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While economists continue to fret about whether the US will go into a double-dip recession, ponder if an additional Keynesian stimulus is the right policy solution, worry about whether a sovereign debt crisis will break the euro, and debate which nation, the UK or Germany, has hit upon the better model for fiscal restraint, in India such hand-wringing might as well be taking place on another planet. Here, the Great Global Recession already seems like nothing more than a passing storm. The country’s annual GDP growth is expected to race ahead at 8.5% this year, completing a remarkably quick rebound given that as recently as the third quarter of 2009, India’s GDP growth had slowed to 5.3%. Now, business confidence is high. Companies are hiring again. India’s bond ratings are back to pre-crisis levels. And India’s benchmark Sensex index just topped 20,000, equalling the heights it last scaled in January 2008.
Indians are once more talking about their country’s rise as an economic superpower with the same sense of inevitability that they did before 2008. Even the prospect of a double-dip recession in the West does not seem to spook India’s business and government leaders.
“It would be wrong on my part to say that we are totally insulated from the impact of the outside world,” said Pranab Mukherjee, India’s finance minister, speaking to Emerging Markets in his wood-panelled office on the very afternoon the Sensex retook the 20,000 mark.
“But at the same time, our growth projection is substantially driven by domestic demand, and therefore domestic demand will help us to reach the growth trajectory that we want to achieve.” Mukherjee reckons that emerging markets such as India will prop up the rest of the world, ensuring there is not a return to a global slump.
The numbers for domestic demand certainly look strong: in the first quarter of the current fiscal year, which ended in August, estimates are that private consumption demand ticked up at 3.8% and investment demand surged ahead at 7.6%. And while as recently as six months ago, doubts remained about the breadth of India’s recovery from the downturn, those concerns have mostly dissipated.
The quarterly growth estimates released at the end of August showed an overall GDP growth rate of 8.8%, with India’s industrial sector charging away at 10.3%, its service economy motoring ahead at 10.3% and its sluggish agricultural sector still turning in a respectable expansion of 2.8%. These numbers are similar to those India experienced before the slowdown.
But Mukherjee does acknowledge there are some dark clouds on the horizon.
In the near term, the most ominous of these is inflation. Consumer prices are rising at over 11%, the highest rate of any G20 nation. Wholesale inflation, at 8.5%, is also relatively high. Food prices – which are closely watched in a country where nearly 40% of its 1.1 billion people live below the poverty line, and high food costs have touched off riots – continue to climb. Data released September 30 showed the food price index rose 16.44% in the year to September 18, compared with 15.46% a week earlier.
“Inflation is a matter of concern,” the finance minister says, and the government is trying to lower prices by importing grain. He praises the Reserve Bank of India, the country’s central bank, for having raised benchmark rates five times since April 2009, including its first-ever mid-quarter policy action last month. The bank’s repo rate stands at 6%, its reverse-repo rate at 5.5%, and its cash reserve ratio is 6%.
INFLATION WARNING
Mukherjee is hopeful that this year’s abundant monsoon will moderate food price increases and that the central bank’s rate hikes will help rein in the general rate of inflation. But he said India might have to get used to inflation rates that would seem worrisome in more developed economies.
“I am afraid we may have to live with an annualized basis inflation of around 5–6%,” he says, although this might not be a problem as long as India can keep up the pace of overall economic growth. “Given its size and the stock of money available, 5% or 5.5% inflation is manageable.”
Comments like this, however, have unnerved some analysts, who point out that China achieved double-digit growth for most of the past decade while prices either increased slowly or fell. Ruchir Sharma, head of emerging markets for Morgan Stanley Investment Management, recently wrote that all of the 13 countries that have managed to sustain long-term economic booms since World War II did so in environments where inflation was low and stable.
Other policy-makers and analysts say the real key to moderating food inflation is agricultural and transportation reform. India’s farm productivity ranks among the lowest in the world. And what farmers do manage to produce often fails to make it to the consumer due to an archaic system of middle men and poor road infrastructure, particularly in rural areas. By some estimates, more than 40% of the food harvested in India rots before it can reach market.
“Food prices are rising very rapidly in the face of rising incomes and a very poor food distribution system,” says Saumitra Chaudhuri, a member of India’s powerful Planning Commission. “We need to fix agricultural production as well as distribution, so it is much more efficient, and spoilage is greatly reduced.”
Basic structural reforms may be necessary to tackle another contributor to general inflation in India: wage pressure. India possesses a vast pool of workers, but the amount of skilled labour is relatively limited. So when demand picks up, wage increases tend to outstrip productivity gains. “Vocational training is highly underdeveloped,” says economist Rajiv Kumar. Kumar says that while the government has been focused on creating new universities, more needs to be done to insure that the vast majority of Indians – who do not go on to post-secondary education – are prepared for productive jobs.
One reason India was able to weather the global slump was the government injected the equivalent of $9 billion into the economy in the form of three emergency stimulus packages. But the hangover from that stimulus now forms another of the obvious dark clouds on India’s economic horizon: the country’s fiscal deficit soared to nearly 7% of GDP last year, among the highest levels in the world.
On the day Mukherjee revealed this figure in July 2009, the Indian stock market plunged 869 points, its largest ever fall in response to a finance minister’s budget address.
Today, Mukherjee says his government is fully committed to bringing India’s deficit back below 4% over the next several years. The government’s fiscal target for the current year is a deficit of 5.5% of GDP, next year it is 4.8% of GDP, and in the 2012–13 fiscal year it is 4.1%.
“This medium-term road map has injected a lot of confidence into the mind of investors, and the business sentiment is high,” Mukherjee says. “This year, I have not completely rolled back the concessions I gave to industry, but I have partly rolled it back. Next year I am hoping to roll it back fully.”
Government has withdrawn some of the reductions it made in customs and excise duties. It has also partly de-regulated fuel prices, which were heavily subsidized, and proposed revamping India’s tax system to generate more revenue.
Some of these moves were deeply unpopular. The fuel price hikes, for instance, led to political protests against the government. But Mukherjee says, “The fuel subsidy burden, beyond a certain point, is not sustainable, and it also leads to inefficient allocation and use of scarce resources. We have attempted to put in place a sustainable system of subsidization taking into account the level of crude prices.”
WINDFALL FINANCES
Mukherjee likes to point out that his ability to reduce the deficit has been aided by an unexpected windfall: budget planners had estimated that auctioning off India’s 3G telecom spectrum earlier this year would raise Rs350 billion. But when the dust settled from the auction, the government was actually Rs1.05 trillion richer, meaning it had close to 1% of GDP in unexpected additional funds to help close the deficit. To date, tax, customs and excise collections are also running ahead of projections, giving Mukherjee additional breathing room.
While the threat from India’s fiscal deficit attracts more attention, some analysts point to India’s yawning current account deficit as a bigger potential worry. Montek Singh Ahluwalia, deputy chairman of India’s planning commission, expects India’s current account deficit to equal 3% of the country’s GDP this fiscal year, its highest level since India’s financial crisis in 1991. National savings have been eaten away by government expenditures, so the country is increasingly dependent on foreign capital flows to cover this gap.
At the moment, that’s not a problem. India is among the hottest investment destinations in the world, and foreign institutional money is pouring into the country. What’s more, in late September the government raised its limits on foreign investments in India’s government bond market, which has the potential to raise the country’s foreign hard currency reserves.
But what comes in can also flow out again. Foreign funds fled India during the latest crisis, not so much because the investment picture in India changed dramatically, but because investors needed to realize gains to cover losses elsewhere. That could happen again. And if the rest of the world continues to recover economically, India will face increasing competition for foreign investment from other markets, which might make it harder for India to attract the foreign reserves it needs to fund its current account deficit.
Mukherjee says India is wary of becoming too dependent on foreign investment. “We are watchful,” he says. “We definitely don’t want volatility in capital outflows, but the Indian market is quite stable.” He says he is not planning any restrictions on capital inflows either, but that the government will continue to monitor the situation.
Most of these dark clouds remain just that, clouds. They might produce a monsoon downpour, or they might simply pass by or burn away. Having come through the economic crisis relatively unscathed, the Indian economy still possesses tremendous structural strengths: a domestic savings rate of 35%, a declining age-dependency ratio, and a demographic bulge that means millions of young people will be joining the workforce for years to come.