Growth Performance and Outlook

Marking a distinct break from the past the economy grew at an average of 8.5 per cent and the per capita GDP at 6.9 per cent in the five-year period from 2004/05 to 2008/09, despite the crisis-affected year of 2008/09. The Indian economy weathered the financial turbulence well and grew at 6.7 per cent in 2008/09, which despite being 2 per cent lower than the average of the preceding three years, was still of a lower order than in most of the world. This achievement belongs to the common Indian citizen with credit being shared by the policy maker. The rapid adjustments in the monetary and fiscal policies were well calibrated and not excessive, enabling the Indian government to contemplate a return to fiscal consolidation in 2010/11 and an early normalisation of the monetary policy stance.

The Indian economy escaped the global contagion primarily because the Indian banking sector was not exposed to the risky assets, similar to those financed in the advanced economies. The three important lessons to be drawn from this are, first, prudence is an essential virtue for financial and fiscal stability; second, deposit-based banking, as is practiced here, is perhaps the more solid foundation to bank lending than the one based on short-term borrowings from capital markets by banks; third, the financial regulators should be intimately conversant with the products and practices that they are enjoined to regulate.

In 2009 and 2010, the principal factors detrimental to prospects of a sharp recovery in the growth rate of the Indian economy derive from the international situation. The recession in the developed economies will make recovery a slow and long drawn out process with negative implications for import demand for manufactured goods and services. The weakened state of these economies and the global financial system hold out the possibility that conditions could suddenly deteriorate in the wake of a negative shock, such as a payment crisis in a large bank or a crisis precipitated by a sovereign creditor. Though, the deficient monsoon will pull farm sector growth down, that should not be a handicap if the monsoon is normal in the following years.

Internationally, oil and commodity prices have started rising and as economic growth picks up, there is a distinct possibility of further increases. The loose monetary and fiscal stance adopted across the world will support strong price gains, even as the real economic activity recovers at a slow pace. On the domestic front the sharp increase in the price of food grains, especially rice and pulses, other primary food products and of sugar is a major policy concern. Even in the winter of 2008/09, as world prices of manufactured goods and internationally traded basic foods were declining, the domestic prices were increasing. The weak monsoon rains and available acreage data suggest a lower kharif output rendering the management of inflation in food products a severe challenge in this fiscal year. While the current weather conditions favour a strong rabi (winter) crop, the possibility of adverse weather conditions in rabi cannot be completely ruled out.

The industrial sector is likely to show vigorous growth in the second half of the year and farm sector output and GDP growth are likely to be negative. Given the variability of the key elements, the Indian economy is likely to grow by about 6.5 per cent in 2009/10. It is unlikely that growth will be lower than 6.25 per cent but possible that it could reach 6.75 per cent.

The impact of the global economic and financial crisis on India operated through three channels – a) the financial channel which diminished the ability of Indian companies to mobilize equity and debt in foreign and domestic markets, b) the trade channel which operated by eroding the import demand in developed economies and c) the collapse of business and consumer confidence in the developed economies, which depressed sentiments worldwide, including in India. This was truer of the private corporate sector/consumers in the metropolitan centres than in semi-urban/ rural areas.

Structural Factors that Underpin Prospects of Recovery of Growth

The Indian economy has witnessed a structural break from the past in respect of the generation of investible resources. During the past five years, the rate of domestic capital formation has climbed to 39 per cent in 2008/09 from 25 per cent, while the domestic savings rate has increased to nearly 38 % in 2007/08 from 26 per cent. The spurt in growth in the recent past was mainly driven by an increase in investment, especially private corporate investment. This was matched by an improvement in the savings rate, led by fiscal consolidation and a reduction in the negative savings by government.

The large increase in domestic savings rate by nearly 10 percentage points of GDP permitted incremental investment of about the same order to be largely financed from domestic resources. It is estimated that primarily as a result of the large negative savings by Government the domestic savings rate which dropped by about 3 percentage points of GDP, is not likely to recover to the 2007/08 levels in the current fiscal.

The contribution of capital formation to growth was significant in the recent past. The aggregate contribution of domestic consumption expenditure to overall GDP growth has been fairly steady at around 4 percentage points while the contribution of capital formation peaked at close to 6 percent of GDP in 2005/06 and 2006/07. The large import component in the context of the accelerated growth is reflected by the large and sustained negative contribution of net exports in these years. Provisional data for 2008/09 suggest that private final consumption expenditure slowed sharply during the year. This was, however, partially offset by the large increase in public consumption expenditure.

Farm prospectus

The SW Monsoon has been deficient to the extent of 22.7 per cent in 2009 with major shortfall in July impacting the kharif prospects negatively. The subsequent recovery of the monsoon in August and September has however strengthened the prospects of the rabi harvest. The reported area sown up to September 30, 2009 showed a decline of 8 per cent, amounting to 5.4 million hectares, of which paddy contributed the largest acreage loss at 5.9 million hectares, which was partially offset by an increase in the acreage under pulses.

Based on the acreage data and other parameters, the Council’s assessment is that the there will be a loss in kharif foodgrain production largely contributed by rice, with some offsetting output gains from pulses. The output of coarse cereals will remain unchanged. There will be some gains in the rabi output. It is expected that the total foodgrain production in 2009-10 will drop to 223 million tonnes from 234 million tonnes in 2008-09 and the output of oilseeds will decline to 276 million tonnes in 2009-10 from 282 million tonnes in 2008-09.

It is expected that growth in farm output will be (–) 2.0 per cent. However, if the rabi crop is smaller than last year’s and the non-crop sector suffers more than anticipated, the overall decline of farm sector GDP could be higher.

The non-farm sector

With a restoration of normality in operating conditions, a strong bounce back is expected in the rates of output and GDP expansion in the non-farm sector in the second half of 2009/10, especially in the industrial sector.

• Mining - Due to the substantial increase in production of crude oil and natural gas and coal , the GDP arising in this sector is expected to increase by 10 per cent this year.
• Electricity – The period April to September 2009 witnessed an increase in cumulative power generation by 6.8 per cent. The output levels is likely to improve in the balance part of the year to average at least 7 per cent growth.
• Manufacturing - Output growth in manufacturing has been sluggish since November 2007. However, manufacturing output bounced back in June 2009, growing by 7.8 per cent, then 7.4 per cent in July 2009 and 10.2 in August 2009. Though, export demand is yet to pick up, the recovery in manufacturing output is broad-based and strong enough to suggest a recovery based on domestic demand, improved business confidence and a stable operating environment. Manufacturing output growth is likely to recover to over 9 per cent in the second half of the fiscal and average 7.7 per cent growth in 2009/10.
• Construction - Construction growth, which had slumped in the third quarter of 2008/09, has recovered since then. Strong output growth in cement, recovery in steel output and home loan disbursements suggests improved construction activity. It is expected that the GDP arising in the construction sector, will expand by around 8.8 per cent in the current fiscal.
• Services - The larger part of services that are in the nature of intermediate services for industry will benefit from an upturn in industrial activity. Transport services have picked up. IT and ITES will have strong domestic demand, though exports will remain weak and government expenditure on services (salary and arrears) will continue to show growth in the first half of the year, but slow down in the second half. Overall services sector GDP growth is expected to be around 8 per cent this year.

Balance of Trade

In 2009/10, the export outlook will not be favourable to expansion. Exports after reaching their lowest point in the last quarter of 2008-09, have been steadily improving since June, 2009, reaching $14.3 billion in August, 2009. The Council expects strong growth in the second half of 2009-10, with the value of exports for the current fiscal reaching $183 billion as against the DGCIS figures of $182 billion in 2008/09. The value of imports in the first five months of 2009/10 was $102.3 billion - a decline of 33.4 per cent over the corresponding period of last year. This will reverse in the second half of the year and for 2009/10 the value of merchandise imports is projected at $281 billion, 4 per cent lower than 2008/09. The trade deficit corresponding to the DGCIS trade data system is projected at $107 billion, lower than the $109 billion recorded last year. Adjusting for this, on Balance of Payments basis, the merchandise trade deficit for 2009/10 is projected at $ 117 billion or 9.4 per cent of GDP.

Capital Flows

In-bound foreign direct investment (FDI) has picked up in the first quarter of 2009/10 and will be sustained through the balance of the year to aggregate $37 billion in 2009/10. Outbound FDI is projected to be $14 billion. Portfolio inflows, a large negative number last year, are currently showing a rising trend which is expected to continue. Net inflows are projected at $25 billion in 2009/10. With improved global financial conditions, the overall inflow under the head of loans, is expected to be around $8.7 billion.

Banking transactions including change in Non Resident bank deposits is expected to cause a net inflow of $3 billion while other capital is expected to be a negative $1billion. That makes for an overall positive balance on the capital account of a little over $57 billion. After financing the CAD of $25 billion, an amount of $32 billion is projected to be absorbed in the foreign currency assets of the RBI.

Prices

The year-on-year rate of inflation as measured by the Wholesale Price Index (WPI) was 0.8 per cent as at the end of March 2009 and then entered negative territory at the beginning of June 2009. However, this was due to the base effect and the price levels were actually rising since January 2009. In the first half of 2009/10 the overall WPI index has risen at an annualised rate of around 13 per cent, with a sharp increase in the foodgrain index, which is clearly outside the policy comfort zone of 4 to 5 per cent.

Inflationary pressures are yet to surface in the developed economies, largely on account of the negative impact of lower energy prices. However, even as the developed economies come out of recession, inflationary pressures will increase and the open monetary and fiscal stance will fuel inflationary expectations. An unambiguously spelt out strategy and a clear timeframe for returning to more normal monetary and fiscal times will curb the inflationary pressures. In India, given the strength of inflationary pressures in the first half of 2009/10, due in part to the drought and expectations of lower supply, it is easy to envisage a situation in March 2010, where inflation is higher than 6 per cent. Inflationary pressures on the food front will be a major policy concern in 2009/10. A strong supply response - a more co-ordinated release of stocks through the public distribution system, open market sales of public stocks, precautionary arrangements for importing some foodgrain and attention to ensuring a strong rabi harvest will be an antidote to food price pressures.

Monetary and financial sector

The 4 per cent cut in the Cash Reserve Ratio (CRR) during the crisis released almost Rs 1,60,000 crore in the banking system but a large part of this remained as excess liquidity and was parked with the RBI. To an extent this continues till date. Bank credit to the commercial sector was sluggish in the second half of 2008/09 and credit offtake continues to be sluggish in 2009/10. Up to the fortnight ending September 11, 2009, non-food credit was up only by 1.8 per cent on a year to date basis, the lowest in five years.

Indian companies have, however, managed to raise large volumes of debt from the domestic capital market and in the current fiscal, the debt mobilised in the capital market has been significantly larger than the flow of bank credit to the commercial sector. The amount mobilised through equity issuance in the first five months of 2009/10 has also been high.

Banks have added to their holding of government securities, both in the second half of 2008/09 and in the current fiscal. This, on the one hand, is a risk minimising response while on the other, it is a natural corollary of the large supply of government securities during this period to finance the larger than expected fiscal deficit. The funds sequestered under the Market Stabilization Scheme (MSS) have proved useful both in the previous year and in the current one to finance government expenditure. Out of the Rs. 178,000 crore with RBI in the beginning of the crisis, by mid- September 2009, only Rs 19,000 crore remained outstanding under the MSS.

With tangible improvement in economic conditions, the domestic demand for credit is likely to pick up. Deposit re-pricing by commercial banks and a more stable situation is also likely to see banks push lending more and overseas sources of borrowing are likely to improve. Mobilization of additional equity finance by Indian companies will also improve the capital structure of Indian companies and ease bank lending.

Indiabiznews, October 22, 2009