Indian Economy in Deep Waters

The Indian economy is gripped by a veritable crisis. Agrarian woes are deepening, industrial growth is sharply dipping, inflation is persisting in the alarming zone, the unemployment rate is remaining chronically high, the fiscal deficit is defying all limits, the rupee is nose-diving against the dollar, exports are decelerating sharply with imports shooting up, and on top of it all, the country is all set to be on the brink of a sovereign debt crisis engendered by a serious Balance of Payment (BoP) crisis reminiscent of 1991, when India had to pledge gold to rescue itself from a sovereign debt default situation. Standard and Poor (S&P) has threatened India with “junk” status credit rating. The Indian economy is at the risk of falling out of the BRIC (Brazil, Russia, India and China) group of nations. Standard and Poor’s report suggests that unless the government is able to handle the current situation of slow growth and economic downfalls, it won’t be able to maintain an investment grade rating and so might have to fall out from among the BRIC nations.

But our Finance Minister won’t agree. He believes, “there are no significant events to indicate that the economy’s vulnerability to shocks has increased, though growth numbers for the fourth quarter 2011-12 have come below expectations.” He also put up a brave face, to vow that there would be a turnaround in the growth prospects, and that the government has the current situation well in hand. Ever since the Lehman collapse occurred in 2008 and the global financial crisis broke out, the refrain of the UPA government at the centre has always been that India is safe and is “insulated from the global crisis”. The message sent out by the Finance Ministry whenever the rupee or the stock market dipped was that the “fundamentals of the economy are sound” and there is no cause of concern. But the disturbing indicators are too many for any informed person to ignore.

Let us first hear from the RBI, the government’s chief monetary regulatory agency. In its Financial Stability Report (FSR) of December, 2011, it has observed that “In an increasingly integrated global economic and financial system, India’s growth performance has been affected through the trade, finance, commodity and confidence channels. Domestic demand has also decelerated, weighed by global factors as well as domestic headwinds including the cumulative impact of interest rate hikes and of elevated inflationary pressures. The slowdown in the industrial sector and deceleration in private consumption may affect the future growth of the services sector as well….Inflation in India has remained at high levels. Global commodity prices, including energy prices, are contributing to inflation risks….The current environment of risk aversion and depreciation of the Indian rupee could complicate the refinancing challenges faced by Indian corporates with regard to their Foreign Currency Convertible Bonds (FCCBs) and External Commercial Borrowings (ECBs). FCCBs raised in pre-crisis years at zero or very low coupons will need to be refinanced through domestic sources at the higher interest rates prevailing currently.” Do all these parameters suggest that the country is insulated from the global crisis and the fundamentals of the country are so strong that the people of the country need not worry at all?


The Indian economy is heading towards an ideal ‘Stagflationary’ situation manifested by a deceleration in the growth of the economy coupled with a nagging inflation. India’s economic growth rate has now declined in the ninth successive quarter, and in the three months ended March, 2012, the manufacturing sector expanded at the lowest rate (0.1%) in a decade. The CSO quick estimates released on 12 June, 2012 indicates that, the Indices of Industrial Production for the Mining, Manufacturing and Electricity sectors’ growth rates for the month of April 2012 stand at (-)3.1%, 0.1% and 4.6% respectively as compared to April 2011. On the other hand, according to the same estimates, provisional annual inflation rate based on all India general CPI (Combined) for April 2012 on point to point basis (April 2012 over April 2011) is 10.36 %, while the corresponding provisional inflation rates for rural and urban areas for April 2012 are 9.86 % and 11.10 % respectively. Food articles constituted the main component of this inflation and the rate stood at 10.18% in April, 2012 compared to April, 2011. The most disturbing feature of the present inflationary trend is that there is no sign of significant easing out of the rate of inflation despite repeated intervention by the RBI to check money supply by way of hike in lending rates. After effecting 13 rate hikes since March 2010 to cool persistently high inflation, RBI cut CRR by half a percentage point to 5.5%, while keeping policy rates unchanged.

Indian economic policy makers are surely caught in a catch-22 situation. The FM in his budget speech this year has himself admitted, “India’s inflation is largely structural, driven predominantly by agricultural supply constraints and global cost push. Evidence suggests that prolonged periods of high food inflation tend to get generalised.” Still the government prefers to rein in inflation only by tinkering with the bank rate to control money supply. But repeated rate hikes have failed to contain inflation and has only raised the cost of investment of the industries and created disincentive for industrial investment. This is reflected in the negative growth in the gross fixed capital formation. Growth in investment expenditure as represented by gross fixed capital formation remained in the negative zone for the third quarter in a row. This is having a cascading effect on industrial growth, which is amply manifested in the poor IIP growth rates. The monetary policy review released by the RBI earlier this year reported an “almost 36% dip” in inward foreign direct investment (FDI). Foreign institutional investors (FIIs) invested just $9 billion (bn) in 2011 and investments in the earlier two years were $24.3 bn and $23.2 bn, respectively. Glenn Levine, senior economist at Moody’s Analytics, attributed the slowdown to weak external demand, rising global uncertainty, elevated interest rates, high inflation, stagnant government policies and declining business confidence. As a matter of fact, fall in domestic demand also contributed significantly to the present industrial slump. As Arjun Sengupta Committee’s report suggests, two decades of neo-liberal economic policies have pushed 77% of the Indian population to a daily income level of less than Rs.20/-. How can a domestic market survive on such a dismal purchasing power of the vast majority of its consumers?

Public Finances in Disarray

The Budget speech of the FM this year has admitted that the combined effect of lower tax and disinvestment receipts and higher expenditure has pushed the fiscal deficit to 5.9% of GDP in the Revised Estimates for 2011-12 as against the projected 4.6% last year. The targeted deficit for 2012-13 has been pegged at 5.1% of GDP. But the trend of tax collection and the overall finances of the government at the very beginning of the fiscal have forced the government to declare an austerity measure. The government has blamed it all on the increase in subsidy bills, particularly on oil and has already increased the price of petrol by about 7%. Hike in the prices of diesel, cooking gas and kerosene is in the offing. But the “austerity” response of the government to tame deficit is likely to end up in fall in employment rate; in which case, what will happen to the much-touted ‘growth story’?

BoP crisis

India’s balance of payment (BoP) slipped into the negative territory for the first time in three years on shrinking dollar inflows, while the country’s current account deficit widened further. India’s BoP experienced a significant stress as trade deficit widened and capital inflows fell far short of financing requirement resulting in significant drawdown of foreign exchange reserves. The trade deficit is estimated to have increased by 56 per cent between 2010-11 and 2011-12 to touch 10.6 per cent of GDP. Foreign exchange reserves are falling: by mid-May foreign reserves had fallen by $2.6 billion relative to end-March, $4.9 billion relative to end-December and $15.7 billion relative to a year earlier. And the Reserve Bank of India’s (RBI) reference rate for the rupee has depreciated by more than 10 per cent over just three months.

Exports have slowed because of the persisting global crisis, though in financial year 2011-12 exports rose 21 per cent in dollar terms to $303.7 billion as against the previous year’s $251.1 billion. But the trend is one of slowdown. In March 2012, exports, at $28.6 billion, were 6 per cent lower than the $30.4 billion in March 2011. On the other hand, for the whole of financial year 2011-12, imports grew much faster at 32.15 per cent, to $488.6 billion. Oil imports were up 47 per cent (at $155.63 billion) relative to the previous year’s $105.9 billion. Non-oil imports also grew by 26 per cent, to $333 billion ($263.8 billion). And in this case the trend is one of further increase. Imports during March grew by 24 per cent, to $42.5 billion ($34.2 billion), with oil imports rising by 32.45 per cent, to $15.83 billion, and non-oil imports by 20 per cent, to $26.7 billion. Over the year, the trade deficit, or the gap between exports and imports, grew to $185 billion in 2011-12, which swallowed a large share of India’s revenues from remittances and services exports. The current account deficit seems to have widened in recent months. The consequence has been a weaker rupee.

Instead of catching the BoP bull by the horns, the government of India has been relying too much on capital inflows to fill the current account deficit. Indian rulers do not seem to have taken any lesson from the international experiences or from recent theoretical research on the risks attached to capital flows. The Vodafone tax episode and the retraction of the government over retrospective effect of the proposed general anti-avoidance of tax measures would indicate how abject we are on reliance on capital flows. Our excessive reliance on such flows has created double jeopardy. At one level it has weakened the RBI’s ability to intervene in the market to iron out the volatility in the exchange rate; at another, it is robbing the country of precious foreign exchange reserves by creating excessive short-term liabilities through currency borrowing, etc. The net result is, Rupee has become the most poorly performing currency in Asia, excepting Japan. In spite of all efforts, RBI has failed to arrest the fall of rupee, making the country vulnerable to external shocks. According to the Securities and Exchange Board of India (SEBI), foreign institutional investors (FIIs) who pumped in huge volumes of dollars into the debt and equity markets, reduced their net investment in recent months. Initially this was because they sold out in order to garner surpluses that could help cover their losses or meet commitments at home. But now it is because they are wary of the India’s prospect and fear a further devaluation of the rupee. The result: a decline in reserves and expectations of a further depreciation.

India’s Eurozone exposure is seen to be $60 bn. and RBI’s Financial Stability Report 2011 had estimated it at 8.6% of GDP. A more worrying feature of the debt profile is that a large part of it is short-term and a substantial part of it falls due in the coming months. This will drain our reserves further unless there is faster accretion which seems unlikely at this juncture. Significantly, these short-term liabilities have been created due to RBI’s own policies to manage the rupee rate. During times when the inflow was declining and the rupee rate went up, the RBI created newer windows like foreign currency loans for corporates, lifting the ceiling on loans, subscription to domestic bonds by FIIs, higher interest rate for non-resident external (NRE) accounts, etc. But short-term debts will begin to flee and queer the pitch further with adverse consequences.

Economic Survey, 2011-12 informs that, India’s external debt stock increased by US $ 20.2 billion (6.6 per cent) to US $ 326.6 billion at end-September 2011 vis-à-vis US $ 306.4 billion at end-March 2011, primarily on account of higher commercial borrowings and short-term debt. The long-term external debt at US $ 255.1 billion accounted for 78.1 per cent of the total external debt while the short-term debt was at 21.9 per cent. Government (sovereign) external debt stood at US $ 79.3 billion, while non-Government debt amounted to US $ 247.3 billion at end-September 2011. Whereas, during fiscal 2011-12, forex reserves declined to US $ 292.8 billion at end January 2012 indicating a fall of US $ 12.0 billion from US $ 304.8 billion at end-March,2011. The decline in reserves is partly due to intervention by the Reserve Bank of India to stem the slide of Rupee against US dollar. The rate at which the reserve is depleting and the debt burden is increasing with rupee falling every day, it is everybody’s concern how India will manage the reserve-debt gap in the short run.

It is here where the similarity between the Indian woes and the European maladies is apparent. There, too, the accumulation of large volumes of public debt has made sovereign default a possibility in the absence of additional credit to meet expenditure. However, additional credit was provided only on the condition that the country opted for austerity, imposing a huge burden on its people in the form of increased unemployment, reduced incomes and a collapse of social security outlays. Will India go the European way? The trend appears to be so. The industrial lobby and its neo-liberal stooges have been mounting pressure on the government to accelerate liberal reforms in the form of FDI in multi-brand retail, pension reforms, labour law reforms, increasing FDI limit in insurance and banks and outsourcing of government jobs to private agencies. If that be so, the Indian workers also are surely to go the European and American way of popular resistance. The 28th February General Strike was only a small indication of the broader and more vigorous resistance to come.

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