What holds India back?

Last updated on: April 4, 2008 at 5:22 am by jessicafick

What holds India back? 2008-04-04T05:22:16-05:00 jessicafick

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This article was written for Drishtikone by Atul Surana who is a Certified Financial Planner.

According to the Asian Development Bank (ADB), the developing economies in Asia will not be immune to the global economic slowdown. At the same time, they will not be hostage to it. Citing rising commodity prices and food inflation as the prime hurdles, the bank has stated that the growth prospects of Asian economies are likely to depend much more on how successfully countries manage their internal risks and overcome domestic constraints to growth. While the ADB has reduced its 2008 GDP growth forecasts from 10.8% to 10.0% for China, the same has been pegged at 8.0% for India from 8.5% earlier. Attempts by the government bodies to dismiss fears of a slowdown in growth have been quelled by some of the key factors that have made the earlier growth projections unfeasible.

Moderated consumption growth: The firm lending rates have resulted in a sharp reduction in consumption growth that was expected to lever India’s growth on the back of its demographic dividend (growing young population). Leveraged spending by households has already declined sharply, as reflected in two-wheeler and auto sales, consumer durables production and mortgage lending growth. Consumer goods production growth has decelerated sharply to 4.3% during the three months ended January 2008 from the peak of 18.5% in June 2005 (Source: CMIE). Two-wheeler sales have been declining year on year for the past 11 months. Growth in fresh mortgage disbursements has remained low at single-digit levels for the last few quarters.

Lower exports: Besides the moderation in consumption growth, the export sector has also suffered a meltdown because of weakening demand in the developed world and appreciation in the rupee. Export growth in rupee terms has weakened to an average of 7.9% over the past six months compared with 23.3% during the 12-months ended March 2007. A leading indicator of exports to the US (US ISM New Orders Index) predicts a further slowdown for India’s exports over the next six months.
Deferred corporate investments: The extended duration of weak consumption growth patterns has also weakened business sentiments. The sharp slowdown in demand for goods has started weighing on the corporate sector’s confidence in capacity utilisation. The risk of poor takeoffs and underutilisation of new capacities that would hurt corporate profitability is leading to corporates deferring their investment plans.

Monetary restrictions: The Reserve Bank of India (RBI), unlike its US counterpart (Federal Reserve) has shown its intolerance to excess liquidity and inflationary trends so far. This has, at times, been even at the cost of slower growth and dampened investor sentiments. However, the generous fiscal incentives offered in the budget and thereafter (the recent import duty slashes) are expected to undo the damage. Two of the key measures, the Rs 600 bn farm loan subsidy and the Rs 300 bn increase in salaries and pension payments to central government and railways employees are also expected to provide some support to consumption growth.

Commodity and food prices: Inflation based on the Wholesale Price Index accelerated to 6.7% in March 2008, from the lows of 3.1% in November 2007. The key components of the index – food, fuel and metals – contributed to this acceleration. The government’s measures at discouraging exports and encouraging import of some of the deficit commodities, however, do not seem to be going well with the producers of the same.

It has to be noted that the Indian market is structurally suited for leveraging shortages rather effectively. Added to this is the information asymmetry among various class of consumers as well as between consumers on one hand, and producers and consumers, on the other. Further, the sustained flow of foreign money, thanks to the excessive global liquidity in the world, has fuelled the rise of the stock markets and real estate prices in India to unprecedented levels. This boom has naturally led to corresponding booms in various related markets as much as the increased credit flow has in a way resulted in overall inflation.

Since economic policies are a combination of fiscal, monetary and trade policies, one needs to understand that these policies are typically complimentary. Hence the fiscal and monetary policies are currently lending the trade policies redundant. One policy route, however, yet unexamined in the Indian context is the exchange rate policy, especially revaluation of the Rupee as an instrument to control inflation. Going forward, this is expected to be an important aspect of financial deliberation.

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