India: The deepening downward spiral

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India: The deepening downward spiral

India: The deepening downward spiral

Asia Pacific Economic Outlook, September 2012

The economic outlook remains weak, growth is decelerating, and consumer and business confidence are plummeting. Perhaps the only aspect of India not under a persistent cloud is the Indian landmass itself. According to recent estimates, the country is likely to receive 10 percent less rain this year than usual, and floods and droughts caused by an erratic monsoon are threatening to decimate agricultural production.

The outlook for the Indian economy remains weak, growth is decelerating, and consumer and business confidence are waning. In addition, the monsoon has been erratic, leading to floods in some parts of the country and droughts in others. The Prime Minister’s Economic Advisory Council (PMEAC) lowered its growth estimate to 6.7 percent for the current fiscal year. Despite the revision, the PMEAC’s projection seems optimistic, and GDP growth could end up even lower. Meanwhile, inflation remains sticky, and the government’s woes arising from a high fiscal and current account deficits continue to loom large. In all, India’s leading indicators cloud the outlook for the economy, and policy uncertainty clouds it further.

As of this writing, India has received 10 percent less rain this year than it usually does. Moreover, the variation in monsoons across states is expected to have a significant impact on grain production, and farm output may experience a contraction this year. The sowing of key crops is behind schedule owing to a delayed monsoon, and the resulting losses to farmers on the summer crop are unlikely to be reversed even if the monsoon were to pick up in the coming weeks. Moreover, consumers may have to bear double-digit food inflation for many more months. In addition, a poor monsoon will also result in lower farm incomes and squeeze the spending capacity of a majority of India’s rural consumers. The PMEAC expects the agriculture sector to grow by a mere 0.5 percent this fiscal year. With over 15 percent of the country’s GDP and the income of nearly 50 percent of the population dependent on agriculture, a weak monsoon does not augur well for India’s growth prospects.

Meanwhile, retail price inflation fell marginally to 9.9 percent in July 2012 compared to last year. Yet inflation remains at extremely high levels. In July, the consumer price index for vegetables and edible oils recorded an increase of 27.3 and 17.4 percent respectively over the previous year. Moreover, the prices of food grains pulses rose sharply during the same period. Meanwhile, inflation measured by the wholesale price index declined to 6.9 percent in July, down from 7.3 percent in June 2012. The marginal decrease in retail and wholesale inflation is unlikely to prompt the Reserve Bank of India to cut the interest rate in its next monetary policy meeting. In all likelihood, the bank will probably keep interest rates on hold during its next policy meeting in September as the possibility of rising food prices due to a weak monsoon cannot be ruled out.

However, the high-interest-rate environment has hurt Indian companies, which have higher interest payments. In addition, higher crude prices, rupee depreciation, and rising power costs have impacted corporate performance. A study conducted by the Centre for Monitoring Indian Economy (CMIE) estimates the net profit margin of Indian companies to have contracted to 5.4 percent for the quarter ending June 2012, the second-lowest quarterly margin in the last decade. Yet the outlook for the coming quarters is much better, and CMIE expects the profitability of companies to improve. Recognizing the importance of kick-starting the manufacturing sector and boosting domestic investment, the finance minister has urged public sector banks to cut lending rates. Moreover, the finance minister has also asked banks to consider lowering rates on consumer credit in a bid to boost consumer spending. While some bankers feel that there is some room to cut lending rates, India’s top public sector banks have witnessed a broad-based deterioration in asset quality during the April–June quarter. As a result, banks will likely be cautious and selective if they reduce interest rates in the near term.

India’s economy is operating below its potential, and its inflationary environment does not bode well.

Policy measures are also presenting challenges to the Indian economy. Fortunately, the government has made some headway with regard to its foreign direct investment (FDI) policy. The finance ministry approved 49 percent FDI in the insurance and pension sector, up from the current ceiling of 26 percent. However, before the bill comes up for parliamentary approval, it first needs to be approved by the cabinet. In addition, the central government is likely to approve FDI in multi-brand retail in September 2012. Under the proposed bill, state governments will have the right to decide whether or not they will allow FDI in the retail sector in their respective states.

India’s economy is operating below its potential, and its inflationary environment does not bode well. Furthermore, a weak monsoon is making matters worse and is likely to have an adverse impact on the economy. Growth forecasts have been lowered, but the economy could be tipped downward if the government fails to implement market-friendly economic policies.

 

About The Author

Pralhad Burli

Pralhad Burli is a senior analyst at Deloitte Research, Deloitte Services LP.

India: The deepening downward spiral
Cover Image by Stephanie Dalton