India: Tempered growth

Having recorded higher-than-expected growth in the second quarter of 2012, India should see a welcome fillip for an economy struggling to replicate the stellar performance of recent years.

GDP increased at a rate of 5.5% between April and June, according to the Central Statistics Office in Delhi. Driven on by rate cuts aimed at stimulating domestic demand, such growth came as a mild surprise to economists that had been predicting expansion of 5.2%, according to median estimates by the Bloomberg News Survey. The construction and financial services sectors were the standout performers, increasing by 10.9% and 10.8%, respectively, while manufacturing and agricultural growth were down by 0.2% and 2.9%, respectively.

Although a growth rate exceeding 5% would be welcomed in most economies around the globe, for India it is close to the lowest growth in a decade and well below the level of 9% that the government has targeted to drive up living standards and create jobs for its 1.2bn people.

Given the relatively sluggish performance of the economy, in August Prime Minister Manmohan Singh’s economic advisory panel cut growth forecasts for the year to March 2013 to 6.7% from a previous estimate of 7.5-8%. This follows a July decision by the IMF to revise growth projections downward to 6.1% for 2012 and 6.5% for 2013, from 6.9% and 7.3%, respectively.

Struggling economies throughout the globe are partly responsible for the recent corrections. Indian export growth is currently on a downward curve, slipping from 18.1% in the first quarter of the year to 10.1% in the second. The country had the highest global export growth in 2011, reaching 16.1%, according to the World Trade Organisation (WTO).

However, despite attempts to diversify its export base, including efforts to close the $40bn trade gap with China, exports are likely to weaken throughout the rest of 2012, while imports continue to grow, reaching a 7.9% increase in the second quarter, compared to 2% in the first.

Nonetheless, with domestic consumption accounting for almost 70% of the Indian economy, according to the Reserve Bank of India (RBI), the country has been largely protected from the global crisis and continues to be seen as a solid long-term prospect by many investors. The Bombay Stock Exchange is up more than 12% this year, with companies focused on local consumption performing particularly well. According to Reuters, net foreign institutional investment in stocks and bonds had quadrupled to $16.7bn in the first eight months of 2012, adding $4bn since the start of July alone.

To some extent, investors appear to be betting on irrefutable long-term demand drivers, such as the market of more than 1bn consumers. In the shorter term, however, the prospects for domestic consumption are less clear. A drop of 17% in the rupee against the dollar in the past year has increased the cost of imports, particularly oil, and, along with rising food costs, has pushed inflation towards 7%.

Sumita Kale, the chief economist at Indicus Analytics, a local research firm, told OBG, “As a result of inflation, people are scaling back and household budgets have been changing over the past year. We do not know how long this situation is going to last, and so a rebalancing of the budget is taking place in the household.”

This trend is of particular concern to the RBI. Despite a rate cut to 8% from 8.5% in April 2012, the government is reluctant to reduce borrowing costs further. Indian interest rates have come down only once in the past two years, as the government continues to be more concerned by inflation than domestic demand and growth.

As growth slows, however, the budget deficit has become a priority. With tax revenues being threatened, the government is said to be contemplating budget cuts. Kale, however, told OBG, “Even if there is a policy move, which is unlikely, I do not see any change [in the economic situation] in the next three or four quarters”.

The biggest issue is likely to be the politically sensitive subsidies on diesel, other fuels and fertiliser. The RBI is looking to contain the budget deficit to 5.1% of GDP for this fiscal year (down from 5.8% for 2011/12) by keeping the subsidy programme below 2% of GDP. However, Kale told OBG, “It has become a political issue, not an economic one. I do not see any reduction in the subsidy bill [in the near future].”

Citigroup and Crisil, the local subsidiary of Standard and Poor’s (S&P), have both predicted that the fiscal deficit will widen as a result of weak economic growth. Indeed, in June 2012, S&P warned that the country risks losing its investment grade status.

“Fiscal slippage, combined with persistently high inflation, could further weaken investor confidence. Both the government's debt burden and fiscal flexibility could continue to erode, in step with rising external vulnerability due to higher trade and current account deficits. India's credit quality would suffer under such a scenario, and a downgrade could result," the ratings agency said in a press statement in June.

The August reinstatement of former minister of finance, Palaniappan Chidambaram, who steered the country through the worst of the 2008 crisis, suggests the government is taking the current situation seriously and is aiming to put the $1.84trn economy back on track. Investors in the country’s stocks and bonds continue to have confidence in the India’s future, however; a positive sign that the potential of the economy will be fulfilled.