Given India’s slowing economy, large public deficit and a rising subsidy bill, many had expected some hard measures of reform in the country’s fiscal year budget announced on 16 March by the finance minister. However, there has been no major proposal for economic reform in the government’s budget statement. The budget set a deficit target of 5.1% of GDP in 2012/13 and announced rises in services and excise taxes to help achieve this.
This deficit target is far above the authorities’ 4.6% deficit target for 2011/12 and takes into account increases in services and excise taxes, as well as import duties, as part of a bid to raise 400 bn rupees (US$ 7.8bn) in additional tax revenue. This deficit target is based on an assumption that global oil prices will average US$ 115/b and that real GDP growth will reach 7.6%.
It is believed that, without a reliable parliamentary majority, efforts to implement structural economic reform will continue to be hindered. So a growth rate for the 2012 fiscal year of more than 7% for the Indian economy seems unlikely, considering the current circumstances of the economy. This means that the government’s ability to meet its subsidy reduction target is far from assured.
Dual government budget and current account deficits on the one hand and elevated inflation that exerts downward pressure on private consumption growth (the main driver of economic expansion, accounting for nearly 60% of nominal GDP) on the other, together with high interest rates, are deterring capital investment. Therefore, we expect economic growth of slightly below 7% for India in 2012
In fact, recent data releases, including national accounts data for the fourth quarter of 2011, indicate a significant slowdown in economic activity. After 13 consecutive increases in the repurchase (repo) rate, the interest rate at which the Reserve Bank of India (RBI, the central bank) supplies funds to the banking system, since January 2010, the RBI cut its benchmark rate by a surprising 50 basis points, reducing the repo rate to 8.00%. The RBI has already cut the cash reserve ratio in April, to increase the liquidity, particularly in the economy, needed for manufacturing expansion. Rates are likely to continue to fall in the future, if the government succeeds in curbing the elevated inflation.
Wholesale price inflation rose to a non-seasonally adjusted 7% year-on-year in February, from 6.6% in January. Food articles and manufactured food products have a 24.3% weighting in the wholesale price index. In its review of monetary policy, released in January, the RBI mentioned high global oil prices, the recent depreciation of the rupee and the persistent fiscal deficit as sources of inflationary pressure. In view of these factors, it is expected that inflation will remain high and elevated throughout 2012 and into next year.
The rate of consumer price inflation accelerated to 8.8% year-on-year in February, from 7.7% in January. Overall, inflation in the food and beverages category averaged 6.6%, but, in some categories, the rate of price increases was of particular concern. These included: milk and milk products (up by 15.8%); oil and fats (12.8%); and eggs, fish and meat (10.6%) (EIU, April 2012).
The rupee is forecast to depreciate in the short term. India’s widening trade and fiscal deficits have put pressure on the currency. A poor outlook for the global economy, which, combined with decelerating economic growth in India, has led to a sharp slowdown in the capital inflows on which the country relies to finance its persistent fiscal and current-account deficits.
The slowdown in global economic growth in 2012 is likely to reduce capital inflows to India further and to worsen both the trade and fiscal positions, with the consequence that further downward pressure could be exerted on the local currency. The current account deficit is forecast to widen in the short term, from the equivalent of an estimated 2.2% of GDP in 2011 to 2.4% in 2012, owing to subdued global demand and relatively strong import growth.
Merchandise export growth (in US dollar terms) is expected to slow, while imports continue to grow. As import expansion will be from a much higher base, the country’s trade deficit will widen. Capital inflows have been financing India’s persistent current account deficit, but the sovereign debt crisis in the Euro-zone and political strife in the Middle East create the possibility of greater investor risk aversion reducing prospects of DFI growth in India in the 2012/2013 fiscal year.