Over the past few months, inflation is projected as the most crucial thing to look out for the year 2011. Economists believe, that inflation would remain high and will be a roadblock for the economic expansion, however VMW Intelligence expects inflation will come down to 6 per cent and it was largely risen by huge public debt. What is the fountainhead of this high inflationary pressure in the Indian Economy? Let’s discuss it now!
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Theme For 2011: Inflation
The new decade starts with the bang of inflation, and everyone believes it is going to impede the faster expansion of global economy. Predominantly, inflation is playing a bigger role for the policy makers to factor in while cogitating the policy for the sustainable economic expansion and without affecting the current economic growth rate and this trend in real is followed across the globe as the apprehension of discernible impact of inflation on the economy is high. India has a high inflation rate of around 8 per cent and core consumer prices is currently reading at more than 15 per cent, giving policy makers a food for thought for a stricter policy to contain the rise in prices, since VMW believes, high inflation could come down to 6 per cent in the next few months owing to expectations of good crop output resulted by good monsoon rains last year. For now, inflation is rising because there are some reason, which does exist. fundamentally, inflation is rising due to supply side constraint and inflation is not only making a new monthly highs alike gold prices in India, but other largest emerging economies such as China, Brazil and Russia too has high inflation rate at 5.1 per cent, 5.63 per cent and 8.1 per cent respectively and developed economies are also seeing the risk of high inflation. The reason is simple, one: food prices and two: economic recovery around the world pushing commodity prices upward. For every country, abnormal inflation is a problem (deflation too!). What does abnormal inflation means here? VMW have used this term in the context of micro economy for the middle-class population of the country. India’s annual food price inflation rate is more than 15 per cent and making it rowdy for the people to survive with high inflation rate (that’s why, VMW is maintaining negative Political Outlook for the country). At the bottom of the production pyramid of an organization, the price of an article is rising significantly and directly impacting the consumers and inflating the price of the basket of goods. Moreover, consistent rise in government borrowings and expansion of money supply in the United States or so-called Quantitative Easing has also propelled the higher growth in inflation as the expansion of money supply means, more dollars or rupees in hand to spend.
What The Year 2011 Stores For India?
People’s perception about the global economy has still not changed even after robust recovery in economy from the bottom. People’s concern is sustainable job environment, which is still not there and would take more time to repair. Domestic consumption is on high in the emerging economies and those economies are now leading the global economic expansion. Year 2012 could emerge as the revival of the next business cycle (i.e. expansion).
VMW has given inflation as the year 2011’s theme and it’s evident that food prices, expansion of money supply in the United States, stimulus packages announced during the economic crisis and economic recovery sending the commodity prices higher are the tangible factors for the higher inflation figure across the emerging economies as well as the industrialized economies. If we make a focus on the Indian economy, India, so far, has maintained a good resilience in terms of economic expansion but, nevertheless, the recent boutade of scams, fresh highs of corruption level and lack of policy reforms from the UPA government for faster economic growth has made a significant impact on India as an investment destination. Here, VMW has the another concern, which is Current Account (CA) Deficit. Current account deficit is expected to expand further backed by depreciation of Indian Rupee (due to high inflation and real interest rates) will make imports dearer and India’s largest import product is crude, higher crude oil prices as projected and lower expectations of foreign capital inflows.
Source: VMW Analytic Services (©2011. VMW. See Copyright Notice)
For FY2009-10, and FY2010-11 (Apr-Sep), India’s current account deficit was $38.38 billion and $27.9 billion respectively and India largely depends on the portfolio investments as well as foreign direct investments to finance the minus CA. The oxidized image of India followed by the intransigence mismanagement in the allotment of 2nd generation of wireless technology spectrum would make an impact on the foreign investors’ sentiment (the main source of the capital account) and it becomes hard for India to finance the CA deficit through short-term financing (which is a typical FII investments in India). Although FDI is better than the portfolio investments due to the longer time horizon and stable source of financing the negative current account. However, that too has seen a reduction due to the tough entry barrier because of lack of economic policy reforms, which was supposed to be introduced during the last fiscal year.
India has a wide range of corruption. Accentuating the subject, private sector is always accountable for fostering the corruption in a country and India has a long way to go to ameliorate its regulatory framework to counter it. Every country has corruption, however it should not become a norm.
As per local media, year 2010 declared as the year of scam. Apparently, India is a capitalist economy and almost every country in this world has a certain level of corruption. It is not startling, that India has seen multiple scams in a wide range of issues (of course the extent of corruption matters, too) but here the question is, how the country deal with those issues and the ability of its judicial system to resolve it. Although, certain system can stand some corruption. However, India has the systematic corruption in the certain system, and it should be checked with priority. But VMW does not believes that these reasons will play a significant role in the economic growth for a longer period, since the country’s justice department is accountable to fix those issues and India is efficient enough in this regard.
Public Debt & Political Outlook: Our main focus has shifted from inflation to recent political instability in India. Political developments is enough to equate the real interest rate either high or low. If we discuss the economic outlook for the year 2011, inflation, interest rates, current account deficit and depreciation of local currency could be the reason for slowing the down the economic growth. RBI is worry about the only thing, which is inflation and to control that thing, it would virtually hamper the dream level of economic growth (10 per cent). We still believes that the country’s economic progress to continue to persist but certain macro issues will cut the economic outlook to certain extent and will keep foreign investments away from the economy i.e. scorching level of public debt. Rise in government spending and widening of fiscal deficit would jeopardize the economic growth. Since, we already projected that the inflation will come down to 6 per cent in the next few months however, the public debt and loose in fiscal policy will almost lead to rise in real interest rates, and downside in real economic growth.
Source: VMW Analytic Services (©2011. VMW. See Copyright Notice)
As per VMW Analytic, India’s public debt swollen to 76 per cent of the total GDP. Inflation is rising, real economic growth is at risk, interest rates are on the growth track leaving all worries to central bank. Government has total control to its control panel to monitor all the situation. A tight fiscal policy will increase confidence over the debt sustainability and virtually increases real economic growth, reduces pressure on the interest rates. If we go through our analysis, over the past few years, specifically since fiscal year 2007-08, borrowings of central government has seen a significant rise. Since fiscal year FY-2007 through FY-2010, public debt grew at 10.45 per cent annually (compounded annual growth rate) in comparison to 6.48 per cent from FY-2003 through FY-2006. For a sustainable economic growth, India needs to maintain it fiscal policy to curb risk premium. Moreover, the political uncertainity could jeopardize the fiscal balance of a country and it is extremely important, that government should work with the opposition parties to avoid any circumstances, which is not healthy for a capitalist economy.
Endnote: Nevertheless, west is rebounding and demand for east’s exports are increasing gradually. In our previous economic research, VMW has projected the higher supply side inflation, now which can easily be seen, but it will come down soon. India’s public debt zoomed to more 76 per cent of the total GDP, which is much higher than our previous economic outlook research (55 per cent was then) and the further fiscal imbalances and rise in government cash balances will keep inflation on the higher side for the next few months but the we have projected the cut in inflation rate backed by lower food price inflation. Since, the central bank’s responsibility is to keep the moderate inflation rate, liquidity in the system is expected to remain narrow with high interest throughout the year. Even though, RBI has raised its policy rates by more than 100 bps in the past fiscal year, however we does not rule out the further revision. RBI is ready to revise interest rates further and even ready to hamper the economic growth to certain extent to control inflation up to its comfortable level or at least somewhere around its comfort zone levels (which is 5 per cent). It’s obvious that high interest rate would make an impact on the Indian companies’ finances, since much of the companies are having debt in their books of accounts, resulted higher interest cost hitting the company’s bottom-line and halting the investments plans.
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