Global Outlook

A ‘domino effect’ of the current crisis on the Indian economy could soon be a reality.

Contributed by Nirmal Bang

By Nirmal Bang

Comatose is a condition pertaining to or affected by coma. And coma, a word derived from the Greek word ‘koma’, meaning deep sleep, is a state of extreme unresponsiveness, in which an  individual exhibits no voluntary movement or behaviour. Sounds too medical? Indeed.

But look at the headlines of pink papers and the term comatose will surely seem appropriate for the current state of the Indian economy.

While rising inflation and high interest rates to tame inflation have been a part and parcel of the Indian economy since some quarters now, factors such as lower index of industrial production (IIP), widening  current account deficit, higher fiscal C deficit, weak currency and a reduced gross domestic product (GDP) have also been spoilsports.

Latest first. The index of industrial production (IIP) contracted by 5.1%  year-on-year (y-o-y) in October. And in the current financial year, April to October ’11, IIP has grown by a paltry 3.5% as compared to 8.7% in the corresponding period last year.

The sharpest-ever decline in capital goods pulled October IIP growth down to the crisis low of January–April ’09.

Economists feel IIP growth is likely to remain gloomy for the subsequent part of the current fiscal, ending  March ’12. What worries them more is that the current pace of softening IIP numbers risks the current fiscal’s GDP growth below 6.5% The other big issue is India’s fiscal deficit, which has been under the vigilant eye of investors. Government revenue slippage is an ongoing issue, which is evident from theApril–October ’11 numbers. The  deficit stands at a stark 74% of the budget targets, pegged at Rs.3,07,000 crore against the budget estimates ofRs.4,12,800 crore.

“Fiscal trends have remained unchanged this year, with revenues remaining below budget estimates while expenditures continue to overshoot,” says a Citi report.

The current run rate for net tax revenues is 7.3% versus budget estimates of upwards of 17.9% while that of expenditures is 10.2% vis-à-vis budget estimates of 3.4%. Lower tax revenues, expenditure overshoot, lower divestment proceeds and higher oil under-recoveries are the reasons for the slippage and measures to arrest them are limited.

“While a fiscal slippage is well priced in, the extent will depend on the quantum of deferment of oil under-recoveries and measures to meet the divestment target,” the Citi report adds.

While the market is not conducive to disinvestments, oil under recoveries paint a scary picture owing to the absence of deregulation in diesel and cooking fuels, which has resulted in mounting losses for most oil marketing companies.

According to Citi, if crude averages $105/barrel and the rupee averages Rs.50/dollar during the second half of the current fiscal, oil under-recoveries are likely to rise to Rs.1,28,900 crore.

And assuming the continuation of the subsidy-sharing framework, where the government’s share is 50% of the  total losses, the subsidy burden could rise to Rs.70,400 crore or 0.8% of the GDP. The government has not budgeted for the same.

“However, as in the past, the government could defer the payment  due to oil companies to the next fiscal year,” the Citi report points out. The bottom-line is that the deficit is likely to widen to anywhere between 5.1% and 5.8% of the GDP in the current fiscal depending on the extent of the payout of oil subsidies.

The wider deficit, higher than budgeted targets of 4.6% of the GDP, could result in additional funding requirements to the tune of Rs.50,000 crore over and above the recently announced borrowing programme of additional Rs.53,000 crore.

A collective impact of the fiscal odds is vehemently visible in the GDP growth numbers. For the third quarter ended October, India’s GDP y-o-y growth slowed to 6.9% compared to 7.7% which was witnessed in the previous quarter. The culprit was the slowdown in domestic investments.

The writing on the wall is distinctly clear: the growth momentum has slowed. India is slowing due to the tightening of the monetary policy to bring inflation under control, says a Deutsche Bank report.

“However, the slowdown is driven by dip in investments, which can also be explained by the administrative hold up of investments, slow structural reform implementation and a more uncertain global backdrop,” the report points out.

And the government’s ‘one step forward and two backward’ move was clearly visible in the way it handled the issue of increasing the limit for foreign direct investment (FDI) in single brand retail.

The current administration’s commitment to economic reforms is reflected in its efforts to get the bill to liberalize FDI in the retail sector through the Indian parliament.

“The very high degree of opposition,  not just from opposition parties but from within the governing coalition itself, reveals the complex nature of India’s democracy,” says a Deutsche Bank report.

And beyond the domestic pressure points, global developments too have been at negative play for India. During 2011, India has been one of the worst performing markets among emerging economies.

“Much of which has been due to the sharp fall in the rupee, as both the  market and the currency now reflect a high degree of investor disillusion compared with the euphoric mood,” says the Deutsche Bank report.

Also, the corporate sector faces numerous issues, ranging from declining profitability to leveraged balance sheets, where many have exposure to external commercial  borrowings in a scenario where the rupee has weakened by close to 20% in a matter of four months. And there are others too who have foreign currency convertible bonds (FCCBs) repayment liabilities staring in their face in the coming fiscal.

Given that an economic slowdown is evident from almost all economic indicators, the Reserve Bank of India (RBI) has no choice but to change its stance and adopt a wait-and-watch approach to tackle the crisis.

While the stated stance of policy has been to tackle inflation even at a marginal trade off of growth, given the possibility of a global growth  scare, the RBI would be left with no choice but to start cutting rates to boost the economy.

After all, inflation numbers for November at 9.11% should give the RBI the much needed comfort. “Growth is clearly decelerating,” the RBI said in its mid-quarter monetary policy review on 16th December.

Currently, both inflation and inflationary expectations are within RBI’s comfort level.

“However, reassuringly, inflationary pressures are expected to abate in the coming months despite high crude oil prices and rupee depreciation.” The RBI said that while inflation remains on its projected trajectory, the downside risks to growth have evidently increased.

The guidance given by the central bank in the second quarter monetary  policy review was that, based on the projected inflation trajectory for the economy, further hike in key interest rates was not warranted.

“In view of the moderating growth momentum and higher downside risks to growth, this guidance is being  reiterated,” said RBI. “From this point on, monetary policy actions are likely to reverse the cycle, responding to the risks to growth.”

Despite all this, the odds clearly outnumber the evens. And in medical terms, the comatose analogy fits best for the Indian economy.

For those who know, and even for those who do not, a patient in a  comatose state does not need a life support system or a ventilator, unless the health worsens. What more can one hope for the Indian economy but to ‘get well soon’.