State of Indian economy

Current state of the Indian economy A balancing act

March 2012 www.deloitte.com/in

Current state of the Indian economy A balancing act

Overview With recent global developments contributing to a significant rebalancing of portfolios as a result of rapidly changing risk perceptions and appetites, the Indian macroeconomic environment has looked turbulent during the past year. After a promising start to the decade in 2010-11, with achievements like maintaining GDP growth rate around 8 percent, bringing down fiscal deficit to 4.8 percent of GDP as well as containing current account deficit to 2.6%, the fiscal year 2011-12 has been challenging for the Indian Economy. The year started on a note of optimism through impressive growth in exports and high levels of foreign exchange inflows, only to moderate as the year progressed through continued monetary tightening in response to the untamed inflationary pressures.

Gradually, high levels of inflation gave way to a slow-down in the growth. Additionally, as fiscal conditions worsened over the year, export numbers were revised in light of data discrepancies leading to a widening of trade deficit. In light of a perceivably weak macroeconomic environment, a well-planned economic revival policy from the Government’s part is required to get back the Indian Economy on the path to stable and prosperous growth.

Global winds Performance of major advanced economies has been a point of concern as the economic outlook of the Euro Area continues to be grim in the shadow of a protracted sovereign debt crisis. Japan is still trying to cope up with the economic impact of natural calamities which is having an impact on its export partners. Despite some modest signs of improvement in the US, the European debt problem has unquestionably remained as a dominant global factor and a source of volatility in asset and currency markets all over the world. By contrast, emerging market economies have generally shown reasonable robustness – mainly on account of their domestic drivers and increasing linkages with each other. Nevertheless a slowdown in advanced economies is a point of concern as it impacts the investment and exchange rate channel of the domestic economy.

India is still growing at a rapid pace in comparison to other countries; however that should not deter from the opportunity to push through further reforms, create infrastructure and generate economic opportunities.

India is still growing at a rapid pace in comparison to other countries; however that should not deter from the opportunity to push through further reforms, create infrastructure and generate economic opportunities.

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After achieving 8.4% growth in the past fiscal, India’s economy has decelerated sharply to achieve 6.1% GDP growth in the third quarter of 2011. It is worrying that growth is estimated to be less than 7% for the fiscal year ending March 31. High fiscal deficit, lack of foreign investment, tax and manufacturing reforms are some of the hindrances plaguing the Indian economy.

The Domestic growth story While the rest of the world has been grappling with the after effects of the European debt crisis, the Indian economy in 2011-12 has also seen moderation in growth. Quarterly growth rates have consistently fallen in 2011-12 and Quarterly Growth of Indian GDP (%) 9.8

9.4 8.5

7.8

7.5

7.4 6.1

Q1

Q2

Q3

2008-09

8.3 7.6

7.4

7.8

7.7 6.9 6.1

5.8

Q4

Q1

Q2

Q3

2009-10

Q4

Q1

Q2

Q3

2010-11

Q4

Q1

Q2 2011-12

Q3

for the first time since the global crisis of 2008, GDP growth rates in India has declined below 7 percent to reach 6.1 percent in the third quarter of 2011-12. Earlier expectations in the range of 8 percent to 8.5 percent have been reduced gradually and now the Economy is expected to grow at less than 7 percent. GDP grew at a modest 7.3 percent during the first half of the financial year but turbulent global conditions coupled with a weak industrial sector has resulted in a slowdown in GDP growth in the second half of the year. With the exception of Services, GDP growth and its two main components Agriculture and Industry have recorded lower growth in 2011-12 as compared to the last year.

Sectoral Outlook After an impressive growth of 7 percent in 2010-11, the Agricultural growth rate has declined to 3.2 percent during first nine months of this year, perhaps also contributed by a high base effect. However, the agricultural output Current state of the Indian economy A balancing act | 3

in absolute volume is expected to reach record levels owing to a good kharif and rabi harvest in the country as well as strong trend growth in horticulture and animal husbandry.

For the first time in 27 months, the industrial growth recorded a negative growth of 5.1 percent in October 2011. Although it later reverted back to 6 percent in November, the CSO expects the industrial sector to grow at a mere 3.9 percent compared to a 7.2 percent growth rate in the last financial year. IIP growth rate during the first three quarters of 2011-12 (April to December) was significantly lower at 3.6 percent compared to a corresponding growth rate of 8.3 percent in the last year confirming a contraction in industrial output. Regulatory hurdles and ban on iron-ore mining in some states have hastened the contraction during the first half of the current fiscal. In terms of the use based classification, weakness in capital goods, intermediate goods and consumer durables sectors has dragged down the industrial production. Still, a robust manufacturing Purchasing Manager’s Index (PMI) is an optimistic indication of the undergoing recovery. To optimize on the untapped potential, the economy needs to focus on a clear cut mechanism for the implementation of the National Manufacturing Policy to revive industrial growth. The 12th Plan, which has doubled the 4

projected investment in infrastructure over the five year period 2012-17 to $1 trillion, taking annual investment in infrastructure from the current level of 6 percent of GDP to over 10 percent, also presents a golden opportunity for the industrial sector.

The government has recognized that a manufacturing thrust is required for the benefit of the economy. Establishment of the National Investment and Manufacturing Zones – the green field integrated Industrial Townships or development of Delhi Mumbai Industrial Corridor as a global manufacturing and investment destination are thoughts to stimulate infrastructure growth using ecofriendly green technology. Initiatives for upgrading the agricultural productivity & support structure to efficiently market the agricultural produce would also be a welcome move to improve agricultural performance. It is however important to note that implementation would remain the key to success.

Despite a weak global economy and a slowing domestic market, the Service sector has maintained its strong performance during the year, proving it to be the most resilient sector of the economy. With growth rate of 8.8 percent achieved till December 2011, the advance

recent months implying a significant slowdown in investments. Such pattern would certainly be detrimental to the medium & long term growth prospects.

IIP Growth rates 16% 12% 8% 4%

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2010-11

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2011-12

estimates by CSO project a growth rate of 9.4 percent in 2011-12 as against a growth of 11.1 per cent in 2010-11. Within services, trade, transport and communication grew the fastest at 10.6 per cent in 2011-12 as against 11.1 per cent in FY11.

The Demand side of growth In addition to the depressed global environment, high levels of interest rates, prolonged inflationary pressures as well as above target fiscal deficit have led to a decline in demand in most of the interest sensitive sectors. The growth of largest component of aggregate demand in the country – private final expenditure has moderated to 5.1 percent in April to December 2011 as compared to 8.5 percent during the last year. The contraction in fixed capital formation in 2011-12 is one of the main factors behind the slowdown in growth. The real gross fixed capital formation to GDP ratio declined from 34 percent in Q2 of 2010-11 to 30.5 percent in Q2 & further to 30 percent in Q3 of 2011-12. The same is also evident from a contraction in capital goods in

The Monetary efforts to contain stubborn inflation After consistently high levels of inflation around 9 to 10 percent for more than twenty months, the Wholesale Price Index (WPI) dipped to a 2 year low of 6.55 percent during the month of January 2012. The Finance Minister is confident on moderation in inflation and expects it to be around 6.5 percent by end of March 2012.

Primary articles inflation, which was in double digits for over two years till October 2011, moderated to 8.5 percent in November 2011 and further to 2.3 percent in January 2012.

Manufactured products inflation remained elevated through-out the year 2011-12, albeit declining from 8.1 percent in October 2011 to 6.5 percent in January 2012. However, concerns remain in the form of fuel group inflation, which touched 15 percent mark in November 2011 for first time in 2 years, reflecting impact of high global crude oil prices and rupee depreciation.

In response to the untamed inflationary levels for long time, the Reserve Bank of India (RBI) has been tightening monetary policy for last two years with thirteen increases in the policy rate viz., repo rate which is raised from 5 percent in March 2010 to 8.5 percent in October 2011.

Repo rate has been maintained at the same level since then as moderation in the prices is evident.

Additionally, structural changes and increase in agricultural productivity would certainly be helpful Current state of the Indian economy A balancing act | 5

Africa and other developing countries witnessed an increase in their share of India’s export basket while USA and EU observed a decline. Though Indian exports remain healthy in a turbulent global environment, the weakening export trend has been a point of concern.

in containing the food articles inflation, the major contributor.

Though inflation has moderated recently, high inflation during the current fiscal added to the woes of the common man. Basic food item and fuel prices remained high while high rates raised input prices and borrowing costs, forcing small and medium sized enterprises to cut margins and incur losses.

An Outward analysis A potential Eurozone default could spell doom for both the Indian Service and Industry. Eurozone accounts for nearly 15 percent of merchandise trade and is the biggest market for the Indian IT/ IT-eS segment after the USA. Despite increasing close linkages & interdependence of the Indian economy on the global economy, the impact of global instability on Indian exports has been minimal as recently, the economy was able to explore new markets and diversify its export destination. Countries like OPEC, Eastern Europe, 6

Exports grew at 41 percent during the first half of the current fiscal but subsequently slowed down in later months as during the period of April to December 2011, exports grew at 25.8 percent and stood at US $ 217.6 billion. Imports grew at 30.4 percent during the same period and amounted to US$ 350.9 billion. Ratios of growth for exports & imports have reached 21.4 percent and 29.4 percent respectively till the month of February, widening the trade deficit to the tune of US$ 166.8 billion – putting further pressure on Current Account Deficit (CAD). During first half of 2011-12, CAD, though widened in absolute terms, relative to first half of last year, however, as a proportion of GDP, the CAD at 3.6 percent was a shade lower than 3.7 percent in first half of last year. With the worsening situation, it is a challenge to meet an annual CAD level for the last year which was only 2.6 percent.

Rising CAD combined with rebalancing of global portfolios by FIIs and the tendency of exporters to defer repatriating their export earnings, has led to significant pressure on the rupee. The Indian rupee depreciated by about 17 percent against the US$ during August to December and is now hovering around 50 Rupee mark.

Similarly, the Eurozone crisis coupled with lack of fiscal space to grant stimulus to the

It is important to now consider ways to reverse the country’s economic slowdown and instill confidence in investors. economy and a variance in opinion on matters of domestic policy reforms could potential affect the investment climate. The first quarter of the financial year started with a promising FDI growth of 132.9 percent, but thereafter the growth slowed down to 8.8 percent in Q2 and further to just 0.4 percent during Q3 of 2011-12. The economy needs a clear plan outlining the key sectors where the government wants to attract more FDI. This would provide foreign investors a focused view, unlike current confusion on FDI in retail industry.

The Fiscal Challenges The central government’s key deficit indicators have worsened during 2011-12, primarily on account of a decline in revenue receipts, particularly the tax receipts and underachievement in budgeted disinvestments as well as increase in revenue expenditure, mainly oil & fertilizer subsidies. With rise in international crude oil prices the budgeted oil & fertilizer subsidies have been elevated multifold.

By the end of January 2012, the fiscal deficit (Rs. 4.35 lakh crores) has already crossed the total budgeted fiscal deficit for FY 2011-12 (Rs. 4.13 lakh crores). Considering the same, the budgeted fiscal deficit to GDP ratio of 4.6 percent is now likely to escalate to about 5.5

percent mark, which will also have further inflationary implications. This is also reflected in the increased borrowings by the Government.

Beyond the budgeted estimates of Rs. 4.17 lakh crores, the Central Government has announced an increase in borrowings through dated securities of about Rs. 0.93 lakh crores in September and December. About 83 percent of revised gross and 80 percent of net market borrowings were raised up to January 16, 2012. This is another challenge for the Indian Government to protect the credibility in respect of the fiscal conditions.

To sum up, with increasing financial as well as trade integration of the Indian economy with the global economy, the potential for achieving sustained growth is high. However there remains a need for efficient ground level implementation of policy decisions and the need of a long term outlook to resolve economic challenges.

India’s competitive edge in services may only remain for a short period in the future and newer engines of growth need to be discovered. An effective manufacturing policy which is integrated into the rural framework can go a long way in bridging the rural urban divide and unite the economy to grow inclusively as one.

Current state of the Indian economy A balancing act | 7

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