Indian Economy Overview
India has been one of the best performers in the world economy in recent years, but rapidly rising inflation and the complexities of running the world’s biggest democracy are proving challenging.
India’s economy has been one of the stars of global economics in recent years, growing 9.2% in 2007 and 9.6% in 2006. Growth had been supported by markets reforms, huge inflows of FDI, rising foreign exchange reserves, both an IT and real estate boom, and a flourishing capital market.
Like most of the world, however, India is facing testing economic times in 2008. The Reserve Bank of India had set an inflation target of 4%, but by the middle of the year it was running at 11%, the highest level seen for a decade. The rising costs of oil, food and the resources needed for India’s construction boom are all playing a part.
The aversion to regulation, the reluctance to even recognize the existence of bubbles in asset markets and a sledgehammer approach to monetary policy are dogmas that underpinned economic decision-making through much of 2008. These have led to the worst economic crisis in recorded history.
Recent Growth Trends in Indian Economy:
India’s Economy has grown by more than 9% for three years running, and has seen a decade of 7%+ growth. This has reduced poverty by 10%, but with 60% of India’s 1.1 billion populations living off agriculture and with droughts and floods increasing, poverty alleviation is still a major challenge.
The structural transformation that has been adopted by the national government in recent times has reduced growth constraints and contributed greatly to the overall growth and prosperity of the country. However there are still major issues around federal vs. state bureaucracy, corruption and tariffs that require addressing. India’s public debt is 58% of GDP according to the CIA World Fact book, and this represents another challenge.
During this period of stable growth, the performance of the Indian service sector has been particularly significant. The growth rate of the service sector was 11.18% in 2007 and now contributes 53% of GDP. The industrial sector grew 10.63% in the same period and is now 29% of GDP. Agriculture is 17% of the Indian economy.
Growth in the manufacturing sector has also complemented the country’s excellent growth momentum. The growth rate of the manufacturing sector rose steadily from 8.98% in 2005, to 12% in 2006. The storage and communication sector also registered a significant growth rate of 16.64% in the same year.
Additional factors that have contributed to this robust environment are sustained investments and high savings rates. As far as the percentage of gross capital formation in GDP is concerned, there has been a significant rise from 22.8% in the fiscal year 2001, to 35.9% in the fiscal year 2006. Further, the gross rate of savings as a proportion to GDP registered solid growth from 23.5% to 34.8% for the same period.
Reasons for the downturn:
The global economic crisis has been with us for 6 months now. This period has seen the rapid withdrawal of foreign investment from the stock market and the drying up of foreign direct lending to and investment in Indian companies, leading to a general credit crisis. There has also been other fallout, such as exposure of the shaky base of our real estate industry. Here are a few reasons in my view which have been at the back of such crisis situation in the Indian economy:
Exports and imports and subsidies:
Exports have been steeply declining from September onwards. Exports during October 2008 were 12 per cent lower than a year ago, witnessing a decline for the first time in 5 years, due to the sharp economic slowdown in the west. A significant part of these exports are of agricultural commodities and products of labor intensive sectors - textiles, garments, handicrafts, leather goods, gems and jewellery. These falling exports affect a large number of producers. The falling exports of agricultural commodities and their falling prices in the international market have in turn resulted in falling prices in the local market too.
The other factor is the amount of subsidies given by the government for certain commodities. The government imports urea at Rs 31,116/ton and sells it for Rs 4,830/ton. DAP is imported at Rs 58,584 and sold for Rs 9,350/t. MOP is imported at Rs 35,563/ton and sold for Rs 4,455. The amount of subsidy given by the government has been climbing steadily over the years and today stands at a whopping Rs. 119,772 crores (estimated for 2008-09) - almost three times higher than the amount doled out during the previous year. The surging oil, fertilizer, and food subsidies are likely to upset the entire applecart of Indian finances.
The annual DGGP growth at constant prices is already in serious decline. Very strong revenue gains, which masked many shortcomings of the economy in yesteryears, are also showing signs of slowdown. And as if all this was not enough, India's trade deficit is likely to exceed 8% in FY09. According to Moody's latest report on Indian economy "higher oil prices and lack of fiscal policy reactions amidst high pent-up price pressures are putting the burden of macro-economic adjustment on monetary authorities. As a result, policy as well as market interest rates could rise, and a sharp deceleration in growth may follow."
Inflation and crude oil prices:
Indian inflation raced to its highest level in 13 years, accelerating to over 12 percent after a fuel price hike. The higher inflation rate was on account of higher prices of both commodities like metals but also food articles like vegetables and edible oils. Inflation had a spiraling effect on many commodities. For example, since prices of raw materials like steel rise, there is also a rise in products using these raw materials, like the automobiles manufacturing firms, which in turn hike the prices and ultimately pass on the burden to the end consumers. As part of the fight against inflation a tighter monetary policy is expected, but this will help slow the growth of the Indian economy still further, as domestic demand will be dampened. External demand is also slowing, further adding to the downside risks.
During past two years the cost of crude imports has gone up from $40 billion to approx. $100 billion - an unaffordable luxury. This escalation in the energy bill itself amounts to about 6.5% of the country's GDP. While the Indian crude basket has risen by 181 percent since April 2004, the retail prices of petrol have gone up just 29 percent until the end of year 2007. In other words, the government treasury goes on taking it on its chin while the consumers are blessedly unaware about the rising prices. As a result while on one hand the consumption continues to grow unabated, on the other the country's finances continue to take a hit below the belt.
Stock Markets:
Major reasons for the fall of stock markets in India:
1. Unnecessary hype
2. Too much dependent on US market
3. Foreign investors
Stocks have come down by more than 50% from their all time high. $6b of foreign funds has flowed out of the country in that period, reacting both to slowing economic growth and perceptions that the market was over-valued. The selling pressure among the FIIs was the major reason for this trend. Following the FIIs selling, the Indian and other investors (short term) panicked, slipping out of the stock market. Also, the Indian economy is not decoupled from the US economy. Since NASDAQ and DOW JONES have been struggling to sustain, Indian counterparts have also followed the suit. The major reason for stock market collapse can be attributed to the fact that the Indian markets were growing at a pace faster than expected, in other words, it was overvalued.
The following data suggests the same:
Jan-Dec 2007: markets closed at 6,138 with returns of 54.76% for the year
Jan-Dec 2006: markets closed at 3,966 with returns of 39.84% for the year
Jan-Dec 2005: markets closed at 2,836 with returns of 36.34% for the year
Jan-Dec 2004: markets closed at 2,080 with returns of 10.69% for the year
In 2008, Sensex touched 21000, an unprecedented jump from 7000 a year ago, which clearly suggests that the market was getting overvalued and inflated.
The big and secretive India-focused funds have booked losses to the tune of 46% in 2008 — in the process effectively wiping out the 50% returns clocked by the posted by them in 2007.
Yields in the Government securities market hardened substantially during the current financial year in both primary and secondary segments.
Real estate markets:
According to industry sources, the average drop in sales for the industry in the last calendar year was more than 60%. Since April, there has been another drop of 30-40% in sales compared with those last year. What’s more, the drop has not just been in the bigger metros, but in tier-II and tier-III cities as well. They have seen an average fall of more than 25% between February and August, according to the data compiled by the Associated Chambers of Commerce and Industry of India. In fact, with the Reserve Bank of India tightening lending rules, it has become difficult for developers to secure finance.
Also, interest rates on home loans have increased tremendously, causing several families to postpone house purchase plans. Real estate developers like Unitech and DLF which had raised a huge amount of money through IPO’s have found their stocks plunging to below the IPO prices. The basic reason for this has been that the companies were evaluated on the assets that they had. But as the real estate prices have fallen sharply, their asset base has decreased in value and their share prices have also dropped drastically.
Infrastructure:
The index of the six core infrastructure industries dipped to 5.3 per cent (Provisional) in November 2007 even as production of crude petroleum declined to 0.3 per cent. The index of six core infrastructure industries, with a combined weight of 26.7 per cent in the Index of Industrial Production (IIP) with base 1993-94, stood at 233.3 (Provisional) in November 2007 and the growth dipped to 5.3 per cent (Provisional) compared to 9.6 per cent in November 2006.
During April-November 2007-08, the six core infrastructure industries registered a growth of six per cent (Provisional) as against 8.9 per cent during the corresponding period of the previous year.
The Indian government views investment in the creaking infrastructure of the country as being a key requirement, and has ear-marked 23.8 trillion rupees, approximately $559 billion, for infrastructure upgrades during the 11th five year plan. It expects to fund 70% of project costs, with the other 30% being supplied by the private sector. Ports, airports, roads and railways are all seen as vital for the Indian Economy and have been targeted for investment.
Power sector problems:
India has to compete ever harder in the energy market place in particular and has not been as adept at securing new fossil fuel sources as the Chinese. The Indian Government is looking at alternatives, and has signed a wide-ranging nuclear treaty with the US, in part to gain access to nuclear power plant technology that can reduce its oil thirst. This has proved contentious though, leading to leftist members of the ruling coalition pulling out of the government.
Industrial Growth Pattern:
The adverse effects of rising interest rates and tight monetary policy are evident. Higher rates affected sectors such as automobile and housing the most. As a result production of machinery and transport equipment and non-metallic products which has cement as a major item slowed down. Small sectors like jute and jute products, wood and wood products along with basic metals have recorded outstanding growth in the range of 16-22 %. Besides, power generation rose 7% on top of an 8.9% growth in July 06.
As per used-based classification, the impact of interest rate is visible in many sectors. Deceleration in capital goods production in the initial months of FY08 has put a pause button on the five-year rally. Moreover, there is a sharp moderation in intermediate goods to 4.7% as against a growth of 10.7% a year ago. Slowdown in investment activity coupled with a lower intake of raw material reflects a moderation in industrial activity so far this year. Whether the latest figures are just an aberration or a beginning of a southward trend remains to be seen.
Monetary factors:
The expansion in money supply was limited to 6.6% compared to 8.2% in the previous year (calculated from end of March 2008 end to end of September 2008). Growth in net foreign exchange assets of the banks slowed to 6.0% compare to 11.0% in the previous year. This was mainly on account of drawing down of forex reserves by RBI to meet the USD requirement in the market. However, the non-monetary liabilities were seen to be on the rise. In September 2008, growth in the aggregate deposits fell from 10% in the previous year to 7.7% in September this year. Investments in government and other approved securities were observed to fall to low levels.
The rise in the lending rates is also hurting the retail customers. Retail lending rates across most products - auto loans, personal loans, and loans against securities - have been going up in recent past and are likely to do so in the coming future. The customers are unable to borrow, thus capping the demand as well as pushing up the loan defaults. (Bad loans have been rising across most retail products in the past few months.) Goes without saying the companies in India are taking a double hit: rising cost of capital and inputs and lowering demand due to reduced purchasing power by the customers. The two phenomena have already reduced the rosy projections by company analysts about stock price forecasts way behind the curve.
Fiscal policy:
In the Budget for the fiscal year 2008-09, the government's revenue expectations were realistic, but expenditure appeared to be underestimated. This may be because expenditure to the tune of 2.0-2.5 per cent of GDP remains off budget. There was no provision in the budget for the loan waiver of $16.8 billion to the farmers (earlier Rs.60, 000 crores and now it is increased to Rs.71, 680 crores) and huge amount of $6.36 billion arrears to the Central Government employees (Rs.27145 crores for the Central sixth pay commission recommendations), which is expected to 1.85 per cent of the official GDP for 2008-09.
India’s fiscal deficit remains one of the largest in the world. Fiscal deficit seen at 5.5 pct of GDP in 2009/10. Revenue deficit seen at 4 pct of GDP in 2009/10 much higher than the 3 per cent of GDP mandated by the Fiscal Responsibility and Budget Management (FRBM) Act.
The interim budget presented is seen as a pre election budget and has pushed the burden on the next government.
Political factors:
India today does the face the danger of a political nature as well. This phenomenon was partly displayed during the debate over the Indo-US nuclear deal. A seemingly innocuous bilateral treaty, it created frenzied debate, polarized the polity and the nation, and forced the government through a no-confidence motion. To a complete outsider, it all seemed a lot of action for something which appeared quite routine. To Indians though, it all seemed wearingly familiar.
Two other areas where the impact of the political-business nexus can be seen are agriculture and retail. Organized retail presents a massive opportunity for India to broad base its growth, and help kick start the agriculture sector, with estimates ranging from $ 500 billion to over $ 1 trillion. A large amount of agricultural produce in India is wasted each year due to the lack of cold storage, to the tune of $ 7 billion. Investments, both foreign and domestic, should be welcomed in this sector, as well as initiatives to promote local small businesses. Yet, the whole sector has been dominated by big players, who would rather establish consolidated supply chain which would squeeze prices all along the retail chain.
Some personal views:
The fiscal deficit scenario is a bit of a worry for the future generations. As seen by most of the economists, I too agree with the fact that the burden of current deficit will have to be borne by the future generations in the form of increased tax rates which will in turn reduce their savings, which ultimately may result in reduced investments. This would imply a slump in the growth rate which will result in a cycle of decreased investments, reduced income and ultimately low growth.
India's rupee has depreciated considerably in the past few months after being appreciated to as low as Rs. 39 per dollar. This means reduction in imports which had caused inflation to rise to above 12%. Due to monetary policies of decreased interest rates and inflow of money in markets, government has been able to bring it down to 4%. But will it be able to keep it to that level remains to be seen.
