India: Citius, altius, fortius

India: Citius, altius, fortius

India: Citius, altius, fortius

Global Economic Outlook Q2 2013

India’s economy is showing signs of a recovery. The government’s fiscal consolidation plan, along with a moderation in wholesale prices, will give the central bank flexibility to cut interest rates.

India: Citius, altius, fortiusThe Indian economy is operating in a difficult macroeconomic environment, part of which is due to a prolonged period of weakness in the global economy. Moreover, a host of domestic factors caused an economic deceleration. As a result, the Indian economy is experiencing one of its slowest periods of growth in nearly a decade. India’s GDP grew just 5.5 percent and 5.3 percent in the first two quarters of the 2012–2013 fiscal year, prompting the Central Statistical Organization to lower its growth estimate to a meager 5.0 percent for the year as a whole. While the Ministry of Finance’s and Reserve Bank of India’s estimates for GDP growth are slightly higher, the bottom line is that the Indian economy will slow down considerably from a growth rates of 9.3 percent and 6.2 percent achieved during 2010–2011 and 2011–2012, respectively.

Slower GDP growth is primarily attributable to a weakness in the industrial sector. The Index of Industrial Production grew a mere 0.7 percent between April and December 2012, down from 3.7 percent for the corresponding period in 2011–2012. Meanwhile, growth in the agriculture sector has been slow after an erratic start to the monsoon season, which likely caused lower growth in allied sectors as well. Furthermore, cautious monetary policy and tight credit conditions put a lid on the possibility of an investment-led growth revival. However, India’s growth rate appears to have bottomed out, and the tide is likely to turn in India’s favor. The government and policy makers exude confidence that the economy will bounce back. In all likelihood, growth will be faster, investments will be higher, and the domestic economy will emerge stronger in the coming months. Based on current forecasts, the economy is expected to achieve a growth rate of 6.1–6.7 percent in the fiscal year beginning in April 2013.

Maneuvering monetary policy

In its third-quarter monetary policy meeting held on January 29, the Reserve Bank of India (RBI) cut its policy rate by 25 basis points. This marked the first instance where the central bank tinkered with policy rate since April 2012, as opposed to its reliance on consistent cuts to the cash reserve ratio in an effort to add liquidity and enhance credit availability in the markets.

Meanwhile, inflation based on the wholesale price index (WPI) persisted around 7–8 percent through the most part of the 2012–2013 fiscal year. However, WPI inflation fell to 6.6 percent in January 2013, its lowest level since December 2009. The declining trend in the WPI is certainly a positive sign for the economy, but a majority of the decline is due to a moderation in non-food manufacturing inflation. On the other hand, food prices remain elevated and are an area of concern. Unlike the previous year, when food inflation was mainly driven by higher prices of protein foods, the price of cereals has exerted upward pressure this year. An increase in the minimum support price for rice and wheat, coupled with supply-side bottlenecks, contributed to an increase in inflation for cereals. Rising food inflation has widened the gap between inflation measured using the WPI and the consumer price index (CPI) to over 4 percent in January 2013, primarily on account of the greater weight given to food items in CPI. India continues to witness double-digit CPI inflation, which stood at 10.8 percent in January, following a reading of 10.6 in December 2012.

So far, the RBI has adopted a cautious monetary stance in an attempt to maintain a balance between containing inflation and managing liquidity requirements to support growth. The RBI’s stance was also considered necessary amid deteriorating fiscal conditions and an uncertain global macroeconomic environment. However, a moderation in wholesale prices and the possibility of an improvement in the government’s fiscal situation give the central bank some flexibility to reduce interest rates in the near future. While the choice may not be easy, the RBI will certainly weigh the costs of slower growth against the possibility of an uptick in inflation.

The government and policy makers exude confidence that the economy will bounce back. In all likelihood, growth will be faster, investments will be higher, and the domestic economy will emerge stronger in the coming months.

A path to fiscal consolidation

The Indian economy benefitted significantly from increased government spending in the post-financial-crisis era. However, central government fiscal deficits soared to 6.0 percent and 6.5 percent of GDP in 2008–2009 and 2009–2010, respectively. Fiscal consolidation began in 2010–2011, and a partial withdrawal of the fiscal stimulus and an economic recovery ensured that the fiscal deficit fell to 4.8 percent of GDP. However, GDP growth faltered in 2011–2012, and the fiscal deficit, once again, ballooned to 5.7 percent. Massive expenditures on welfare programs; subsidies on food, fuel, and fertilizers; and a shortfall in tax and divestment receipts contributed to the government’s slipping fiscal projections in 2012–2013. Revised estimates peg the deficit at 5.2 percent of GDP, and the final level could be marginally lower.

India ran the risk of its sovereign rating being downgraded to junk status in the absence of a clear fiscal consolidation plan. In his budget speech, the finance minister reaffirmed a commitment to continue on the fiscal roadmap laid out during the last year that would limit India’s fiscal deficit to 4.8 percent of GDP during the 2013–2014 fiscal year through measures that largely rely on expenditure cuts and disinvestment proceeds. However, the success of the fiscal consolidation plan is largely dependent on underlying assumptions, and the threat of a sovereign downgrade has not been entirely averted. The government was not able to meet its disinvestment target in the current fiscal year, and part of the reduction in the fiscal deficit in 2013–2014 assumes ambitious disinvestment revenues of nearly $10 billion. Furthermore, the government is anticipating an increase in non-tax revenues, a large proportion of which is expected to come from telecom spectrum proceeds. Meanwhile, non-tax revenues in the current fiscal were also lower compared to the initial target. On the other hand, plan expenditures are slightly higher because of low base effects, but the government subsidy bill is expected to decline. The deregulation of diesel prices and the limit on subsidized LPG cylinders will help in curtailing the government’s expenditure on subsidies. However, if global crude prices rise due to geopolitical tensions, the government will have to make some tough policy choices in the face of an upcoming election.

The other deficit

Some experts contend that a persistent deficit on the current account poses a bigger challenge for the Indian economy. India’s current account deficit rose to 5.4 percent of GDP in the second quarter of the 2012–2013 fiscal year, taking the deficit to 4.6 percent for the first half of 2012–2013. Export growth fell faster than imports during the second quarter. Moreover, the import bill was partly buoyed by increasing gold imports. As a countermeasure, the government increased the tariff on gold imports from 4 percent to 6 percent in order to make gold imports more expensive. However, gold imports are expected to decline significantly only when households find other investments more attractive.

So far, the current account deficit has been financed without drawing down reserves. While foreign direct investments have declined in the first three quarters of 2012–2013 compared to the previous year, foreign portfolio investments have registered a healthy increase. Earlier, the government’s plan to implement the General Anti-Avoidance Rules (GAAR) increased concerns for foreign investors that led to substantial capital flight. After due consideration, the government decided to implement a modified version of the GAAR. A global recovery and an uptick in external demand will likely support a revival in the export sector, which augurs well for the economy. However, India’s import basket, which consists largely of petroleum imports, will likely continue to exert pressure on the country’s current account.

The Indian economy is showing early signs of a recovery, suggesting that the worst may be over.

Will India capitalize?

India’s once-agrarian economy suddenly turned to the services sector in its pursuit of an ample growth engine. While its transition from agriculture to services led to high economic growth, it also left the manufacturing sector underdeveloped. More than half of India’s population engages in agriculture, and the high-productivity services sector is not creating enough jobs for a growing workforce. Currently, India has an opportunity to move a large proportion of its workforce from low-productivity sectors such as agriculture to high-productivity sectors like manufacturing, and enhance agricultural productivity while reducing the number of people dependent on agriculture. In a recent economic survey, the chief economic advisor, Raghuram Rajan, highlighted that creation of productive jobs will be crucial for India’s long-term growth.1 Investments in education, skill building, and infrastructure, coupled with business-friendly regulations and labor laws, are levers that could potentially create an enabling environment that propels the Indian economy to higher growth.

The Indian economy is showing early signs of a recovery, suggesting that the worst may be over. The purchasing manager’s index indicates an expansion, WPI inflation is on a downward trend, and the buoyancy of equity markets and portfolio investments underscore the return of investor confidence. Furthermore, the government hopes that its recent push for reforms will help trigger investments and jumpstart the economy. Overall, the Indian economy is expected to perform better in the coming year, which is a positive sign amid a host of macroeconomic challenges. If the global economic recovery surprises on the upside, India’s growth forecasts will likely be revised upward.


View all endnotes
  1. Raghuram G. Rajan, “An introduction to the economic survey 2012–13,” Ministry of Finance, India,, accessed April 15, 2013.


Pralhad Burli

Pralhad Burli is senior analyst at Deloitte Research, India.

India: Citius, altius, fortius
Cover Image by Maria Corte Maidagan