Indian Economy in 2012: The Impact Of Political Drama On The Broader Economy.

The global uncertainties immobilized the economic growth around the world and emerging economies were not left behind. India economy too stalled in the second half of year 2011 caused by cumbersome inflation and rising policy rates. Lots of constraint is on the way of the Indian economy.

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Alongside the assembly elections in five Indian states, the unequivocal major economic indicators are the important source of conviction for the economy this year. Unlike last year, the economic growth is expected to be above the potential economic growth and the falling inflation should be given a credit for the same. Asia’s third largest economy was on the backburner due to higher interest rates and inflation last year, fallen down to below 6 per cent of annual expansion. India’s home grown problem rooted from the corruption charges against the federal government and paucity of important economic reforms, which was expected during last year, push the Indian economy on the downside. In our last economic outlook report, we emphasized that RBI will not even think about the economic growth prospect since inflation was the major quagmire for the central bank and has left with no room for further inclination on the price rise. Central bank’s primary job is to have stable prices in an economy with stable job prospect. However, only the stable economy would ensure the good job prospect and RBI at this point does fail to act on just because to bring down the inflation under control. Nowadays, the Indian Rupee is in the global headlines as the “worst performing currency in Asia by falling more than 20% against the US Dollar”. Indian Rupee  (INR) is one the most risky and volatile currency in the world with managed float system. RBI intervenes when the currency’s fall is wild and threatens the economic prospect like it does last year. Below is the balance of India’s international trade.

Rupee’s Fall – How fatal could it be?

What makes rupee a black beat? India’s home grown problem widens the parity between major currencies. The Indian currency is on the down-fall and depreciated against USD last year by more than 20 per cent. Reasons could be anything but the ultra reason is the government’s inaction for the economy. Major economic reforms remained unclear and stalled in the legislative assembly which depressed the investment prospect in the country. This fiscal (FY2012) till Nov 2011, India received about $1.01 billion in foreign portfolio investments or popularly known as FIIs – in compare to $31 billion in fiscal 2011. The one interesting findings of our research is that,  India remains a favorite destination for the long-term investments and its  position of being an investors’ darling remains intact. The foreign direct investment into the country is somewhat sluggish but remained buoyant. So far, in this fiscal, India attracted FDI of nearly $33 billion, which is comparatively larger than FY11. Apparently, the currency has lost its value by 20 per cent. However, it is not necessary that rupee’s depreciation can only have an adverse effect. We understand that India does not have a positive trade balance and the trade gap could largely get affected by depreciation of the quote currency (INR). However, most importantly, on the fiscal side, despite the rupee’s fall, India can subsist with the expensive US Dollar. From the latest figures related to the Indian government’s external borrowings, India owes a very little amount of total debt quoted in foreign currency  (about nine per cent of total public debt, see the provided table) and the expensive USD could not significantly affect the  interest payments of the government on an annual basis since it accounts for 20% of government’s expenditure – means the general budget will not get imbalanced and will be focused on the fiscal consolidation. Perhaps, the local currency depreciation seems to have lesser impact on the fiscal side and will not be subsided during the crucial budget session, when India’s Finance Minister Mr. Mukherjee presents the general budget.

Indian Government Borrowings
Public Debt		Upto Sep 11	Upto Jun 11	% of Total Debt
Internal Debt		2935618	2816693	76.06%
External Debt		340750	312280	8.83%

The considerable point is, rupee’s fall could be a can of worm for the Indian companies, since they borrow money from low-cost capital supplying countries like Japan, the United States, the United Kingdom and the Euro zone to meet their funding requirements for working capital, project expansion and capital expenditures. As per latest data, the Indian companies’ net outstanding of offshore commercial borrowings is almost 30 per cent of the total external debt, up from 27 per cent in 2010, facing the biggest currency translation risk due to currency’s movement. This lion share of external debt could even rise further due to valuation effect. On the other side, trade deficit will become a cumbersome since India’s biggest supplier is Saudi Arabia, which exports $20 billion worth of crude oil annually and rise in USD will make imports expensive. However, what about the exports or consumers of the Indian product? One side, we understand that the imports are getting expensive and   widens the trade deficit, but on the other side, exports will become cheaper for the Indian suppliers too. So, where’s the problem? India’s exports are not a bottom-rung which does not attract any buyers. We have provided the international trade results which show a narrow gap in second half of last fiscal year. Trade gap was fallen down to $2.6 billion in Dec 2010, it is indeed the trade gap widened to $20 billion in this fiscal largely due to higher oil imports, but this is a temporary movement. Subsequently, the richness of export’s value could offset the import’s losses.

Inflation Prospect

It’s evident that the price levels are significantly decreasing to the lowest levels in two years and peaked around 10% in Sep, 2011 which we have projected a year ago. Primary articles including the food and non-food articles grew by 3.04% in Dec 2011 but the important indicator for the central bank while taking monetary action, “Manufacturing” index is still unstable enough to hinder any policy action on the down-side. Prices in the month of Dec, 2011 increased by 7.47%, lowest in 24 months. Due to the new base effect, it is certain that inflation could even fall to 5% in the next 2-3 months, below the RBI’s comfortable levels. However, does it lead RBI to think about interest rate cut? Any policy action at this point will cause prices to exaggerate as the price indicator does not show the stability and largely abated due to base effect. Even, the RBI wouldn’t be in a hurry to take policy action to stimulate the economy and under the current bleak economic circumstances on the basis of current inflation figures.

The core problem of the headline inflation is the rise in non-food articles and food prices remained subtle at higher prices but the growth with the corresponding year was not as high as the growth of the manufacturing sector. It’s quite clear that the RBI’s policy rates will not come down to the levels of 2008 until the adequate price stability.

India Economy: What’s Next? Medium-term is Bright But Sustainable Long-term Growth Seems Hundred-to-one!

With a dismal performance, India’s home grown problem is enough to dent its economic growth, so it does last year. From 9.1 percent of annual economic expansion to 7.5 percent is an evident that the economic growth bulldozed in the second half last year. From the internal problems to the external, the broader economy faces a downward pressure. Inflation caused the major problems in the economy starting from higher borrowing cost. India’s central bank,RBI revised interest rates in its each monthly review meeting, which pushed the Indian companies to go  abroad for raising funds. Per the current statistics of VMW Analytic, Indian companies’ borrowing through the external commercial borrowing route for fiscal 2012 is at $99 billion, increasing the overall external debt burden to $326 billion. Here, the sore point is the rupee’s depreciation. Although, the government’s external debt is around $27 billion out of  $721 billion of total public debt. The Indian currency is one of the considerable remora in the current scenario. Like we discussed the flip side of the rupee’s fall, its performance on the broader perspective is a confrontation for the Indian corporate. India, as of now, is not a suitable country to have its currency undervalued or expensive against the US Dollar as the country’s infrastructure bottleneck is a barrier to growth. Everything is tied-up to this problem. Even the prices have been a stubborn due to supply chain constraint and technological barriers, giving the Indian economy a challenge with a small room to grow at 9 percent.

If we look at the foreign reserves asset of the central bank, there is a consistent decline due to rupee depreciation. Since the Indian currency is a managed float currency, RBI generally intervenes in the currency market to balance the cross border trade on the either side – so it does taking the same action to tweak the INR/USD relationship. Is it necessary? Apparently, the domestic demand is the biggest driver of the Indian economy and India could not satisfy its demand through its domestic produce. Crude Oil is the biggest single commodity and a best example to demonstrate the domestic demand. Expensive rupee will virtually make the imported products expensive. In this situation, RBI starts purchasing the INR (when rupee depreciates) by selling the USD from its reserve assets to take it back to the comfortable zone of trade. The purpose of highlighting this is to think about the important source of financing the trade deficit. RBI is gradually losing its important asset which could make the situation worse and unbalanced BoP. Perhaps, selling USD to give INR a relief is not a permanent solution. There is a lag in infrastructure commitment by the federal government. The urbanization process is at a slower pace and the existing urban cities do not have abundant financial sources to make a considerable investment for a sustainable growth. With 5 per cent allocation of GDP’s resource to the country’s infrastructure, government would not be able to meet its long term strategy and sustainable economic expansion in the long run will become a challenge. VMW discussed the issues on infrastructure challenges in its next research that will be available soon.

Even, there is a significant decline in the fiscal consolidation efforts by the federal government. Indian legislative assembly stalled because of countless issues, hindering the important bills to be passed in the lower house, pausing the foreign inflows into the country. The pulse of  foreign inflows can be measured by looking at the performance of India’s benchmark indices – BSE Sensex, which illustrates the apprehension of foreign investors. In year 2011, India attracted the foreign portfolio investment of $1.01 billion, significantly lower than a year ago.

The first half of the fiscal remains to be volatile until the wind-up of legislative assembly elections. By analyzing the price index, inflationary pressure will be moderate for the next two quarters yet its not likely to remain subtle, pushing the policy makers to proactively work on the fiscal consolidation. In our last research update, we stressed on the inflation side that must be subdued to contain the rising cost of capital. Although, it’s now easing and currently reading close to the RBI’s comfort level. As of now, we’re not expecting anything in surprise from the central bank since prices have not yet stabilized and policy action will have a counter effect on the overall micro side. The other challenging factor, which we have discussed in our Mar 2011 report, that the political uncertainty could deteriorate the investment prospect of the country and so far, the challenges remain same in this year too. Prime Minister Mr. Singh had proposed to introduce the 100% FDI in single brand retail sector to promote the foreign investments and technological advancement in the country to improve supply chain and bring pricing stability, but that too ended without action. The recent Supreme Court’s judgment in Vodafone’s tax case will likely to have a positive impact to boost long-term investment and additionally, it gives a clarity on India’s tax regime.

Indian Economy 2011 Overview: Challenges For The Global Economy Surfaced After Recent Sovereign Debt Crisis.

Everyday is bringing the new challenges to the global economy and this time around, the massive public debt of a country is creating a three-ring circus on the streets and the possibility of disagreement over debt ceiling in the United States could set off the fresh concerns of the global economic recession – VMW Research Team brings you the latest update on the global economy and would address all your concerns related to the Indian economy in particular.

 

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Global Economy in Brief – Consternation of Sovereign Debt!

Once again, the default on debt repayment haunting the economies around the world after the tragic incident in Argentina in the early 2000s, when hyperinflation undermined the Argentine’s export competitiveness and triggered the chronic deficit in current account of the Balance of Payment (BoP). The 1998 Asian Financial Crisis also played a greater role in Argentine’s hyperinflation and bank run, which ultimately led to default in debt’s payment, as the major chunk of current account deficit financed by borrowings, that gradually dragged the economy in 4-year of depression. Greece is the latest case of a defaulter in debt repayment and subsequent to this, Standard & Poor’s or S&P has downgraded Greece’s debt to CCC rating (Junk or extremely high risk), the lowest in the world. Greece is not the only country in Europe to get support from the EU and the IMF. Iceland and Portugal have already bailed-out. It is expected that the other European countries might be getting snared into the sovereign debt crisis such as Italy, Spain and Russia. Why such type of instances unfolding after two years of the global economic recovery? Greece was one of the fastest growing economies in the region with expanding areas like tourism, port infrastructure and transportation. Robust economic growth and lower interest rates put the Greece’s economy on structural weaknesses as the country borrowed exceptional amount of money and hid the exact borrowing numbers. Subsequent to the economic crisis in 2008, countries like Greece, Spain, Ireland, Poland  are having a slower economic growth, lower foreign investment inflows and tremendous amount of overspending (fiscal deficit). Such kind of problems has a material impact on an economy, and these countries will take several years to recover their credibility. Another nerve-racking concern is that the creditors of these countries are mostly foreign holders and this is making a panic situation to overcome from this crisis. Is the European Union going to be transformed with all these dire economic developments at the time when the economy like Greece and Portugal have implemented an austerity plans to cut down on their annual spending?

 

Economic circumstances of the United States is somewhat, but not completely due to economic structure and positioning, similar to the European economy having the forebode public debt estimates, even assumed double the size of the US economy by year 2035. This is something, which cannot be accounted for the current-year’s economic outlook as yet. Now, let’s discuss the US’ military operations, since the largest spending after healthcare is “Defense”. According to the US Department of Defense or DOD, War in Afghanistan costs the United States about $6.5 billion a month, increased by 50% from year 2010 (about $4.4 billion) while the cost of war in Iraq is about $7.9 billion a month but seeing a reduction in spending followed by the contraction of boots number on the ground. So far, since the US invasion in Iraq and Afghanistan after the 9/11, US spent more than $1.414 trillion. The positive point is, after the reduction of boots in Iraq, the US’ spending has been reduced to half of the total spending in FY09 owing to the withdrawal of the large amount of troops from the country. Now the United States has started an exercise to reduce the number of troops in Afghanistan, which could make a positive development for the US economy going forward as the country can curb its swelling deficit over the years. Thus, the US President’s ambitious plan to cut overspending by FY15 will be feasible. However, the VMW is not certain about the cut in fiscal deficit as the economic output in the subsequent years  is also expected to remain under pressure and the revenue side of the US budget would not increase. According to the report of Congressional Budget Office (CBO), there is a wide gap of revenue between the baseline projection of CBO and the US President’s budget. This could boost the fiscal deficit and rise in interest cost for the government. The recent debate on the US debt ceiling has unearthed the risk of US economic growth and questions the capability to meet the obligation. In early 2009, VMW had posted an update on Twitter, quoted as “US have to prove its solvency followed by massive government’s support to the banking sector by spending trillions of dollars of taxpayers’ money.” The debt crisis in the EU region and the United States could reverberate across the world, since this could lead to fresh inefficiency of the banking system after normalization. All-embracing, the United States has to make an economic friendly defense and healthcare spending policies to reduce the ratio of public debt to the GDP and combat the expected rise in interest cost to alleviate the risk of prolonged stagnant economic development and sovereign debt crisis.

  

Japan’s economy after the earthquake disaster continues to see downward pressure due to supply side effect, lowering the production. Although, after four months, the Japan’s economy has shown some sign of picking-up as the production and domestic demand is improving. The consumer prices have also changed slightly positive. VMW has analyzed that the Japanese economy could gain some momentum going forward amid high uncertainty in the other industrialized economies since it is an exporting economy. In the meanwhile, Japan is currently working out to impede the greater  downside risk to the economy followed by series of disaster ranging from the leak of nuclear radioactive material to reconstruction in order to restore supply chain. The immediate step of the Japanese central bank was to add liquidity in the banking system to keep up the short-term requirements faced by the tragic incident.

 

 

Economy of India

 

High Inflation – “Temporary But Unsustainable”

Most important area of this VMW research. Let’s start with “inflation”. Is inflation really going to indent the economy and undermine the real economic growth? Per our empirical findings, inflation is expected to peak between 10-percent and 11-per cent and would fall down to 5.5 per cent in the second-half of FY2013. Why? VMW believes that the good monsoon rains this year, persevering high interest rates  amid tighter monetary policy, stable crude oil prices throughout the fiscal and controlled global food prices amid high volatility could be the reason of falling inflation back to 6.0 per cent. Look at the inflation chart. VMW Research Team has worked on the inflation to build this chart, which shows that the inflation is expected to peak-out at nearly 11.00 per cent and will come down to 6.0 per cent by the second half of fiscal year 2013. However, interest rates are expected to remain high to support the sustainable and materialistic economic growth with consistent risk of high inflation as the higher economic growth means an uncomfortable inflation rate (mildly higher than the RBI’s comfort zone viz 5.0 percent). It is apparent that the Reserve Bank of India will continue to monitor the supply side effect on the economy, which could keep the inflation rate at the attentive level even after falling back to 6-per cent.

 

 

After a series of measures to curb the overspending by the federal government, the recent price hike in petroleum products will spur the price rise, to some extent, which is to be limited for certain months. This could be the possible reason of a double-digit inflation rate which the VMW is expecting in the Indian economy. To elaborate the inflation issue further, we need to discuss the most important factor such as oil prices and food prices. Although, VMW is not seeing any immediate appreciation in oil prices due to bleak economic output, intervention of the west and the International Energy Agency (IEA) in oil markets. But the risk remains owing to the arab spring and instability in the northern parts of Africa. As per the IEA report, the economic growth engines – China and India will drive the global energy demand higher. What matters the most is the policy implementation of the respective governments since crude oil is predominantly the largest imported product for the economy like India, and it is unclear, by when the oil production will peak? The latest shock to the energy sector was given by Japan’s nuclear disaster followed by earthquake and tsunami, questions the safety of nuclear energy and reducing the demand, which just accounts for 6% of the total energy consumption. However, contrary to our assumption, the IEA believes that the nuclear energy will account for 8% of the total energy demand by 2035, which is still much lesser and slower in terms of growth due to safety and security concerns. Government has to act and respond to the oil consumption and the growing cost of supply by improving the viability of the alternates to the oil. It could ease the demand for the oil, and we can see the peak of output even before 2020.

 

After discussing  the future of crude oil price and demand, there is another phobia, which needs attention, viz Food Prices. According to the available data, wheat production is not impressive due to continuous dryness in EU-27 nations including Germany, France and the UK. But the lower consumption is Russia would yield the wheat exports higher and offsets the EU-27 and Canada decline in trade. Interestingly, Pakistan this year has a surplus amount of wheat output and plans to export 0.3 million tons, for which Bangladesh is an immediate consumer. On the other side, Rice production has largely been affected by bad weather in the United States, China, Cuba and many other nations in the western hemisphere dragging down the projection of rice production. However, projections for Egypt and Guyana have been raised. Many other commodities like oilseeds, corn and wheat are witnessing the downward pressure in the Ending Stocks threatening the volatility in global food prices. Combining all the factors, food prices is expected to remain volatile since market drivers are pointing towards the instability in production and ending stocks, as the major crop producing nations are facing the bad weather, which imbalances the global production under higher costs.

 

 

Core Economic Developments

 

 

In the last two years, India’s public debt has been limited to a range of 75 percent to 80 per cent of the total economy and the annual growth in public debt has also come down to below 10.0 per cent. To discuss the issue of public debt, VMW has gone through the 11th five-year plan, a document which is a facet of the government’s action plan. Perhaps, none of the five-year plans have been accomplished so far and this time around the government is still not able to meet the infrastructure goal due to funding deficit. According to the Planning commission, 8.37 per cent of the total GDP is supposed to be invested in the infrastructure development. However, the government has proposed to invest only 4.0 per cent of the total GDP. Based on these assumptions, the government borrowing is expected to continue to rise amid shortfall of investments in the required sectors of the economy. Apparently, the infrastructure in India is a bottleneck to the economic growth and the local firms are not able to realize the economy of scale.

 

 

If we talk about the physical infrastructure, in particular, about 95 per cent of the total traffic generated through railways and road. In contrast, several parts of the country are still not connected even by road. Nevertheless, the situation of a road getting deteriorated even in those cities and villages which are connected by road due to short funding to maintain the condition. Most of the government’s efforts are going futile because of the shortage of funds with the highway authorities and local state bodies such as municipal. Furthermore, several states are facing the supply-side constraint such as the absence of fair deal and federal law to acquire land for highways, expressways and road transportation. In addition to this, inadequate institutional capacities, shortage of a raw material due to poor connectivity in areas such as North-East states of India. The institutional implementation is necessary and for that, the adequate funding assistance from the Central Government is important. VMW-RT analyzed that, going forward, to meet the targets of the five-year plan and to sustain our ambition of expanding the economy with structural growth – government is in desperate need to continue with its plan to borrow money. Thereby, the fiscal deficit is an important indicator to watch-out for in the next couple fiscal years. In the figure given below, VMW has discussed the federal government’s finances and where the government does spend the taxpayers’ money.

 

 

 

Although, we have projected the higher growth on the spending side and government’s borrowing plan. The revenue side is not expected to outpace as fast as the expenditure is growing since the direct tax income to the government will see a moderate growth and the non-tax revenue this time around is likely to be marginal, which could make a significant gap in income and expenditures. Although, the Indian government is taking measures to cut down it spending on subsidy, however the subsidy part accounts for 12.0 per cent of the total expenditures and the major pie of the government’s revenue goes to the planned expenditures. What is plan expenditures? Of course, the recommendation of spending by the Planning Commission of India – which is absolutely required. On the other side, the “Interest” cost burden on the government is also rising with a significant portion of the expenditures is going in the payment of interest on the outstanding debt. Since, we have projected the rising government borrowings; the interest payment burden on the government is also expected to rise, which could undermine the government spending in planned expenditures. To offset the fiscal imbalances, government should oversee the non-plan expenditures carefully such as the interest payments, transfers to the Federal State governments and the Union Territories, Subsidy and Defense. The federal government has already started the exercise by gradually reducing the subsidy burden. However, it would not make a significant difference in the government’s balance sheet and the proper management of the “other government expenses” is necessary. Above all, the inflationary pressure must be subdued to balance all the finances and to contain the rise in cost of funds in the country.

 

On the monetary side, by taking certain inputs from one of our earlier research done on the RBI’s monetary policy dated back in May, 2011. We have projected that the interest rates will remain moderately high for the next couple of fiscal years to freeze the wild rise in prices. To counter the rising inflation, Reserve Bank of India has  revised its policy rates for more than 10 times in the last 14 months and its stance on the Monetary Policy is somewhat having a mute effect on the commercial bank’s lending power. Banks are not expedite in responding to the RBI’s increase in policy rates and credit growth is quite high, fairly above the baseline projections of RBI to meet the economic needs due to accommodative financial environment and solid inflows into the country.

By concluding our analysis on the Indian Economy and the Global Economy, the slower growth in global economic expansion is temporary – due to policy action by the central banks around the world by raising interest rates and subdued commodity prices. India, in particular, the economic output is expected to see some sluggishness due to inflationary effect on raw material and expected slowdown in demand-side due to higher cost of credit. However, balancing the government finances by cutting down on unnecessary spending and focus on the planned expenditures to improve physical infrastructure in the country so that the long-term foreign inflows could be sustainable to finance the current account deficit will make a greater positive impact on the Indian economy over the long-term.

 

India’s Annual Monetary Policy 2011 – Inflation Is Expected To Remain High Amid Robust Economic Growth.

The thirst of robust economic expansion and higher commodity prices will technically push inflation on the upside and interest rate in India is expected to remain high for the next couple of fiscal years as the RBI seeming to keep interest rates on the higher side to maintain the cost of credit exorbitant to lessen the demand.

 

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It was the confrontational step of the Reserve Bank of India by revising another 50 bps in its policy rates to address the wild price rise situation in order to eliminate the risk of higher inflation and to persuade the Indian economy to grow fast but sustainably. VMW has analyzed the inflation problem from the household’s kitchen to the corporate decision maker and found that the food prices are not rising as fast as the non-food articles do, due to increase in international commodity prices. Food prices in March rose by 9.47 per cent while the prices of non-food articles rose by 25.88 per cent largely inflated by expensive crude oil and other important imported commodity products. So far, the effect of RBI’s rate tightening and expensive commodity prices – rallied on the economic euphoria – can be seen on the Capital Goods sector of India. India’s IIP index has been fluctuating, and the capital goods, index in particular, has performed deplorably (see figure below) due to higher cost of credit, tolling in the company’s income statement in terms of higher interest payments. Construction, Energy, Real Estate, Diversified and Infrastructure companies have piled up billions of dollars in terms of debt to function their operations and to execute their awarded projects.

 

The important wings of the Indian government and the Reserve Bank of India are expecting the inflation around 6 per cent by the end of the fiscal year 2012. However, the VMW’s estimates are bucking the government and RBI’s estimates – expecting the inflation to remain above 6 percent and even in a double digit by the end of this year (up to 11 percent). The only fundamental cause is the India’s hunger of economic expansion at a faster pace, and the same would not pull down the inflation to lower levels, since it will dramatically push the demand in the economy for pricey imported commodity. Moreover, the US Federal Reserves’ monetary expansion program, known by Quantitative Easing or QE2 is scheduled to end by Jun, 2011 and, perhaps, it will not reduce the impact of higher inflation in the economy right away and high supply of a dollar could depreciate it against the other major currencies, which will push the international commodity prices. The expensive imports will prevail upon the higher current account deficit until the export figures too remain blunt. Henceforth, the Current Account Deficit remains a prime concern for the economy. Although, RBI is not considering it as a major threat but the VMW is deliberating the same, and the prime predicament could be the lower portfolio investments since Foreign Institutional Investors’ flows (FII) are the immediate source of financing the Current Account Deficit and Foreign Direct Investments are not as easy as the FII flows are due to scores of roadblocks to the investments and instability in national politics and India’s foreign policy.

 

Inflation always Remained High in India and Now Needs Government Intervention Plus Tighter Monetary Policy from RBI’s Side. 

Now, in our research lab, we have analyzed the inflation problem. Look at the GDP Deflator and the WPI Inflation rate – how these trend lines have emerged over the past six fiscal years. GDP deflator is one of the other important tools to measure inflation, and it show, the inflation problem was relentlessly haunting the Indian economy. The most significant discovery is, the RBI loosened the policy rates during FY08, when India faced the condition of deflation due to change in the base year and was not reflecting the correct picture. However, GDP deflator remained at the alarming levels. At the same time, in FY09, RBI has raised the interest rates to prevent India to be a victim of the global financial crisis.

 

Here, we are not suggesting the RBI to track the GDP deflator, but to align its monetary policy to fix the “structured inflation problem”, caused by huge government borrowings, and at the same time, to make the economic growth sustainable and to refrain from the economic overheating. Plus to this, there is an urgent need of government intervention in terms of policies to overhaul the distribution of agricultural produce, to check the government borrowings and bringing down the fiscal deficit, which is now estimated at 5.6 percent until Feb, 2011 and 5.8 percent for FY2011. This will also subdue the prices.

 

 

Future of the Interest Rates in India

Rise in crude oil prices and other imported commodity price holes the Indian Economy up. It is one of the biggest risks to India since the country is not completely reliant on its own energy output and imports more than 70 percent of crude oil from GCC countries and other OPEC members. It’s expected that the global economic recovery would not stall but the pace will come down most importantly when the United States has stepped up its efforts to bring down the fiscal deficit to 4.1 percent by 2014. Nevertheless, the real economic output could remain under pressure due to the effect of increasing government debt. Since, we have focused on the final output (GDP) and it shows the prices of final produce in a particular financial year are increasing by more than 7.0 percent, whereas the WPI inflation is fluctuating throughout the discussed fiscal years. Provided herein is India’s stock of money or M3 for the last three fiscal years, which reverberates above 20 per cent. However, it is now falling significantly back to 15 per cent, and it shows the RBI’s action in policy rate is working, which means the monetary policy has a certain effect on the core inflation problem and would make an impact on the demand side but it is not sustainable as the government’s borrowing plans are on track.

 

 

 

 

Lower money supply has side effects too as it will increase the cost of credit further, and it will reduce the access to credit. Moreover, the stock markets could not function properly in this environment since the economic activity declines, which will eventually reduce the value of people’s retirement savings. However, the RBI has only one choice – tight monetary policy to tame inflation by giving up the India’s ambitions of double digit economic growth.

 

This VMW Research is originally published at UNIDOW.com