Growth will remain comparatively high in India during 2012

Although forecasts have been revised downwards, economic growth in India will remain high in an international context: 8.4% in 2012. Inflation is expected to slow down.
Analisis Credito y Caución
Madrid - 01-dez-2011

The Indian economy had achieved high growth rates of more than 7% each year since 2003, peaking at 9.7% in 2006. Only in 2008 did output slip - to 5.1% - due to the bursting of the domestic shares and other asset bubbles in the wake of the global economic crisis. In contrast to other Asian emerging markets, Indias economy is driven mainly by domestic consumption, with exports accounting for only 15% of GDP. The external sector has traditionally been dominated by services: especially information and communication technology, and business service outsourcing.

Real GDP growth stood at 8.8% last year, driven by the booming services and manufacturing sectors and private consumption. However, a moderate decrease is currently taking place this year and will continue in the coming months, as the global economy weakens and interest rates remain high. Overall economic growth is forecast to slow to 7.9% in 2011.

Although forecasts have been revised downwards, economic growth will remain high in an international context: 8.4% in 2012. Inflation is expected to slow down next year. The sustainable foreign debt level, high reserves and prudent foreign debt management will continue to underpin Indias sovereign payment capacity.

Inflation is the main concern

Consumer price inflation was 12% in 2010 as food prices rose sharply and prices for capital goods, shares and real estate also tended to increase rapidly. Fuel price increases have contributed to the overall price inflation as has the inability of the supply capacity of the Indian economy to keep pace with demand.

While inflation has decreased somewhat since January 2011, it nevertheless remains quite high and the upward pressure on price levels will continue for the time being. Therefore, high consumer prices remain a serious concern, undermining the purchasing power of the many poorer households. According to World Bank estimations more than three quarters of the populations still live on less than US$ 2 a day. Food inflation, which accounts for over 14% of overall Wholesale Price Index [WPI] inflation, has remained high since December 2010, despite good harvests, indicating that the price level is driven even more by structural bottlenecks.

To curb inflation, the Reserve Bank of India [RBI] has tightened monetary policy by repeatedly raising key short-term interest rates: by 350 basis points since March 2010. In September this year, the RBI again increased interest rates: by 25 basis points to 8.25%, and further increases are anticipated. This is in contrast to some other emerging markets that have recently lowered interest rates as a reaction to the Eurozone debt crisis and faltering US economy.

High budget deficits persist

The governments poor budgetary discipline is reflected in persistent budget deficits. The central budget deficit is 5% of GDP for 2010 and 4.7% of GDP for 2011, but the total deficit, including those of the federal states, amounts to 10% of GDP according to the IMF. The main reason is the low tax base, combined with high expenditure on subsidies for fuel, food and fertilizer. While these deficits can be financed by domestic borrowing, that has pushed domestic public debt as high as 70% of GDP in 2010.

Beside the high budget deficit, Indias main structural deficiencies are: the underdevelopment of the agricultural sector; poor infrastructure; inflexible labour laws; excessive bureaucracy; rigid land laws [Land Acquisition Act], and a shortage of skilled labour due to the poor education of most of the population.

India is the worlds largest producer of coal, which provides more than 50% of its energy consumption. 66% of oil and gas is imported. Electricity supply is highly unreliable, representing a major impediment for the economy. The high dependence on oil imports and the high subsidies associated with it are the Achilles´ heel of the Indian economy.

Many expected that, after its success in the 2009 general election, the Congress party would finally tackle the necessary structural reforms that it had been unable to pass in its first term due to its dependence on support from left-wing parties. Although the government has launched some initiatives to fight rural poverty and to cut fuel subsidies, the prospects for significant structural reforms remain bleak: it still does not command a parliamentary majority, the political landscape remains fragmented, and there are strong anti-reform forces within the Congress Party.

Several corruption scandals have undermined the governments authority, making the building of parliamentary alliances to achieve majorities even more difficult. Therefore, further progress in structural reform is unlikely in the short term. The next general elections are scheduled for 2014, but an early election cannot be entirely ruled out.

Terrorist attacks in November 2008 proved a serious setback to relations between India and Pakistan. Unofficial bilateral meetings by senior officials have been resumed, but relations remain strained and may well deteriorate again. Relations with China remain sensitive, due in part to border disputes. However, economic ties are improving. After decades of rather lukewarm relations with the US, Washington now considers India a strategic partner and potential counterbalance to Chinas rising power in Asia.

Still a long way to go

As a lower-middle income country, India still has a long way to go in terms of development. Welfare is unequally distributed among regions and social groups, but a middle class that is able to sustain a buoyant domestic market is growing rapidly, creating increasing demand for consumer goods and opportunities for domestic and foreign investment.

Moreover, the economic structure has to be significantly upgraded, especially with regard to Indias poor infrastructure. The issues of power supply, roads and railways, and the poor education system urgently need to be addressed. More public/private investment partnerships for infrastructure projects are needed, and the government plans to increase incentives for private investors. So far, private sector participation in infrastructure development has been concentrated mainly in the telecoms sector, with such participation in other areas, as sanitation, power generation, roads and railways, much lower than expected.  Consequently, there is a continuing problem of power and water shortages in all Indias major cities. The government is still deferring major structural reforms to stimulate FDI, i.e. to allow foreign investment in the retail sector.

Indias growth profile, in contrast to that of China, is reflected in a substantial twin deficit: both the public sector account and the current account registering negative figures. Indias public sector deficit adds to the government debt, which reached 70% of GDP in 2010. Fiscal discipline in India is quite poor, based on low tax revenues and the extensive programme of subsidies on food, fuel and fertilizers. Although the current account is structurally negative, ample international liquidity and a low level of external debt ensure that India will continue to be a fast-growing and robust market.

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