Indian economy showed remarkable resilience and bounced back to the growth path of 9 per cent in FY 2010-11. However, attaining the average growth rate of 9 per cent that India has witnessed in recent years appears distant. The overall scenario does not augur well for targets such as 9- 9.5 per cent overall growth rate, 11-12 per cent manufacturing growth with moderate headline inflation of around 5 per cent in 12th Plan period.
Currently, it seems that growth story has partially derailed. Further, monetary tightening for the 9{+t}{+h} time, including the measures announced on May 3, 2011 leading to increase in repo and reverse repo by 50 basis points, would affect bank credit to the commercial sector and the overall investment activity in the economy. It is also evident that the Reserve Bank of India was left with little choice, but to increase the rates given the headline and core inflation.
In the last few months starting from the third quarter of 2010-11, the industrial sector has slowed down considerably and it would be too optimistic to expect a positive turnaround very soon. There has been an overall decline in manufacturing, mining and electricity generation, indicative of decreased economic activity . The capital goods sector continues to decline at a high rate while basic and intermediate goods have slowed down. Though the World Economic Outlook of April 2011 maintains status quo in 2010-11 and predicts that the emerging economies led by India and China will continue to lead the world economic growth rates, the slowdown in the industrial sector in India points to the domestic factors at play.
FDI slowdown
The decline of FDI inflows into India during 2010-11 and the low investor confidence can be attributed to several factors. These include consistent price rise leading to increasing cost of production, increase in policy rates over the last few quarters, numerous scams affecting the credibility of various corporates , increase in oil prices, renewed debate on land acquisition and environmental clearances and the debate on the safety of nuclear energy post the crisis in Japan. One way to give a push to industry and services sectors is to carry out reforms in important areas as promised by the Finance Minister in Budget 2011-12. Unfortunately, governance and corruption issues are delaying reforms since their implementation requires political consensus. Certainly, lack of reforms is also leading to low investor confidence.
The most comforting point for the government is the increase in agricultural output in the last couple of quarters which has reduced the prices of the food products. Food and vegetable prices moderated in the last quarter of 2010-11 though there has been a persistent increase in non-food inflation leading to an increase in headline and core inflation. One would expect inflation to moderate given the high base last year and monetary tightening. However, monetary tightening this time would force the banking sector to raise rates which might increase the cost of credit and affect the supply side.
Infra funding
Key infrastructure industries such as coal, electricity and cement have witnessed slowdown in recent months. Though the Planning Commission has reiterated the importance of infrastructure by raising the required investment to $1 trillion in the 12{+t}{+h} Five year Plan from $515 billion in 11{+t}{+h} Five Year Plan, it may be difficult to raise such resources. According to the Government, nearly 50 per cent of the required investment is expected from the private sector which is yet to fully support the Government's infrastructure initiatives. For example, there is complete lack of private participation in railways, a major infrastructure sector. Therefore, the Government needs to provide bankable infrastructure projects and invite private investors to participate aggressively.
This is necessary to give a boost to employment-generating sectors such as construction and reduce supply-side bottlenecks in the medium term.
The capital goods and construction sector may also have been affected by the increase of policy rates by 225 bps since April last year. Though the monetary policy measures can affect the demand-side factors in the short-run and help contain inflationary expectations, they would adversely affect supply-side factors. In fact, consistent increase in policy rates has led to a decrease in bank credit to the commercial sector and rise in credit to the Government. The expected rise in Government borrowing due to lower revenue on account of slowdown and rise in subsidies would put further pressure on interest rates.
Crude price impact
Given the increasing crude prices, it is a matter of time before the Government raises petroleum product prices to cut subsidies. This could add to the cost of production and further slowdown of industry. When there is sluggish investment growth, expected increase in interest rate may not be encouraging. Besides, issues related to land acquisition, environment and big ticket reforms are nowhere near resolution.
The services sector, which has been the driver of growth with more than 10 per cent growth rate during 2008-09, has also showed signs of slowdown in the last few quarters. Decreased output of the industrial sector along with low demand for India's services have led to decline in the growth rate of trade in services and affected the invisibles account.
Given the current situation, a moderation in growth across all sectors including the services sector is expected. It would be a tough challenge for the Government to manage inflation and bring back the economy on a high growth path of 9 per cent.
Certainly the dream of double digit growth rate is nowhere near coming true.
(The author is Associate Professor, Institute of Economic Growth, Delhi. The views are personal.)