The Indian economy presents a collage of contradictions. At the forefront is dissatisfaction at the status quo in reforms notwithstanding the government’s attempts to make things move. GST, DTC, FDI, PFRDA, land reforms, new banks, etc, are all strong statements of intent that have not quite taken off and only consumed Parliament time.
Growth prospects appear to have descended the stairs and the initial enthusiasm on the decoupling theory with the euro crisis has now given rise to second thoughts and apprehension. Inflation is a worry, not so much because it is high but because we have not really cracked a way out. Now the fiscal deficit and weak rupee have generated a fresh set of challenges for RBI and the tension is palpable. But somewhere within the periphery we have seen higher foreign direct investment and larger recourse to external commercial borrowings (ECBs) provide colour to the portrait. How then does the growth story really add up?
Our own growth expectations have scaled down considerably from the 9% assumed in the Budget to something around 7-7.5%, going by the latest
remarks by the finance ministry (Graph 1). Given that RBI has kept increasing interest rates in a bid to curb demand, this lower growth is a vindication of monetary policy as investment, leverage-based consumption and overall growth has slowed down.
Industrial growth has been declining in the last few months (Graph 2) and while there is still reason to remain sanguine, considering that this has been the slack season where there is relatively less spending, we may still not really expect a major jump in the subsequent months even with higher consumption spending. The major disappointment has been the mining sector that has gone into the negative zone, but electricity production has been robust, thus sending contrary signals.
Further, bank credit growth has slowed down, indicating that there is definitely less borrowing for production and investment. However, at the same time, there has been a steady increase in both exports and non-oil imports (Graph 3), though, admittedly, there is a declining trend. Imports go either as direct consumption or inputs for production; either which way it should get reflected in overall growth. The same holds for exports, which have been buoyant on a cumulative basis, too. Given that around 75% of them are manufactured products, all is not lost.
Where then will growth come from? A major source of strength for the economy is the farm sector, which is posed to register a second successive high growth rate this year. It is quite impressive, given that new peaks were set in FY11. The rabi news also appears to be good in terms of sowing, which, in turn, should provide the requisite support. This higher growth will also get reflected in higher spending in rural India for manufactured goods, which, in turn, should provide the backward linkages to industry. This is good news.
But with agriculture actually accounting for around 14% of GDP, it can support and not really propel the economy. This is where the service sector comes into the frame. With a share of nearly 65% in the economy, it has been the driving force, with growth of around 9% so far, which will be expected to continue in the second half. The corporate sector is still maintaining top line growth while profits have been affected quite drastically this year. But service sector support can be a one-time affair, and cannot be sustained over a longer time frame as this sector cannot grow unless there is real production taking place.
Amid these relatively low-growth scenarios, the financial environment appears to be a bigger constraint starting with inflation. Both WPI and food inflation remain high (Graph 4) and while it will come down towards the targeted 7% level by March due to the good harvests, high base effect and declining global commodity prices (to the extent that it is not diluted by rupee depreciation), monetary policy stance will remain neutral for the rest of the year. Therefore, the investment climate will not change too soon as interest rates will continue to be under pressure until such time that RBI considers a reversal of its stance.
The other factor coming in the way of growth has been the uncertainty on the fiscal side. A slippage is expected, given that the government gave away around R50,000 crore as duty cuts on oil products and also increased the size of its borrowing programme by a similar amount. Now, the crux is whether it will go the Keynesian way and continue with spending—as it is the only entity that can do so at interest rates which come in the range of 8.5-9% (the corporate sector pays base rate of 10-11% plus spread). With pressure to rein in the deficit and the spectre of disinvestment not taking off, revenue declining due to low corporate and industrial growth, and subsidy bill bursting, the focus appears more on controlling rather than fulfilling expenditure programmes.
On this entire canvas of scepticism we have also seen some positive signs from the outside world. FDI has been coming in larger numbers despite the current climate. Clearly, there is faith in the growth story as such investment takes a medium- to long-term view (Graph 5). ECB approvals have increased during the first six months indicating substitution of cheap funds for dearer means of finance.
Where does this really take us? Our story is more like modern impressionistic art. Yes, the pictures are disjointed and hard to interpret cogently, which is a case with all such art. The number of 7% is still actually not bad when the world economies are crawling in sub-2% numbers. The government is struggling with the deficit and policy reforms, while RBI is grappling with all the jigsaw pieces of the financial markets. Maybe it is the clichéd jugaad, but the Indian economy still will manage the bumpy road.
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