Many in India are wondering whether an economic crisis is brewing. Few economists are already sounding alarm bells. The state of the economy is not in a highly dangerous situation yet, but a lot depends on how people react to the petrol and diesel price hike and the rupee’s slide as it will affect their consumption pattern which is important for sustaining demand and economic growth. Also the rupee’s slide to 74.22/dollar will impact the perception of foreign investors about India as an important destination to park their funds which will in turn affect business expectations and private sector’s propensity to invest.
On the surface, India is doing well and it has the highest GDP growth in the world. It registered 8.2 per cent growth in the April-June 2018 — the first quarter of the current fiscal year and expected to grow at 7.4 per cent in 2018. Business activity is being fueled by private sector’s consumption. So far, hike in petrol prices and import duties on some consumer goods has not stoked inflation but the rupee’s steep fall vis-a-vis the dollar in 2018 has led to problems in the current account deficit (CAD).
India’s heavy dependence on oil imports is the main reason for the widening of CAD as it imports 70-80 per cent of its requirements; the recent price hike in international crude oil prices to $85 a barrel has compounded problems.
India’s heavy dependence on oil imports is the main reason for the widening of CAD as it imports 70-80 per cent of its requirements; the recent price hike in international crude oil prices to $85 a barrel has compounded problems. In order to control the widening of CAD (it reached 2.4 per cent of GDP in Q1) which is causing the rupee to slide and prompting foreign portfolio investment to exit (they pulled out $2.45 billion from local bonds and stocks in September 2018), the government has come up with an import control plan which is clearly protectionist. Gold and electronics have been targeted as well as all ‘non essential’ goods. According to an advisor to Prime Minister Modi, the imports targeted are catering to the requirements of the top 10 per cent of the population and include recreational travel and sending children abroad for higher studies.
The government has recently come up with a palliative measure of reducing petrol and diesel prices by ₹2.50 per litre, hoping it will garner the good will of the common man. But the result has been quite disastrous on the stock markets as the oil marketing companies’ shares have plummeted recently. Stocks of Indian Oil, Hindustan Petroleum, and Bharat Petroleum closed 18.245, 22.445 and 18.88 per cent lower respectively on NSE after the announcement.
The rupee has weakened despite the Reserve Bank of India’s intervention in the market by $30 billion. It may drop further because of US Federal Reserve and ECB’s (European Central Bank) monetary tightening policy. The Fed will have a regime of interest rate hikes over this year as it downsizes its balance sheet by selling off its bond portfolio. The ECB is also committed to taper off its bond buying programme. It will mean a rise in hard currency yields and will attract FIIs to go to US and EU. The banking sector in India on the other hand is struggling to manage its huge non-performing assets (over 10 lakh crores) — and even though the central government is helping to recapitalise banks — they are reluctant to lend and as a result private investment has been stagnant.
The rupee has weakened despite the Reserve Bank of India’s intervention in the market by $30 billion.
RBI’s latest move of keeping the repo rate unchanged at 6.50 per cent when market expected a hike by at least 25 basis points (one basis point is one hundredth of a percentage point) has come as a surprise. It is based on low inflation expectations which may prove to be incorrect given the higher cost of transportation and higher cost of production for industry due to rise in price of imported raw materials. But it may help investment by keeping borrowing costs stable.
There is a liquidity crisis in the bond markets which has been triggered by the IL&FS (Infrastructure Lease and Finance Services) defaults. The IL&FS have a loan default of $12.6 billion which has shaken the stock markets. Bond yield have shot up as a result. RBI is likely to go for quantitative easing, buying bonds in order to inject liquidity via its open market operations.
The fiscal deficit targeted at 3.3 per cent of the GDP may not be met as there has been a shortfall in tax collections in most States due to the jerky implementation of the GST as well as hasty tax reductions on consumer goods and small businesses. The Centre is expecting a big windfall in GST collections in the coming festive season. The Central government is supposed to curtail its own borrowing by ₹700 billion but there are indications that the government’s expenditure in this election year will go up. There reasons are — the recent hikes in MSP of major crops, the Modi healthcare programme, ₹1.5/litre cut in excise duty by the Centre which may lead to higher costs of subsidised LPG and fertilisers. All these are indicative of fiscal slippage by the Centre.
The agricultural sector has remained stressed and this year has been marked by farmer agitations.
The agricultural sector has remained stressed and this year has been marked by farmer agitations. Surprisingly agriculture has registered growth rate of 5.1 per cent in the first quarter (April-June). Farmers’ indebtedness and dissatisfaction with the government’s Minimum Support Prices (MSP) for major crops for its food procurement programme, lack of access to cheap institutional credit are some of the problems. The government has hiked the MSP but farmers are compelled to sell at prices below the MSP as they cannot hold on to their crops for long and have to sell to local traders. Wholesale prices in
mandis are often below the MSP.
The whole economic picture can become distorted and the V-shaped recovery may turn into a downturn in the coming months if the rupee falls further and FIIs rush out of India. Consumer behaviour, spending pattern, business expectations/confidence will play an important role as well as how the government manages to rein in its expenditure. The CAD can still be managed with high reserves even though overseas servicing obligation is around $200 billion which will be a drain on the forex reserves.
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