Losing momentum

Economists caution that unless the authorities come up with an agenda of action, the incipient slowdown can get entrenched.

in New Delhi

IN the trajectory from the euphoric statement in the pre-Budget Economic Survey in early 2011 that the economy would continue its dream run of 9 per cent growth in the final year of the Eleventh Five-Year Plan (2007-12) to the recent reality check that it would only be in the 7 to 7.3 per cent range lies a twist in the Indian growth story. The reasons for the changing fortunes of the domestic economy are not far to seek. Union Finance Minister Pranab Mukherjee himself said at the Delhi Economics Conclave in mid-December that the struggle against inflation and tightening interest rate regime has contributed to lowering of growth in demand and investment.

The economy today is in the grip of a host of difficulties: high energy prices, halting pace of recovery in advanced economies, strained government finances partly because of a slowing economy that finds no meaningful alternatives to huge consumption expenditure, and no major relief from high inflation.

Official figures show that the GDP growth dipped below 7 per cent in the second quarter (July-September) of the current fiscal. It moderated to 6.9 per cent in the second quarter of 2011-12 from 7.7 per cent in the first quarter and 8.8 per cent in the corresponding quarter a year ago. The monetary policy review of the Reserve Bank of India (RBI) announced on December 16 attributed the deceleration in economic activity mainly to a sharp moderation in industrial growth. The RBI also saw a significant slowdown in investment. As a consequence, during the first half (April-September) of 2011-12, GDP growth slowed down to 7.3 per cent from 8.6 per cent last year.

The contraction in the index of industrial production (IIP) during October 2011, the latest figure, bears out the worst performance since March 2009. The RBI said the dip in industrial output was mainly because of contraction in manufacturing and mining activities. The contraction was particularly pronounced in capital goods with a year on year (y-o-y) decline of 25.5 per cent, reinforcing the investment decline story.

Industrial output

It may be noted that the country's industrial output steadily increased during the last three years, after the global financial meltdown in 2008, from 2.5 per cent in 2008-09 to 5.3 per cent in 2009-10 and to a relatively robust 8.2 per cent in the last fiscal. In the current fiscal, it became tepid during April to October by logging a measly 3.5 per cent growth compared with 8.7 per cent in the corresponding months of the previous year. In a labour-surplus country with an army of employable people who are either under-employed or unemployed, a slowdown in industrial growth provokes particular concern as it impacts employment, for skilled, semi-skilled and unskilled people alike.

Economists are also worried over the marked decline of the capital goods sector within the IIP, which points to the insipid investment scenario that is in the first instance ascribable to the continuation of astronomical interest rates and elevated levels of inflation in the domestic economy. The persistent deceleration in the mining output, partly due to policy inertia to resolve fuel issues such as ensuring due availability of coal to thermal power stations and natural gas to user-industries such as fertilizer and power, is another factor contributing to the low industrial output.

Export sector

The slowdown has spread, as a logical corollary, from the industrial segment to the export sector. Merchandise exports growth fell sharply to an average of 13.6 per cent y-o-y in October-November 2011 from an average of 40.6 per cent in the first half of 2011-12. This confirms the worst fear expressed even in official circles that the splendid show on the export front during the first half would be daunting to repeat in the second half.

Even as imports moderated less than exports, the trade deficit threatened to go beyond $150 billion for the whole fiscal. In this context, Ramu S. Deora, president of the Federation of Indian Export Organisations (FIEO), rued that despite the negative numbers in industrial output and deceleration in export growth, the badly needed reduction in interest rates could not come about even as the RBI did not tinker with policy rates in its incessant fight against inflation. He requested the authorities to ensure export finance at a concessional rate not more than 7 per cent for medium, small and micro enterprises and 9 per cent for large businesses to boost exports and stem the whopping trade deficit.

The escalating trade deficit in the face of dwindling capital flows from abroad meant putting pressure on the current account, which threatens to go up. No wonder, the RBI rightly put that this combined with rebalancing of global portfolios by foreign institutional investors and the tendency of exporters to defer repatriating their export earnings has led to significant pressure on the rupee.

As of mid-December 2011, the rupee had depreciated by about 17 per cent against the dollar over its level on August 5, 2011, the day on which the U.S. debt downgrade happened, the RBI cryptically put it. The rupee plummeted in value from Rs.45 to Rs.54 to the dollar before recovering slightly to Rs.52.80 on December 16, evoking considerable clamour from the corporates and the political dispensation for the RBI to intervene in the currency market to arrest the fast depreciating value of the rupee. But critics of any interventionist approach by the central bank cautioned the authorities not to fall into such a trap as this would run down forex reserves even when such reserves at $308 billion would warrant no worry.

Fortunately, the RBI did not underpin intervention as it made its stance clear on December 15 by issuing new rules circumscribing the net open positions of banks in foreign exchange, limiting some forms of currency speculations and reducing the ability of importers and exporters to bet on the future of the rupee. But this move too was construed as the tendency of the central bank to micromanage the market, giving wrong signals to investors, particularly overseas ones.

Silence on policy reforms

In the eventual analysis, the government's profound silence on moving ahead with policy reforms in crucial areas, like putting in place a goods and services tax (GST) and pruning the bloating subsidies, have unnerved the sentiments of investors, both domestic and overseas. The recent muddle over opening up foreign direct investment in multi-brand retail without ensuring stakeholders' due consent has only added to the jitters of investors.

To this must be added the woes of domestic companies of working under the unconscionable burden of a high-cost economy which drain them of any energy to focus their attention on the core issue of managing their affairs in a hassle-free fashion.

Economists caution that unless the authorities bestir themselves with purposeful programme and an agenda of action to complement their best intentions, the incipient slowdown of the economy can get entrenched before long.