The action plan for India's government is clear: reviving the investment cycle, sustaining reforms action, combating inflation, reining in the twin deficits of fiscal and current account, creating skilled jobs and enhancing labour productivity, expanding export geographies, removing infrastructure bottlenecks and reducing borrowing costs. An ambitious plan considering the country's challenges, but one that could really push it forward.
The GDP growth rate, which ranged between 7% and 9% during most years of the last decade, fell below 6.5% in 2012 and is around 5% in FY 2013 – the lowest in the decade.
Rating agencies like S&P and Fitch lowered their credit rating outlook given the slowdown in GDP growth and industrial output, widening current account deficit, inflation and fiscal pressures, policy slowdown, etc. However, certain positive news-flow, especially in the second half of the year, triggered short bursts of optimism.
These included easing in manufacturing inflation, some action on the reforms/policy front, plans to bring the fiscal deficit below 5%, as well as regulatory changes to increase savings flows.
The country needs to shift from consumption to savings and investment. India has traditionally been a savings-oriented country, but gross domestic savings as a percent of GDP have declined from the last five-year historical average of 33-34% to around 31% as of FY 2012.
Within households, the share of financial savings has declined in recent years, while that of physical savings has risen, coinciding with the increased demand for gold and real estate. In order to spur retail inflows into financial savings, the government has engaged with asset management companies by initiating several measures like Rajiv Gandhi Equity Savings Scheme to bring in new equity investors, direct mutual fund plans to reduce fund costs, reviving distributor interest through incentives, expansion into small towns by increasing fund expense, flexibility in fund charges, investor awareness initiatives, among others.
India also needs deep changes in its real economy. The need to balance coalition politics took its toll on the speed of reforms. This, along with environment clearance issues, regulatory delays, inflation and the global slowdown contributed to the slowdown in the investment cycle by companies.
Tight monetary policy kept the cost of borrowing high. Infrastructure development was slow due to regulatory delays and challenges of PPP models (Public-Private Partnership) and long-term funding sources for infrastructure projects. Industrial output remained subdued for most part of the year. New projects slowed down and a number of existing projects are currently stalled, facing delays.
Initiation of some reforms since Sept 2012, even at the risk of snapping ties with coalition partners, raised some cheer. The government also set up a Cabinet Committee of Investment as a single window to clear large projects, and is further working towards public spending projects. However, reviving the investment cycle would also demand sustenance of the reforms engine, a more involved decision-making with state governments on issues related to land, resources, closer monitoring of stalled projects and systematic reduction of the cost of funds to catalyze further investments.
CURRENT ACCOUNT TROUBLE
India’s growing integration with the global economy meant that global economic weaknesses impacted demand for exports, while the import bill was affected by price and demand trends in oil, gold, coal, etc as well as depreciation in the Indian rupee (INR). Oil imports have risen to approximately 80% of total oil demand.
Apart from consumption, the demand for gold also shot up due to its perception as a relatively better investment. The trade deficit is about 10% of nominal GDP. Capital inflows from foreign portfolio investors gave some cushion, though these flows are inherently volatile. Consequently, the current account deficit as a percent of GDP increased from a historic average of between 1% and 2% to over 4%, putting pressure on the INR.
From a historical average of Rs45 to the US dollar in the last decade, the INR/US$ exchange rate breached the Rs 50 mark in FY 2012 and further breached the Rs 55 mark in FY 2013. Action on the reforms front in September-October 2012 improved sentiments and the INR appreciated to Rs 53. But it moved back beyond Rs 54-55 subsequently as the current account deficit continued to exert pressure.
The government is working on regulations to curb gold imports and address the needs for domestic oil and gas upstream activities. India is becoming a global production hub for automobiles, consumer non-durables etc. The country needs to improve the relative competitiveness of exports, expand into new export geographies and attempt some import substitution by domestic production.
Apart from stability in prices of import goods, another possible catalyst for INR appreciation would be to increase foreign direct investment (FDI), as it is a more stable and long-term source of foreign capital and should help the current account deficit situation.
The government also needs to keep the budget gap in check and it announced in its recent budget plans to rein it in to below 5% in the coming year. There have been some reforms since Sept 2012; the cap on LPG subsidies and the deregulation of diesel prices should ease the subsidy burden.
As GDP picks up, the net tax-GDP ratio should typically move towards historical averages. While the recent Union Budget kept the tax structure largely unchanged (except for a couple of surcharges on corporate and wealthy taxes), the government is also expected to earn from non-tax sources such as its disinvestment programme, sale of spectrum and other resources like mines, land etc, as well as possible cash dividends from the cash-rich government-owned companies (PSUs).
Opening up of FDI avenues should bring in further long-term capital. Recent announcements included liberalizing FDI norms in sectors like retail, aviation and broadcasting. On the other side, the budget also announced a hefty 29% rise in planned spending, given the need to spur growth in the context of the current slowdown.
In conclusion, India has faced tough economic times before and has always managed to navigate itself and emerge stronger. While the recent reforms initiatives boosted sentiments, it is also imperative to address the challenges confronting this action plan.
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- Sourajit Aiyer works in the corporate planning team of a leading capital markets company in India, where he manages the investor relations function. The views expressed in the article are personal and may not reflect that of the company.
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