India remains a relatively closed economy. Export of goods and services amount to only 19 % of GDP. Despite several violent conflicts, India as a whole is still regarded as a fairly stable nation and a successful emerging economy. Several massive corruption scandals have shaken the government and hampered parliamentary processes and progress since 2010, putting increasing pressure on Prime Minister and leading to temporary blockades of parliamentary business by the opposition. The power and cohesion of the coalition has eroded significantly and even more effort has to be put into building alliances. In particular, smaller and more extreme parties seem to benefit from the current situation.
In response to the reform announcements made since September 2012, two smaller regional parties have left the coalition. This could put some reform proposals at stake, as the announced changes in the insurance and pensions sectors [to permit more foreign investment] require parliamentary approval, and the government now needs the support of MPs from outside the coalition to pass legislation. At least the government won a crucial vote in parliament on its controversial plans to open the retail sector to foreign competition in early December.
In order to strengthen his government, Prime Minister reshuffled his cabinet in October: replacing about a third of his ministers. But despite the recent initiatives, there is some doubt about further and more in-depth reforms to tackle the economys structural deficiencies, as the government remains weak, divided and plagued by corruption scandals. It is nevertheless expected to stay in power for its complete term, which expires in May 2014, simply because some parties within and outside the coalition do not want early elections as they would probably lose parliamentary seats.
The Mumbai terrorist attacks in November 2008 proved a serious setback to relations between India and Pakistan. New Delhi immediately withdrew from the peace talks that had begun in 2004 with the aim of settling outstanding disputes such as the Kashmir conflict, and demanded that Pakistan bring to justice those responsible for the attack and dismantle the terrorist networks. 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.
High interest rates hamper economic growth
Economic growth has decelerated markedly since 2011 after high growth rates were recorded in 2009 and 2010. In Q2 of 2012 GDP increased only 5.5 % year-on-year, followed by 5.3 % in Q3, and the 5.8 % growth rate forecast for 2012 is far below the long-term potential growth rate of 9%.
This slowdown is due mainly to stubbornly high inflation and increased interest rates, which have a negative effect on both consumer demand and investments. Other impeding factors are a disappointing monsoon season, power outages and structural deficiencies, combined with a less benign global economic environment. Foreign direct investments decreased more than 30 % year-on-year in the first half of 2012. Industrial production has been subdued for most of this year: hurt by moderating consumer demand and a drop in exports as the global recovery falters.
Inflation remains structurally high, forecast to be 9.2 % this year. 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].
The high inflation rate has forced the Reserve Bank of India to continue its relatively tight monetary policy: currently the key short-term interest rate [repo rate] stands at 8 %. Since real interest rates are still negative, a cut in the interest rate in order to support the economy is unlikely in the short term. However, at the end of October 2012, the central bank did at least reduce banks reserve requirements to 4.25 % from 4.5 % in a bid to boost lending: it expects that this measure will inject 175 billion rupees [US$ 3.2 billion] into the market.
High budget deficits persist
The governments poor budgetary discipline is reflected in persistent budget deficits. The central budget deficit is 5.8 % of GDP for 2011 and 6 % of GDP for 2012 but the total deficit, including those of the federal states, amounts to about 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, this pushed domestic public debt as high as 70 % of GDP in 2011.
Reform progress has been slow
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. All these factors are barriers to foreign investment and higher growth rates.
The issues of power supply, roads and railways, and the poor education system urgently need to be addressed. More public/private investment partnerships are needed for infrastructure projects, and the government repeatedly voiced its intention to increase incentives for private investors. So far, however, private sector participation in infrastructure development has been concentrated mainly in the telecom sector, with participation in other areas [sanitation, power generation, roads and railways] much lower than expected. Consequently, there is a continuing problem of power and water shortages in all of Indias major cities.
Mounting economic pressure has at last triggered some reforms
By September 2012, the economic slowdown finally led the government to announce some public spending cuts and foreign investment liberalisation: together with a 14 % price increase for subsidised diesel the government has opened the retail sector to international firms, allowing them to buy up to a 51 % stake in Indian multi-brand retailers. However, the implementation has been left entirely to the federal states, which means that some of those that are ruled by opposition parties and Congress allies who are against organised retail can opt out. Other reform measures announced include liberalisation of foreign investment in aviation, broadcasting, power exchanges, and insurance and pensions.
Dependence on oil imports
India is the worlds largest producer of coal, which provides more than 50 % of its energy consumption. 66 % of its 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.
In 2013, economic growth is expected to increase again - to 6.5 % - which is still far below the 9 % regarded as the long-term potential growth rate. Inflation is expected to slow somewhat next year: to around 8 %. Despite a lower budget deficit of 5.4 % of GDP expected in 2013, poor fiscal discipline will remain a concern. This deficit has led to increasing domestic government debt, adding to Indias already high public debt-to-GDP ratio, and the 2014 elections may further worsen the fiscal balance.
The Indian government still enjoys a sovereign investment grade rating of BBB-, but the outlook has recently turned negative. Deterioration in the fundamentals may result in a downgrade to speculative grade, decreasing Indias access to international financial markets and raising interest rates.
Nevertheless, India can to a large extent finance its deficits domestically. Because of its relatively closed economy it is less vulnerable to the unfavourable economic developments in Europe and, unlike other Asian emerging markets, Indias economy is driven mainly by domestic consumption, with exports accounting for only 19% of GDP. Externally, the sustainable foreign debt level, high reserves and prudent foreign debt management will continue to underpin Indias sovereign payment capacity.
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.
Mantenha-se informado. Receba a nossa Newsletter