state of economy 2013

7/29/2019 State of Economy 2013

1/13

Current State of the Indian EconomyCautious optimism for the future

February 2013

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The Big Picture

The Indian Economy has experienced

its worst slowdown in nearly a decade

on the back o global contractionary

headwinds, domestic macro-economic

imbalances and policy reversals on the

scal ront, 2012 has been a challengingyear or the economy. The year started

with news that the previous scals

ourth quarter GDP had dropped to

5.5%. That coupled with low growth,

macro-economic issues such as high

scal decit, 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 oreign

investors. Subsequent downgrading

o the Indian economic outlook rom

stable to negative by a major rating

agency, led to continued downward

pressure on the investment climate.

Additionally, as scal conditions

worsened over the year, export

numbers were revised in light o data

discrepancies leading to a widening o

the current account decit.

In the second hal o the scal, the

Government proactively intervened

with phased reorms to stabilize the

economy. Measures were taken to

reduce subsidies (oil, ertilizers) which

would in turn lower the scal decit.

The Government also took concrete

actions to attract oreign direct

investment (FDI) and strengthen therupee. However, the impact o these

policy reorms remains uncertain in

the short term. Concerns continue

to exist over the current account

decit scenario, prevailing supply side

constraints, inadequate inrastructure

investments and long term policy

directions.

In ace o 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 o the economy look

promising, cautious optimism is the

tone in the short to medium term.

Global Linkages

Perormances o advanced economies

continue to weigh on Indias growth

story.

The World Economic Forums annual

meeting or 2013 was held in Davos,

Switzerland in January 2013, bringingtogether more than 2,000 top business

leaders, international political leaders,


3/13Current State of the Indian Economy Cautious optimism or the uture 3

Economic opportunity is dwindling. While reforms have

been initiated, further action to create infrastructure, boostsavings and generate growth will be welcome

selected intellectuals and journalists to

discuss the most pressing issues acing

the world. The IMF, in its update o

World Economic Outlook, lowered the

world GDP growth projections by 0.1%each or 2013 & 2014 as compared to

the October 2012 projections. This is on

account o downside risks that continue

in light o renewed setbacks in the Euro

area and continued risks o excessive

scal consolidation in the United States.

In particular, the Euro-zone aced

considerable scal strain in the ace

o an austerity driven recession during2012. The Euro-zone manuacturing

activity contracted or a 17th month

consecutively in December, according

to a key survey o business managers.

Indian exports to Euro-zone, which

constitute around 17% o the total

exports, appear to be impacted due

to the decreasing demand rom Euro

countries. In the rst nine months o

2012-13, a 10% contraction in exports

has been observed when compared tothat over a similar period in the previous

year. Moreover, despite the act that the

US government was able to ormulate

a solution to mitigate a dreaded scal

cli, near term risks continue to persist.

This makes the global environment

in the coming years more uncertain

and exporters might nd it more

challenging.

A note o optimism appears to surace

or the Indian service providers with

the recently concluded ree trade

agreement on services and investment

between India and ASEAN countries.

Furthermore, gradual recovery in

Japanese economic conditions along

with recent rebound in Chinas

manuacturing sector is expected to

improve trade conditions in the region.

-1

01

2

3

4

5

6

7

8

World AdvancedEconomies

Emerging &DevelopingEconomies

Euro Area United States

Output Growth Rates in % (Current & Expected)

2010 2011 2012 2013


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The Indian environment

The current state o the economy makes

it necessary or the government to put

in place a robust and implementable

plan o action or its revival. The

economy has experienced a consistent

all in the quarterly GDP growth sincethe beginning o 2011, alarmingly

high levels o twin decits viz. Current

Account Decit (CAD) and scal decit

as well as worrying volatility in the

infow o oreign investments. Though

infationary pressure has receded in

the last quarter o 2012, it still remains

above the target level o Reserve Bank

o India (RBI). This along with otherworrying economic indicators has put

the Indian economy in a challenging

pathway in the short term. Budget

2013 provides an opportunity to regain

ocus by adhering to the path o scal

consolidation and take appropriate

policy initiatives outlining the timely

recovery o the Indian economy.

Strengthening undamentals and

boosting growth inducing investments

is the oremost consideration at this

stage.

In order to understand the current state

o the economy, we discuss the various

aspects o economic perormance o

the country in 2012, in the ollowingparagraphs.

The scal situation

The Government has ound it dicult to

contain expenditure despite proactive

reorms to boost the slowing economy.

The Government revised its scal

consolidation roadmap in October

2012. As per the revised roadmap,the scal decit o the central govern-

ment will be reduced in a calibrated

way rom the targeted 5.3% o GDP

in FY 2012-13 to 3.0% o GDP by FY

2016-17. The revision proved chal-

lenging as the actual scal decit ared

at 5.9%.

Further, the combined scal & revenue

decits had already reached 79% &

85% o budgeted targets by end o

December 2012. Major contributors tohigh levels o decits this year include

lower tax collections due to lower than

6.0

FiscalConsolidationTarget

6.5

4.9

5.95.3

4.84.2

3.6

3.0

0

1

2

3

4

5

6

7

Fiscal Deficit as % of GDP



expected economic activity (reaching

only 63% o annual target in 9 months)

and dismal PSUs disinvestment

collections (accounting only 27% o

annual target in 9 months) as against

persistent unplanned government

expenditure, which has already reached72% o target.

Recently announced initiatives by theFinance Minister to cut down unplannedexpenditure 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

o scal surplus o INR 8,227 crores

during December 2012 sends apositive signal about Governments


6/136

The real sector

Moving on to the other undamental

aspects o the economy, the declining

trend in the GDP growth is proving

to be another major concern or the

government at the moment. Ater a

disappointing growth rate o 5.4%

in the rst hal o 2012-13, the yearly

estimates or 2012-13 have been down-graded and it is now expected to grow

at only around 5%. The countrys GDP

growth at 5.3% in the second quarter is

one o its lowest quarterly growth rates

in the last decade and annual growth o

5% will be the lowest since 2002-03.

The industrial sector, usually sizing

more than one ourth o the total GDP,

perormed signicantly below par this

year with growth o mere 1% during

the rst hal o 2012-13 as against

4.6% in rst hal o 2011-12. The

under-perorming manuacturing sector,

particularly the capital goods industries,

poses a real challenge or the country.

Though subdued investment activity

may play a spoiler, systematic imple-

mentation o National Manuacturing

Policy as well as rise in external demandwill play a critical role in reviving indus-

trial growth.

In the agricultural sector, good winter

crop sowing prospects are expected

to overcome the negative eect o a

decient summer crop output. The

yearly output is likely to be better than

the 2.1% growth achieved in rsthal o 2013, though overall the year

is expected to close at a lower level

compared to earlier years.

4.0

8.17.0

9.5 9.6 9.3

6.7

8.4 8.4

6.5

5.2

-

2

4

6

8

10

GDP Growth Rates (%)

willingness o adhering to its targets.

However, policymakers need to make

sure that the signicant cut backs in

public expenditure do not compromise

the quality o scal adjustment &

development prospects in the long run.



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

perorming the worst, various indicators

o services sector activities such ascargo handling, civil aviation & railway

reight etc. suggest urther weakening

o growth. Additionally, the uncertain

global outlook is likely to aect services

exports adversely.

On the GDP expenditure side, growth

in private consumption has moderated

during 2012-13 due to high infationcoupled with low income growth. While

investments have remained fat on

account o issues such as project cost

overruns and regulatory delays, gross

capital ormation has also decreased

in the economy. Sectors such as

road transport and highway, power,

petroleum, railways, coal etc. continue

to suer due to lack o policy clearances

and more importantly unds. It may take

a while beore the impact o retail sector

reorms and policy initiatives to removeinrastructure bottlenecks and induce

urther investments are elt 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 uture, economicrevival in India will be a challenge. All

round eorts in removing impediments

in business activity and instilling investor

condence will be necessary to revive

sectoral growth.

Manufacturing and the mining sectorneeds urgent revival throughimplementation of the NationalManufacturing Policy and removal ofregulatory hurdles


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The external sector

The other part o the twin decit

problem relates to the Current Account

Decit. The CAD to GDP ratio reached

a highest ever level o 5.4% in Q2 o

2012-13, heightening concerns about

the sustainability and nancing o trade.

At the helm o worsening CAD or

the current year is the burgeoning

trade decit. 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 decit

has surged to US$ 147 billion in the rst9 months as against US$ 137 billion

o last year. Major decline in exports

growth is an eect o 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 o 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 o-set by

inelastic growth in petroleum, oil and

lubricants (POL) imports, contributing

almost 35% o total imports.

During the month o December 2012,

the Government announced export

promotion measures like extension

o interest subvention schemes,

-0.4

-1.2-1

-1.3

-2.3

-2.8 -2.7

-4.2-4.6

CAD/ GDP (%)



broadening scope o Focus Market

Scheme and Focus Products Scheme

etc. However, despite these measures,

exports recovery will primarily depend

on the level o global economic activity.

Furthermore, export diversication

policies have not been signicantlyeective. For example, demand or

Indian goods in developing countries

such as those in Asia and Arica have

dropped recently.

Balance o Payment statistics show

that capital infows have improved in

2012-13 and in act have nanced

the expanding CAD. While net FDIinfows moderated to US$ 14.7 billion

during April-November 2012 (as

against US$ 19.6 billion last year), net

FII infows have shown a signicant

uptrend reaching US$ 11.2 billion in

2012. These robust FII infows seem

to be largely the outcome o improved

sentiments about the Indian economy

in the second hal o the year driven

by recent reorms announced by the

government in September 2012. These

reorms include, inter alia, liberalized

FDI norms or the retail, insurance and

pension sectors, a roadmap or scal

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 o

2012-13, reaching US$ 365 billion

rom US$ 345 billion at the start o thenancial year. This is mainly on account

o 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 o reorms

have helped the Rupee maintaining itsstability against US$ in the last quarter

o 2012.

Infation & Monetary conditions

For most o the period o 2012-13,

the Wholesale Price Infation (WPI) has

remained around the mark o 7.5%. It

reached as high as 8% in August 2012

and then revised down to 7.2% by

December2012, urther moderating to

6.62% in January 2013.

Infation moderation has been aster

than expected in the third quarter

touching a three year low. However,


10/1310

ood infation continues to remain

elevated along with uel & power.

Gradual moderation o international

commodity prices on account o

decrease in crude oil prices and easing

o geo-political tensions in the Middle

East have helped in moderatingdomestic infation. The RBI has recently

made a downward revision o the

baseline WPI projection or March

2013 to 6.8%, an optimistic projection

considering the past trend.

While the downward trend in wholesale

infation is a welcome sign, retail

infation remains elevated. Retailinfation surged to 10.6% in December

ollowing readings o 9.9%, 9.8% and

9.7% respectively in last three months.

Both, ood and non-ood components

o retail infation index suggest

persistent infationary pressure. We

expect that supply side reorms will ease

this pressure in the medium term.

Following an aggressive 50 basis point

rate cut in April 2012, the RBI has

been airly 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 thecash reserve ratio and the statutory

liquidity ratio in order to maintain

adequate liquidity in the economy.

However, as GDP growth continueddeclining and infationary pressures

started to recede in the second hal o

2012-13, the RBI consented by reducing

the policy repo rate by 25 basis points

rom 8% to 7.75% in January 2013.

This is the rst repo rate cut in over 9

months. RBI subsequently also reduced

the cash reserve ratio by 25 basis points

rom 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 i and how much a 25 basis

point reduction will encourage banks

in passing on a signicant benet to

consumers.

4%

5%

6%

7%

8%

9%

6%

7%

8%

9%

10%

11%

Repo

rate

Inflation

Inflation & Repo Rates (%)

Inflation Repo Rate



Outlook

The Indian economy is about to

experience one o the slowest growth

years in nearly a decade. In realization

o this, a push or reorms was made

in September 2012 bringing a sense o

cautious optimism. However, the impacto reorms has remained muted till date.

Global economic uncertainties have not

helped the case or domestic growth

either.

A drop in savings and investment

has exacerbated the CAD and scal

decit scenario. India had achieved

an improvement in domestic savingsrom 26.5% o GDP in 2001-02 to

36.8% in 2007-08 largely due to public

savings and good macro-economic

prospects. While a considerable portion

o savings was eroded due to scal

stimulus in meeting the nancial crisis,

a sustainable plan in putting savings

back on track never materialized.

Consequently, worsening macro-

economic environment particularly high

infation over the past couple o 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 savingsalso ell in light o the wage price

spiral and reduced margins due to


12/1312

high borrowing costs and supply side

constraints. With the RBI maintaining

high rates, corporate borrowing costs

escalated and consequently investments

waned. In addition, surplus unds in

the public system were utilized to und

the governments high scal decitresulting in a crowding out o private

borrowings. Subsequently, investible

surplus has virtually declined to its

lowest in the past ew years.

Deep rooted macroeconomic imbalance

at this point can be corrected through

concrete policy steps to revive growth.

Addressing this will be crucial in theorthcoming Budget or 2013-14.

The key concern at this point is the scal

decit. Sustainable plans need to be

considered to urther 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 ocuses to contain

infation, it is also important or 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 o scal and monetary policiesis thereore expected to help raise

savings and promote investments in the

economy. With increasing investments,

growth is expected to ollow suit.

The eorts o the Finance Minister to

initiative strong reorms are laudable.

Though the announcements o

reorms have helped in liting investorsentiments, committed implementation

o these reorms as well as introduction

o urther reorms will be required to

maintain condence and show a path

to recovery. Budget 2013-14 presents a

good opportunity or the Government

to start the new scal year on a positive

note as the stakes slowly rise.

Data in graphical

representations are

based on reports

published by IMF, RBI,Ministry o Finance,

CSO and Planning

Commission


13/13

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