1. Current State of the Indian Economy
Cautious optimism for the future
February 2013
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2. 2
The Big Picture
The Indian Economy has experienced
its worst slowdown in nearly a decade
on the back of global contractionary
headwinds, domestic macro-economic
imbalances and policy reversals on the
fiscal front, 2012 has been a challenging
year for the economy. The year started
with news that the previous fiscal’s
fourth quarter GDP had dropped to
5.5%. That coupled with low growth,
macro-economic issues such as high
fiscal deficit, expansionary subsidies and
worsening current account balance has
added to the slowdown.
The 2011-12 Budget had proposed
to amend the 1961 income tax
law by introducing retrospective
tax adjustments and General Anti-
Avoidance Rules (GAAR). These steps
were viewed negatively by foreign
investors. Subsequent downgrading
of the Indian economic outlook from
‘stable’ to ‘negative’ by a major rating
agency, led to continued downward
pressure on the investment climate.
Additionally, as fiscal conditions
worsened over the year, export
numbers were revised in light of data
discrepancies leading to a widening of
the current account deficit.
In the second half of the fiscal, the
Government proactively intervened
with phased reforms to stabilize the
economy. Measures were taken to
reduce subsidies (oil, fertilizers) which
would in turn lower the fiscal deficit.
The Government also took concrete
actions to attract foreign direct
investment (FDI) and strengthen the
rupee. However, the impact of these
policy reforms remains uncertain in
the short term. Concerns continue
to exist over the current account
deficit scenario, prevailing supply side
constraints, inadequate infrastructure
investments and long term policy
directions.
In face of a perceivably weak macro-
economic climate, a well-planned
economic revival policy is required to
steer the Indian Economy back on the
growth path. Even though the long
term prospects of the economy look
promising, cautious optimism is the
tone in the short to medium term.
Global Linkages
Performances of advanced economies
continue to weigh on India’s growth
story.
The World Economic Forum’s annual
meeting for 2013 was held in Davos,
Switzerland in January 2013, bringing
together more than 2,000 top business
leaders, international political leaders,
3. Current State of the Indian Economy Cautious optimism for the future 3
Economic opportunity is dwindling. While reforms have
been initiated, further action to create infrastructure, boost
savings and generate growth will be welcome
selected intellectuals and journalists to
discuss the most pressing issues facing
the world. The IMF, in its update of
World Economic Outlook, lowered the
world GDP growth projections by 0.1%
each for 2013 & 2014 as compared to
the October 2012 projections. This is on
account of downside risks that continue
in light of renewed setbacks in the Euro
area and continued risks of excessive
fiscal consolidation in the United States.
In particular, the Euro-zone faced
considerable fiscal strain in the face
of an austerity driven recession during
2012. The Euro-zone manufacturing
activity contracted for a 17th month
consecutively in December, according
to a key survey of business managers.
Indian exports to Euro-zone, which
constitute around 17% of the total
exports, appear to be impacted due
to the decreasing demand from Euro
countries. In the first nine months of
2012-13, a 10% contraction in exports
has been observed when compared to
that over a similar period in the previous
year. Moreover, despite the fact that the
US government was able to formulate
a solution to mitigate a dreaded fiscal
cliff, near term risks continue to persist.
This makes the global environment
in the coming years more uncertain
and exporters might find it more
challenging.
A note of optimism appears to surface
for the Indian service providers with
the recently concluded free trade
agreement on services and investment
between India and ASEAN countries.
Furthermore, gradual recovery in
Japanese economic conditions along
with recent rebound in China’s
manufacturing sector is expected to
improve trade conditions in the region.
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5
6
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8
World Advanced
Economies
Emerging &
Developing
Economies
Euro Area United States
Output Growth Rates in % (Current & Expected)
2010 2011 2012 2013
4. 4
The Indian environment
The current state of the economy makes
it necessary for the government to put
in place a robust and implementable
plan of action for its revival. The
economy has experienced a consistent
fall in the quarterly GDP growth since
the beginning of 2011, alarmingly
high levels of twin deficits viz. Current
Account Deficit (CAD) and fiscal deficit
as well as worrying volatility in the
inflow of foreign investments. Though
inflationary pressure has receded in
the last quarter of 2012, it still remains
above the target level of Reserve Bank
of India (RBI). This along with other
worrying economic indicators has put
the Indian economy in a challenging
pathway in the short term. Budget
2013 provides an opportunity to regain
focus by adhering to the path of fiscal
consolidation and take appropriate
policy initiatives outlining the timely
recovery of the Indian economy.
Strengthening fundamentals and
boosting growth inducing investments
is the foremost consideration at this
stage.
In order to understand the current state
of the economy, we discuss the various
aspects of economic performance of
the country in 2012, in the following
paragraphs.
The fiscal situation
The Government has found it difficult to
contain expenditure despite proactive
reforms to boost the slowing economy.
The Government revised its fiscal
consolidation roadmap in October
2012. As per the revised roadmap,
the fiscal deficit of the central govern-
ment will be reduced in a calibrated
way from the targeted 5.3% of GDP
in FY 2012-13 to 3.0% of GDP by FY
2016-17. The revision proved chal-
lenging as the actual fiscal deficit fared
at 5.9%.
Further, the combined fiscal & revenue
deficits had already reached 79% &
85% of budgeted targets by end of
December 2012. Major contributors to
high levels of deficits this year include
lower tax collections due to lower than
6.0
Fiscal Consolidation Target
6.5
4.9
5.9
5.3
4.8
4.2
3.6
3.0
0
1
2
3
4
5
6
7
Fiscal Deficit as % of GDP
5. Current State of the Indian Economy Cautious optimism for the future 5
expected economic activity (reaching
only 63% of annual target in 9 months)
and dismal PSUs disinvestment
collections (accounting only 27% of
annual target in 9 months) as against
persistent unplanned government
expenditure, which has already reached
72% of target.
Recently announced initiatives by the
Finance Minister to cut down unplanned
expenditure including subsidies are
laudable
Despite these worrying trends,
recently announced strong initiatives
by the Finance Minister to cut down
unplanned expenditure, including
subsidies are laudable. An achievement
of fiscal surplus of INR 8,227 crores
during December 2012 sends a
positive signal about Government’s
6. 6
The real sector
Moving on to the other fundamental
aspects of the economy, the declining
trend in the GDP growth is proving
to be another major concern for the
government at the moment. After a
disappointing growth rate of 5.4%
in the first half of 2012-13, the yearly
estimates for 2012-13 have been down-
graded and it is now expected to grow
at only around 5%. The country’s GDP
growth at 5.3% in the second quarter is
one of its lowest quarterly growth rates
in the last decade and annual growth of
5% will be the lowest since 2002-03.
The industrial sector, usually sizing
more than one fourth of the total GDP,
performed significantly below par this
year with growth of mere 1% during
the first half of 2012-13 as against
4.6% in first half of 2011-12. The
under-performing manufacturing sector,
particularly the capital goods industries,
poses a real challenge for the country.
Though subdued investment activity
may play a spoiler, systematic imple-
mentation of National Manufacturing
Policy as well as rise in external demand
will play a critical role in reviving indus-
trial growth.
In the agricultural sector, good winter
crop sowing prospects are expected
to overcome the negative effect of a
deficient summer crop output. The
yearly output is likely to be better than
the 2.1% growth achieved in first
half of 2013, though overall the year
is expected to close at a lower level
compared to earlier years.
4.0
8.1
7.0
9.5 9.6 9.3
6.7
8.4 8.4
6.5
5.2
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2
4
6
8
10
GDP Growth Rates (%)
willingness of adhering to its targets.
However, policymakers need to make
sure that the significant cut backs in
public expenditure do not compromise
the quality of fiscal adjustment &
development prospects in the long run.
7. Current State of the Indian Economy Cautious optimism for the future 7
A larger concern exists on the services
sector which has moderated during
2012. With “trade, hotels, transport,
storage and communication” an
important sub-sector in services
performing the worst, various indicators
of services sector activities such as
cargo handling, civil aviation & railway
freight etc. suggest further weakening
of growth. Additionally, the uncertain
global outlook is likely to affect services
exports adversely.
On the GDP expenditure side, growth
in private consumption has moderated
during 2012-13 due to high inflation
coupled with low income growth. While
investments have remained flat on
account of issues such as project cost
overruns and regulatory delays, gross
capital formation has also decreased
in the economy. Sectors such as
road transport and highway, power,
petroleum, railways, coal etc. continue
to suffer due to lack of policy clearances
and more importantly funds. It may take
a while before the impact of retail sector
reforms and policy initiatives to remove
infrastructure bottlenecks and induce
further investments are felt across the
economy. However, there are early signs
that the Indian economy may have
bottomed out the growth.
Overall, besides domestic pressures,
with global recovery likely to remain
muted in the near future, economic
revival in India will be a challenge. All
round efforts in removing impediments
in business activity and instilling investor
confidence will be necessary to revive
sectoral growth.
Manufacturing and the mining sector
needs urgent revival through
implementation of the National
Manufacturing Policy and removal of
regulatory hurdles
8. 8
The external sector
The other part of the “twin deficit
problem” relates to the Current Account
Deficit. The CAD to GDP ratio reached
a highest ever level of 5.4% in Q2 of
2012-13, heightening concerns about
the sustainability and financing of trade.
At the helm of worsening CAD for
the current year is the burgeoning
trade deficit. During the period April
to December 2012, both exports (US$
214 billion) and imports (US$ 361
billion) declined. With a sharper drop in
exports than imports, the trade deficit
has surged to US$ 147 billion in the first
9 months as against US$ 137 billion
of last year. Major decline in exports
growth is an effect of sluggish global
demand and an uncertain macro-
economic environment. In January
2013, the World Economic Outlook has
projected the world trade volume to
grow at 3.2% in 2012 as compared to
growth of 12.6% in 2010 and 5.8% in
2011, clearly showing the drop in global
demand. On the import side, the decline
in non-oil imports is largely off-set by
inelastic growth in petroleum, oil and
lubricants (POL) imports, contributing
almost 35% of total imports.
During the month of December 2012,
the Government announced export
promotion measures like extension
of interest subvention schemes,
-0.4
-1.2 -1
-1.3
-2.3
-2.8 -2.7
-4.2
-4.6
CAD/ GDP (%)
9. Current State of the Indian Economy Cautious optimism for the future 9
broadening scope of Focus Market
Scheme and Focus Products Scheme
etc. However, despite these measures,
exports recovery will primarily depend
on the level of global economic activity.
Furthermore, export diversification
policies have not been significantly
effective. For example, demand for
Indian goods in developing countries
such as those in Asia and Africa have
dropped recently.
Balance of Payment statistics show
that capital inflows have improved in
2012-13 and in fact have financed
the expanding CAD. While net FDI
inflows moderated to US$ 14.7 billion
during April-November 2012 (as
against US$ 19.6 billion last year), net
FII inflows have shown a significant
uptrend reaching US$ 11.2 billion in
2012. These robust FII inflows seem
to be largely the outcome of improved
sentiments about the Indian economy
in the second half of the year driven
by recent reforms announced by the
government in September 2012. These
reforms include, inter alia, liberalized
FDI norms for the retail, insurance and
pension sectors, a roadmap for fiscal
consolidation and an increase in FII
limits in the corporate and government
debt markets among others.
The external debt has witnessed
a steep rise in second quarter of
2012-13, reaching US$ 365 billion
from US$ 345 billion at the start of the
financial year. This is mainly on account
of surge in non-resident external
rupee denominated deposits due to
better returns and surge in External
Commercial Borrowings in response
to the government incentives. Hence,
though adverse CAD conditions have
prevailed, the recent spate of reforms
have helped the Rupee maintaining its
stability against US$ in the last quarter
of 2012.
Inflation & Monetary conditions
For most of the period of 2012-13,
the Wholesale Price Inflation (WPI) has
remained around the mark of 7.5%. It
reached as high as 8% in August 2012
and then revised down to 7.2% by
December2012, further moderating to
6.62% in January 2013.
Inflation moderation has been faster
than expected in the third quarter
touching a three year low. However,
10. 10
food inflation continues to remain
elevated along with fuel & power.
Gradual moderation of international
commodity prices on account of
decrease in crude oil prices and easing
of geo-political tensions in the Middle
East have helped in moderating
domestic inflation. The RBI has recently
made a downward revision of the
baseline WPI projection for March
2013 to 6.8%, an optimistic projection
considering the past trend.
While the downward trend in wholesale
inflation is a welcome sign, retail
inflation remains elevated. Retail
inflation surged to 10.6% in December
following readings of 9.9%, 9.8% and
9.7% respectively in last three months.
Both, food and non-food components
of retail inflation index suggest
persistent inflationary pressure. We
expect that supply side reforms will ease
this pressure in the medium term.
Following an aggressive 50 basis point
rate cut in April 2012, the RBI has
been fairly cautious in conducting its
monetary policy through 2012-13.
The RBI chose to keep the rates
unchanged in all its monetary policy
announcements till December 2012.
RBI did, on the other hand, reduce the
cash reserve ratio and the statutory
liquidity ratio in order to maintain
adequate liquidity in the economy.
However, as GDP growth continued
declining and inflationary pressures
started to recede in the second half of
2012-13, the RBI consented by reducing
the policy repo rate by 25 basis points
from 8% to 7.75% in January 2013.
This is the first repo rate cut in over 9
months. RBI subsequently also reduced
the cash reserve ratio by 25 basis points
from 4.25% to 4%.
This monetary policy action is expected
to result in consequent reduction in
the interest rates. However, it remains
to be seen if and how much a 25 basis
point reduction will encourage banks
in passing on a significant benefit to
consumers.
4%
5%
6%
7%
8%
9%
6%
7%
8%
9%
10%
11%
Reporate
Inflation
Inflation & Repo Rates (%)
Inflation Repo Rate
11. Current State of the Indian Economy Cautious optimism for the future 11
Outlook
The Indian economy is about to
experience one of the slowest growth
years in nearly a decade. In realization
of this, a push for reforms was made
in September 2012 bringing a sense of
cautious optimism. However, the impact
of reforms has remained muted till date.
Global economic uncertainties have not
helped the case for domestic growth
either.
A drop in savings and investment
has exacerbated the CAD and fiscal
deficit scenario. India had achieved
an improvement in domestic savings
from 26.5% of GDP in 2001-02 to
36.8% in 2007-08 largely due to public
savings and good macro-economic
prospects. While a considerable portion
of savings was eroded due to fiscal
stimulus in meeting the financial crisis,
a sustainable plan in putting savings
back on track never materialized.
Consequently, worsening macro-
economic environment particularly high
inflation over the past couple of years
and a depreciating rupee put a strain on
domestic savings resulting in households
hedging against this trend by investing
in gold or similar products.
During this period, corporate savings
also fell in light of the wage price
spiral and reduced margins due to
12. 12
high borrowing costs and supply side
constraints. With the RBI maintaining
high rates, corporate borrowing costs
escalated and consequently investments
waned. In addition, surplus funds in
the public system were utilized to fund
the government’s high fiscal deficit
resulting in a “crowding out” of private
borrowings. Subsequently, investible
surplus has virtually declined to its
lowest in the past few years.
Deep rooted macroeconomic imbalance
at this point can be corrected through
concrete policy steps to revive growth.
Addressing this will be crucial in the
forthcoming Budget for 2013-14.
The key concern at this point is the fiscal
deficit. Sustainable plans need to be
considered to further reduce subsidies,
widen the tax base, decrease other
expenditure and augment revenue
through public sector divestments.
However, meeting targets may take
time. While the RBI focuses to contain
inflation, it is also important for it to
consider maintaining adequate liquidity
levels by reducing the statutory liquidity
ratio and repo rates while controlling
the cash reserve ratio. The twin
action of fiscal and monetary policies
is therefore expected to help raise
savings and promote investments in the
economy. With increasing investments,
growth is expected to follow suit.
The efforts of the Finance Minister to
initiative strong reforms are laudable.
Though the announcements of
reforms have helped in lifting investor
sentiments, committed implementation
of these reforms as well as introduction
of further reforms will be required to
maintain confidence and show a path
to recovery. Budget 2013-14 presents a
good opportunity for the Government
to start the new fiscal year on a positive
note as the stakes slowly rise.
Data in graphical
representations are
based on reports
published by IMF, RBI,
Ministry of Finance,
CSO and Planning
Commission
