India: Improving external balance amid weak fundamentals

India: Improving external balance amid weak fundamentals

India: Improving external balance amid weak fundamentals

Asia Pacific Economic Outlook, December 2013

India’s economy continues to show no signs of sustainable improvement, and economic sentiment has suffered due to unfavorable economic developments and policy paralysis.

IndiaAll our previous reports on India have repeatedly discussed its disappointing growth, weakening domestic currency, rising inflation, and deteriorating fiscal and current account balances. Unfortunately, not much has fundamentally changed since we last reviewed India’s economic situation. The economic parameters are either improving marginally or worsening every alternate month as the economy shows no signs of sustainable improvement. However, it is economic sentiment that has witnessed a prominent setback due to unfavorable economic developments and policy paralysis.

Improvement in some quarters

This quarter, India’s economy may grow modestly due to this year’s better-than-average monsoon producing a good agricultural harvest. After a sharp depreciation, the Indian currency gained back its ground in September due to improved market sentiments post the US Federal Reserve’s (the Fed’s) decision to maintain its pace of Treasury purchases and recent monetary policy measures by the Reserve Bank of India (RBI). The currency has appreciated over 10 percent from its lowest level. At the time of writing this article, the Sensex, the Bombay Stock Exchange’s index, had reached a record high of 21,164.

The external imbalance has been one of the greatest macroeconomic worries for India, and recent signs of corrections in the current account deficit are probably one of the biggest improvements. Policy measures by the RBI to curb gold imports and factors such as slowing domestic demand and lower oil prices due to reduced external risks have helped contain growth in the import bill. At the same time, exports have grown faster in the first half of the current fiscal year relative to FY 2012–13 due to currency depreciation and improved global demand. Remittance flows to India have surged as the country’s overseas population has taken advantage of the weaker domestic currency.

India’s poor growth and high inflation require better coordination between its monetary, fiscal, and exchange rate policies.

But no euphoria

However, there is no euphoria in the Sensex’s high levels because the rally is largely driven by global liquidity while retail investors stay on the sidelines. Retail participation is estimated to be at a 10-year low.1 Until the Sensex’s rise is broad based, it is unlikely to be sustainable. Long-term capital inflows remain a concern as direct investments have been steadily falling this fiscal year. At the same time, foreign institutional investments remain volatile.

The industrial production index fell 0.8 percent in August 2013 due to a significant fall in manufacturing production. Consumer goods production decreased for the fifth consecutive month, falling 6.2 percent in August, primarily due to lower production of consumer durables. This is a strong indication of weakening domestic consumption demand. At the same time, inflation moved up a couple of basis points this September; the wholesale price indicator moved up to 6.5 percent, while consumer prices continued to remain close to their three- year peak.

Weak economic fundamentals will likely weigh upon the currency, while external risks and uncertainties may maintain pressure on the trade balance. Moreover, the Fed’s decision to taper quantitative easing has been merely postponed: If not this year, the Fed will eventually decide to reduce its stimulus in 2014, and India may witness similar currency depreciation, unless economic fundamentals improve.

Sentiments deteriorate

Poor growth and the rise in prices are affecting consumer and business sentiments. A recent survey by an Indian industry association indicates that the Indian middle class’s affair with shopping malls is waning. The number of footfalls in malls is expected to decline 35–40 percent in the ongoing festival season as the economic slowdown, high prices, high interest rates, and job uncertainties all weigh upon consumer sentiments.2

According to an RBI survey, consumer confidence diminished in September, with around 60 percent of respondents expecting that economic conditions will worsen.3 The industrial outlook for the overall business situation is at its lowest since 2005 due to the pessimistic assessment of and expectations for exports, imports, and the overall financial situation. The Business Expectation Index fell below the threshold level of 100 to 97.3 for the first time since 2008, indicating that businesses are highly pessimistic about the economic outlook and investment prospects.4 Rising interest rates and the perceived rise in external finance costs are impacting investment decisions, while the perception of profit margins continues to remain negative. All these factors have led to poor production and employment outlooks.

Uncoordinated policy actions

The RBI’s monetary policy actions in the last two months have clearly indicated that it is primarily focused on anchoring inflation. The policy repo rate under the liquidity adjustment facility was raised a total of 50 basis points in two consecutive monetary policy meetings in order to contain inflation expectation. At the same time, significant liquidity was provided to facilitate adequate credit to productive sectors, encouraging corporates to substitute costlier money market sources for bank credit. The policy stance is expected to remain hawkish in the near future, with adequate provision made to ensure smooth liquidity in the system.

Despite government policies and reforms, obstacles to infrastructure and manufacturing investments continue to exist due to a lack of clear direction and disappointing implementation. With elections around the corner, there is not much likelihood that the pace and direction of meaningful policy actions and reforms will change. India’s poor growth and high inflation require better coordination between its monetary, fiscal, and exchange rate policies. However, the gap between desired and actual policy actions and ineffective coordination will likely delay or may even drag down the economy’s recovery prospects.


View all endnotes
  1. R. Mascarenhas, “Retail participation at 10-year low: Investors keep off rally, seek safety in NSCs, bonds,” Economic Times, October 21, 2013.
  2. Associate Chambers of Commerce and Industry of India, “Press release,” October 24, 2013,
  3. Reserve Bank of India, Industrial outlook survey: Q2: 2013–14 (round 68), October 28, 2013,
  4. An index below the threshold of 100 signifies contraction.


Dr. Rumki Majumdar

Dr. Rumki Majumdar is a manager at Deloitte Research, Deloitte Services LP.

Asia Pacific Economic Outlook, December 2013: India
Cover Image by Jessica McCourt