The challenges to India’s growth appear to be overwhelmingly bigger than the opportunities. While old challenges persist, new challenges are coming to the fore. Data released in FY 2013–14 saw a few record-high and record-low figures, unfortunately all indicating a deteriorating economic scenario.1
After a disappointing growth of 5 percent in calendar year 2012, the lowest growth reported in a decade, 2013 started with a weak recovery of 4.8 percent year over year in Q1 2013 compared to Q4 2012, primarily due to weak domestic demand. The fiscal drag, owing to the expenditure reforms initiated in September 2012, contributed the most to the fall in domestic demand over the past two quarters. Private consumption expenditure and capital formation too registered a decline due to poor sentiments, high cost of financing, infrastructure bottlenecks, and weak domestic and global demand.
The emerging challenges
India has been facing some new challenges lately, one of them being the reversal of capital inflows. Lower-than-expected growth, macroeconomic imbalances that include a record-high current-account deficit, poor investment conditions and corporate earnings, and a volatile currency have led to this reversal. The market expectation of an improvement in the US economy and the hint of a possible reversal of monetary stimulus measures by the US Federal Reserve from this year have also contributed to the pace of the capital inflow reversal. Foreign direct investments, which had picked up in the third quarter of calendar year 2013 following the government’s announcement of reforms in the retail and the aviation sectors, are slowing again due to government inefficiencies, regulatory burdens, and a lack of competition in the economy.
Another concern has been the steep currency depreciation in the past couple of months—in particular, the risk it poses to the current-account deficit. The currency depreciated by more than 14 percent against the US dollar in 2012. In the past two months, the currency has weakened by 13 percent, with the Indian rupee touching an all-time-record low of 60.71 against the dollar at the end of June due to heavy capital outflows and month-end dollar demand from importers.
Better than expected
Not all has been bad though, as some of the latest economic data point to better-than-expected performance. There has been some respite in inflation in the past few months due to a fall in food and international crude oil prices. The wholesale price inflation (WPI) has come down from 7.3 percent in February to 4.7 percent in May, while in April consumer price inflation (which has been higher than WPI) fell below 10 percent for the first time in 2013.
There has been, for lack of better words, “good news” in the fiscal and current-account deficits lately, as the actual deficits are reported to be lower than expected. Faced with prospects of a sovereign rate cut and crowding out of private investments in the economy, the government has undertaken a series of reforms, including reducing fuel subsidies and increasing rail fares, since September 2012. Expenditure cuts due to the reforms have helped contain the fiscal deficit to 4.9 percent of GDP in FY 2012–13, a downward revision from its earlier estimate of 5.2 percent of GDP.
The record-high current-account deficit in FY 2012–13 might not be considered good news, but the preliminary estimate for the trade deficit in Q4 of FY 2012–13 came down to 3.6 percent of GDP, compared to a historic high of 6.7 percent of GDP in the previous quarter, thanks to the recent fall in international crude oil and gold prices. The reduced trade deficit helped contain the current-account deficit to 4.8 percent of GDP in the past financial year, lower than the earlier estimate of over 5 percent of GDP.
Despite the recent fall in prices, India has one of the highest consumer price inflations among the emerging nations.
Will “better than expected” be sustainable?
Despite the recent fall in prices, India has one of the highest consumer price inflations among the emerging nations. Inflationary pressures are expected to remain high this year due to a reduction in fuel subsidy (leading to a rise in administered prices), persistent supply-side shortages (due to infrastructure bottlenecks), and the recent depreciation of the rupee. The success of the monsoon in the next three months will also be an important determinant of inflation.
On the other hand, both fiscal and current-account deficits are still wide enough to weigh on investors’ confidence. The FY 2013–14 budget has emphasized measures to control the deficit further, with a target of 4.8 percent. Fiscal consolidation may impact the quality of fiscal expenses and long-term growth prospects. However, with general government elections being less than a year away, the probability of significant reforms and expenditure cuts is low.
The latest monthly data indicate that the trade deficit has bounced back to high levels in the first two months of FY 2013–14. A fall in gold prices has resulted in increased demand for gold imports. A fast-depreciating currency has led to an increase in the import bill for fuel, tempering the advantage of a fall in international crude oil prices. On the other hand, growth in exports remains sluggish due to poor external demand. In other words, there is strong evidence to suggest that the trade deficit is likely to widen in the short term, posing by far the biggest risk to the deteriorating current-account deficit.
Exploring other alternatives within
Short-term risks to global financial stability have come down considerably compared to the past year. However, the uncertainty in the international environment still remains. The need of the hour is to strengthen domestic demand by boosting investment in the economy. This in turn will likely help improve the labor market and consumer confidence. At the same time, the efficiency of the Indian banking system has to be improved, with a focus on managing systemic risks to banks emanating from the external environment as well as recent domestic macroeconomic risks. Challenges will keep coming as the economy gets more integrated with the rest of the world. It is difficult to predict the uncertainties with certainty. The only hope is to explore alternatives within and be prepared to face the unexpected.
- The fiscal year in India begins on April 1 of the first-referred year.