Is India ready to ride out of the economic slowdown?

Last Updated: Sun, Dec 23, 2012 09:33 hrs

I am encouraged by the indications of the green shoots in the economy in terms of production," Finance Minister P Chidambaram said last week as the index of industrial production, or IIP, recorded growth of 8.2 per cent in October - a 16-month high. A few days after that, Naina Lal Kidwai, HSBC's India head and the new president of the Federation of Indian Chambers of Commerce & Industry, said that 2013 will be better than 2012 because China and West Asia, India's biggest trading partners, are looking up and interest rates will begin to come down. "The stock markets are doing well and the last 10 months have seen net inflows from foreign institutional investors. We now have a change of perception and people are optimistic."

Are the signals of economic recovery real? The surge in IIP growth can be explained partly by the low base of October last year. As a result, capital goods showed growth for the first time this financial year at 7.5 per cent. Eight core sectors grew at 6.5 per cent, an eight-month record. And coal grew 10.9 per cent growth. But even sequentially, growth in October was better. When compared to September, IIP grew 5.01 per cent in October. IIP stood at 171.3 in October. This is higher than 167.5 in November 2011. Unless there is a sharp decline in production, industrial production is slated to report high growth in November as well - statistically, as least. This is good news for overall economic growth. Growth in the country's gross domestic product, or GDP, fell to 5.5 per cent in the first quarter of 2012-13 and 5.3 per cent in the second quarter because industry (as measured by IIP) grew just 0.78 per cent and 1.16 per cent, respectively, in the two quarters.

Some silver lining in the dark clouds of gloom was visible in the second quarter when gross fixed capital formation grew 4.06 per cent, up from 0.65 per cent in the first quarter. The recent mid-year analysis of the economy by the ministry of finance noted that the major cause of manufacturing sluggishness in this financial year has been the drop in investment as reflected in the slower rate of growth in disbursement of bank credit and lower investment in new projects. To expedite that, the Cabinet last week cleared the proposal to set up a Cabinet Committee on Investment, or CCI, which will expedite the clearance of all projects of over Rs 1,000 crore. It will monitor the progress of decision-making and implementation of projects. Hundreds of such projects are stuck because of various reasons: mining linkages, environmental clearances, land acquisition et cetera. It will be CCI's job to see that the issues are resolved and these projects take off as early as possible. (Click here for graphics)

The initiative is being driven by Prime Minister Manmohan Singh's office so that the economy comes out of the low-growth syndrome. Investments will also get a boost once the Reserve Bank of India starts reversing its stance of a restrictive monetary policy as core inflation has been on a decline. Repo rate (the rate at which RBI infuses liquidity into the economy) is stagnant at 8 per cent since April. RBI has cut cash reserve ratio on several occasions, and it currently stands at 4.25 per cent (of a bank's liabilities). The central bank, a few days ago, had indicated that it may start cutting rates from January onwards. The problem thus fas has been runaway inflation.

* nohup.out *

Core inflation eased to a 32-month low of 4.5 per cent in November, versus 5.2 per cent in October. Overall, inflation declined from 7.45 per cent to a 10-month low of 7.24 per cent in November. The impact of the Rs 5-hike in diesel prices was not visible in the overall inflation. However, food inflation went up to 8.5 per cent during the month from 6.62 per cent in October. "Growth has bottomed out and inflationary pressures are expected to ease in the second half of the year, while industrial output is expected to improve," said Raghuram Rajan, chief economic advisor, when the mid-year analysis was released. Madan Sabnavis, chief economist, CARE Ratings, says that because of the easy monetary policy being followed by the European Central Bank and United States Federal Reserve, funds will tend to flow to emerging markets. "If we play our cards right, which we have corrected on GAAR and retro taxation, we could get more foreign investment. Our recent policies on foreign direct investment (FDI) and possible action on liberalising the insurance and pension sectors further will help accelerate such flows," he says.

There is also more money in the coffers of the corporate sector: there has been a marked improvement in the bottom-line of non- government, non-bank listed companies. The second quarter of the current financial year saw 31.2 per cent growth in their net profit against a 10.7 per cent decline in the first quarter. Purchasing Managers Index (PMI) for manufacturing was at a five-month high of 53.7 points in November. (Any score above 50 reflects a positive outlook.)

* nohup.out *

Though the reform measures the government has taken ever since Chidambaram became the finance minister in August were prompted by the threat of a downgrade by global rating agencies, these have been noteworthy and have helped revive business sentiment. Fitch and Standard & Poor's had in April downgraded the outlook on India's ratings to negative, which means that there is a 50 per cent chance of India's sovereign ratings downgrade to junk status from investment status in the next 12-24 months. Thus, August onwards a series of pending decisions were taken up - from allowing foreign direct investment in multi-brand retail amid protests from the opposition, a steep Rs 5 increase in diesel prices, putting an annual cap of six subsidised cylinders for each household, allowing foreign airlines to invest in Indian airlines, easing of single-brand retail norms, and the formation of CCI. As a result, foreign investment jumped 270 per cent to $4.6 billion in September from the same month a year ago and 67 per cent to $1.94 billion in October. However, due to the slowdown seen in the first five months (April to August), total inflows in the first seven months of the financial year were down 42 per cent from a year earlier at $14.79 billion.

There is a list of constraints, however, that may suggest that it's too early to call the set of encouraging data as green shoots'. These constraints range from external factors like uncertainty in Eurozone, how US deals with the fiscal cliff, upside risks to inflation, government failing to meet its disinvestment target, rupee depreciation et cetera. Bimal Jalan, former RBI governor, says the "real issue is when will the green shoots turn grey," indicating that the recovery needs to be sustainable. India is headed for decade-low growth of below 6.5 per cent in the current financial year. The ministry of finance recently revised the GDP growth forecast for 2012-13 to 5.7-5.9 per cent from 7.6 per cent at the time of presenting the annual budget. For the economy to grow 5.7 per cent or 5.9 per cent, the second half needs to expand by 5.9 per cent or 6.3 per cent, respectively - a tall order.

India may take solace in the fact that it is still among the fastest growing economies, but as World Bank Chief Economist Kaushik Basu said, the crisis is not over yet. "The year 2013 will also be harsh for India as the European situation will remain very difficult up to the end of 2014 and maybe to the beginning of 2015," Basu said on the sidelines of the Delhi Economic Conclave. The Eurozone, which comprises 18-20 per cent of India's exports, is faces the risk of Greece's exit. According to estimates, the Eurozone recession will continue in 2013. With about a week to go for the year to end, US is approaching tax increases, spending cuts and a reduction in its budget deficit starting 2013, popularly called the fiscal cliff'. And a solution is far from clear. Republicans and Democrats haven't found common ground. This may lead to the slowing down of the US economy, and possibly recession too in the worst case. That would slow down India's growth like other emerging economies. Despite the diversification over the year, the share of US in India's exports is still about 11 per cent.

India's exports in November contracted 4.17 per cent for the seventh month in a row to $22.2 billion due to the slowdown in the US and European markets. The external influence of the dollar and the euro-rupee relation will continue to play hard on India's exchange rate, and one may expect volatility to continue at a time when the current account deficit (CAD) is under pressure with exports slowing down, says Sabnavis. The depreciation in the rupee, which has increased India's import bill, is not expected to reverse in the near term, economists say. The rupee, which was hovering at 52.86 against the dollar in January, appreciated to 49.02 in the beginning of February. However, March onwards rupee only depreciated, touching the low of 57.06 on June 22. At present, it is hovering at about 55 against the dollar. "I do not see it strengthening any time soon and a broad range will be 52-56," says Sabnavis. The rupee will generally be under pressure on the downward side rather than upward. Imports would continue to increase with the recovery being expected in GDP growth, he adds. CAD has been under pressure and touched an all-time high of 45.2 per cent of the GDP in 2011-12. In the first quarter, CAD stood at 3.9 per cent of the GDP.

Also, the revised fiscal deficit target of 5.3 per cent of GDP may show slippages, given that the government's disinvestment target may not be met. Although the government has taken steps to rein in the twin deficits (fiscal and revenue) by raising gold import tariffs, slapping spending restrictions on various ministries, beginning the divestment process and auctioning 2G spectrum waves, more efforts are required, says a YES Bank report. Fiscal deficit touched 68 per cent of the revised target up to October 2012. Moreover, the government could raise only Rs 9,407 crore from the 2G spectrum auction, much lower than the target of Rs 40,000 crore. Hence, it has revised the reserve price and cut it by 30 per cent for a fresh auction soon.

So, keep your fingers crossed.

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