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| You are here:orfonline.org » Publications » Analysis |
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Global economic upturn may help India
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Jayshree Sengupta
04 May 2010
India has a few serious economic problems that are surfacing clearly as we are coming out of the global financial crisis. Number one is inflation, which is almost double digit at 9.9. First only food articles were getting expensive, but now all other items in the basket for the wholesale price index are becoming dearer. The only way out for the government was to let the RBI raise the interest rates and the cash reserve ratio of banks to act as a brake on inflation. The RBI recently hiked the repo and reverse repo rates (overnight lending and borrowing rates) to 5.25 per cent and 3.25 per cent. These can be translated later to a hike in bank lending and deposit rates.
The cash reserve ratio or the portion of deposits that banks park with the RBI has been raised to 6 per cent. This may have the effect of sucking out liquidity from the market as less cash would be available for lending. People will be putting money in the banks instead of consuming more goods, and thus the demand push inflation will be controlled.
Second, many manufacturers are facing a cut-throat competition from China. The Indian rupee has been rising against the dollar, but no amount of pressure is working on China’s determination not to revalue the yuan against the dollar. China has a $16 billion trade surplus against India.
Recently when External Affairs Minister S.M. Krishna went to China he complained about the burgeoning trade surplus China has with India. Chinese exports have been growing at 17 per cent. China has to import more from India, the US and other countries. Recently it has declared that after six years it is experiencing a trade deficit of $7.2 billion. This probably goes to show that China is importing a lot of raw materials and other inputs needed for its manufacturing industries from the rest of the world. Its GDP growth has been impressive at 11 per cent in March.
Many economists are sounding alarm bells regarding the deteriorating current account situation (the summary of trade flows of goods and services, including remittances from Indian migrant workers abroad), and what it would mean in terms of depreciation of the rupee. But contrary to what such a situation demands, the rupee is strengthening. India, however, does not have much to fear because it has nearly $300 billion in reserves. Thus, there is little reason to expect a sovereign bankruptcy but individual pain is possible as companies go bust, especially when they cannot compete with a formidable foreign rival (China).
The third problem is that of capital inflows into Indian markets. The problem of high value of the rupee against the dollar originates from the huge inflow of foreign institutional investments (FIIs) into the Indian financial market. This has been happening over the last few months and the government has resisted taking a drastic policy measure to abate the flow. The recent inflow of FIIs has been due to the high interest rates in emerging markets like India.
All over the world, the interest rates have been kept low to encourage and sustain recovery. But in India the interest rates have been slowly hiked to contain inflation, which has also made this country an attractive destination for parking funds by foreign investors. Also the stock market has been on an upswing and crossed 17K and, therefore, the returns are relatively higher than in other markets. It is this uncontrolled inflow which is increasing the supply of dollars in the financial system and leading to the hardening of the rupee. If the RBI had intervened, it would have bought dollars from the financial markets. But this has not happened.
The hike in the interest rates may further exacerbate the dollar inflows and lead to the hardening of the rupee to less than Rs 44 which will hurt exporters more. If exports slow down from their recent recovery phase - it did so for 13 months --- industrial growth will also decline because 12 per cent of industrial production is exported.
India’s industrial growth has been impressive at 16.5 per cent in February and manufacturing growth, which is the main component of the index of industrial production, has been growing at 15 per cent in March. The interest rate hike will hurt industry where many units have just started undertaking fresh investments. There is a fear that this initiative will be thwarted. Even the demand for goods can be impacted if food inflation continues.
To control food inflation, the supply of essential commodities like pulses, sugar and cereals have to be enhanced. Otherwise the continued thrust and buoyancy of the consumer demand that even Tim Geithner, US Treasury Secretary, noticed about the Indian economy would peter out.
The fact remains that the recovery is still fragile, especially when exports are also dependent on the economic recovery of its global partners. Unless the global economy recovers, India cannot experience robust recovery and, as the Prime minister also hinted at, there is a growing fear of protectionism. The glitches common to all the emerging economies - inflation, exchange rate and capital account problems — will make it harder for the government to attain sustainable development, especially in backward areas. Already there is plenty of disturbing news about the rise of insurgency in these backward regions which is going to be a security threat to investment.
Lastly, a rise in the interest rates will increase the debt service payments of the government because of its huge borrowings from the market. Interest payments already comprise 19 per cent of the government’s total expenditure. During the last two years since the global financial crisis began, the government has been generously doling out money to boost the consumer demand as a result of which this cost has escalated. With the interest rate hike, the government may find it difficult to increase social spending to counter the ill-effects of inflation on the poor, who have not only suffered from job losses due to the recession of the last two years, but have also fought malnutrition. As is well known, India has the highest number of malnourished children in the world.
How to govern the country better with fewer resources and also have inclusive development programmes may be one of the key challenges before India. Like India, the problem of rising internal debt and its servicing is also plaguing some of the countries of Europe and they are facing a double-dip recession. According to the IMF, India’s governmental debt is at 82 per cent of the GDP, up by 3 per cent from what it was two years ago. But India’s growth prospects are higher and the country may be saved from the double-dip recession scenario.
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