Indian Economy 2012

An Overview of the Indian economy in 2012 and its prospects for the future. (Depressed by events in Europe, a look at an economy with a very different economic outlook).

Summary

In the past few years, the Indian economy has been growing rapidly – (e.g.  8.5%2010-11). However, this growth has led to an increase in inflation of 6%. In response to higher inflation, the RBI of increased interest rates and this has caused a slow down in the rate of economic growth.

Indian Rupee

Inflationary pressures and falling competitiveness have contributed to a steady decline in the value of the Rupee. This depreciation in the Rupee is cause for concern because

  • It increases the price of imported raw materials, e.g. oil (thereby contributing to imported inflation)
  • Discourages foreign investment, worried about decline in value of currency.

Fiscal Deficit

Despite high economic growth, the government’s fiscal deficit stands at 5.5% of GDP. This is very high given the state of the economic cycle. With high economic growth, this level of government borrowing has the effect of crowding out the private sector. Public sector debt is 71% of GDP (2011 est) and the credit rating is BBB. It leaves the fiscal deficit vulnerable, should there be a sharp slow down in economic growth.

The Indian Central Bank (Reserve Bank of India) RBI, make commercial banks hold 24% of their core deposits in government bonds. This is ostensibly for a safety valve and improved liquidity, others feel it is to help keep government bond yields low. But, if government bond yields are kept low, it can reduce the incentive for the government to tackle politically popular issues like spending and tax.

Now, would be a good time for India to tackle its budget deficit, but it is uncertain if the political will is there.

Monetary Policy

In response to higher inflation, the Indian Central Bank have increased interest rates in an attempt to control inflation. (The main repo rate is currently 8.5% BBC) These interest rate rises have had the impact of reducing the economic growth rate. Many now predict the growth rate to fall to 6% in 2012. However, the interest rate increases have failed to tackle inflation, partly because of rising commodity prices which put upward pressure on cost-push inflation.

Article on Reserve Bank of India at Economist

Global Trade

India is more insulated to global trade than many other countries. It has strong domestic demand and is more self-sufficient than countries in Europe. However, in an era of globalisation it is still influenced by economic prospects in the rest of the world. It’s main trading partner, such as China (12% of imports) and South East Asia are still performing well. The slowdown in the Eurozone will have some adverse effect on India, but it shouldn’t be a major factor unless there is a very serious credit crunch. India’s biggest export market is the US (12% of exports) Recovery in the US should help demand for manufactured goods.

More worrying is the persistent Indian current account deficit. Despite a falling Indian Rupee, the current account has shown little signs of improvement.

Goldman Sachs forecast the Indian Current account could widen to 4.2% of GDP in 2012 (FT)

Another worrying aspect of the Indian current account deficit is the fact it is being financed by short term capital flows rather than long term investment.

Boom and Bust Cycle

The Indian economy is characterised by strong domestic demand, growing inflation, falling value of currency and current account deficit. This is reminiscent of the Asian crisis of the late 1990s. If India experienced a sustained outflow of capital, it could cause an even quicker deterioration in the value of the Rupee, causing inflation and necessitating higher interest rates which would reduce growth.

However, if capital flows into India can be sustained, there is still much to be optimistic about. India  has great potential for growth, especially if it could:

  • Deal with corruption and encourage greater liberalisation of the economy (Indian economy BBC)
  • If the government reduced its budget deficit and enabled more private sector investment
  • If the RBI continue to keep inflationary pressures under check.

Unemployment and Poverty

Despite several years with growth averaging 7%, unemployment in India is still in double digits (11% Jan 2012). Also, the economic growth still needs to filter down to the rural and urban poor. As estimated 41% of the population live below the poverty line of $1.25

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