India Economy - October 2012

Source: OPEC 11/13/2012, Location: Asia

Despite the appointment of the pro-economic reform finance minister, Mr. Chidambaram, in a cabinet reshuffle of 1 August 2012, it is unlikely that progress in economic reforms will be anything but modest until the next general election. Mr. Chidambaram has his task cut out for him, with persistently high inflation, a weakening rupee and a slowing domestic economy. He is seen as a competent choice for the post, even though this appointment is unlikely to shift the political calculus that will continue to hamper prospects for economic reforms. The liberalization of the retail sector, and the increase in administered fuel prices and railway fares, were all reversed or stalled last year due to political disagreements. The largest political party of the country, the Congress Party, is more likely to use its political capital on promoting its prime ministerial candidate rather than economic reforms (EIU, October 2012).

Rainfall during India’s monsoon season (June-September) was almost 20% below the long-term average. A poor monsoon season is likely to exert a negative impact on consumer spending particularly in rural areas due to lower agricultural income. The government also may have to increase its subsidies on agricultural inputs, reducing its resources for development and infrastructure projects. Monsoons, however, are expected to have less of an impact on inflation as the importance of the summer monsoon season for agricultural output and overall economic growth has declined in recent years, with crop production in the winter season rising and the government’s capacity to respond to inclement weather improving. The agricultural sector is expected to grow by 2.6% on an annual basis.

India’s industrial production fell by 1.8% y-o-y in June. The June figure showed a renewed dip in industrial output, notwithstanding the modest pick-up seen in May, and the index of industrial production, which contracted in March and April of 2012. Following revisions to last month’s data, capital goods production is now estimated to have fallen by an average of about 19% y-o-y in March-June. On a sectoral basis, manufacturing output declined by 3.2% in June, having posted an uneven performance since the beginning of the year. High interest rates continue to deter capital investments and the central bank is unlikely to ease monetary policy unless inflationary pressures abate. In addition, political instability has stymied much needed economic reform, thereby depressing business and investor confidence. Wholesale price inflation decelerated for the second consecutive month in July, with prices rising by 6.9% on an annual basis. The moderation in the WPI in July was driven by a sharp slowdown in fuel price inflation, which fell from 10.3% on annual basis in June to 6% in July. This was the result of a high base in the earlier year period, as administered fuel prices were raised in July 2011.

The weak rupee and India’s persistent fiscal deficit will constitute further sources of inflationary pressure, although slowing domestic GDP growth will moderate these pressures to some extent. The RBI is unlikely to draw much comfort from the slight deceleration that has occurred recently (EIU, October 2012). India’s widening trade gap together with its fiscal deficit has put downward pressure on the rupee. The rupee is forecast to remain weak in the short- to medium-term considering the lack of any sign of improving external demand for the economy’s exports. The current account deficit is expected to widen from the equivalent of 3.2% of GDP in 2011 to 4.4% in 2012 (EIU, August 2012). In the first seven months of 2012, merchandise exports shrank by 4.1% on an annual basis, while imports grew by 1.9%. Inward capital flow also is expected to decrease, lowering demand for the rupee. In the medium- to long-term, however, one can expect a stronger rupee, taking into account the relatively bright prospects for the economy. Services exports will retain their vital role in the country’s external trade as information technology and business process outsourcing continue to lure Western firms to India.

In the budget for the year 2012/13, which was reviled in March, the government outlined a modest programmer of fiscal consolidation, with the budget deficit targeted to narrow to the equivalent of 5.1% of GDP in 2012/13, from an estimated 5.9% in 2011/12. The budget includes an increase in services and excise taxes, as well as import duties, as part of a bid to raise additional tax revenue. On the expenditure side, the budget targets a reduction in subsidy spending to the equivalent of 1.9% of GDP in 2012/13 from an estimated 2.4% in 2011/12. However, the original target for subsidy spending in 2011/12 was 1.6% of GDP. An expected increase in subsidy expenditure due to this year’s poor monsoon season means that government targets look optimistic and unlikely to be met. It is expected, therefore, that the budget deficit will remain high and that it will narrow only slightly — to the equivalent of 5.6% of GDP.


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