been on a downtrend since January 2013. The other big problem for banks is loans to infrastructure -currently a third of all outstanding loans are to this sector, heavily affected by project delays, and a huge debt burden. As a result of this, and a weak economic environment overall, gross non-performing assets (NPAs) of banks are now 3.6% of assets, and this doesn't even cover loans that are being `restructured'. The bottomline is that Indian banking system is going to need hefty doses of additional capital to cover mounting bad debts, as well as support future lending. The biggest lenders in the system are public sector banks and this in turn means that they will turn to the government for more capital. Will the government, committed to a tight fiscal regime, be willing to dole out the capital needed?