The State of the Economy
The three main economic blocks of the global economy are the US, the EU and Japan, and the Emerging Market Economies, including China, India, Brazil and South Africa. Among these two are underperforming.
The US growth remained sluggish in the third quarter of 2010. High unemployment, modest income growth, lower housing wealth and tight credit have constrained household expenditure. The Euro area is showing signs of resilience though not uniformly across the Euro zone. The economic recovery in Japan has also moderated due to slowdown in industrial production and growth in exports. The only block which shows strong economic activity is of the Emerging Market Economies (EMEs) mainly due to domestic demand and partially exports.
In the US and Japan, inflation rates are significantly below desired levels while in the EMEs inflationary pressures has become a major concern due to strong domestic demand. In our case, for a long time, the old wholesale price index (WPI) (base 1990) was followed which hardly gave the real picture of inflation. The new series of WPI released on September 14, 2010 is a better representative of commodity price levels with an updated base (2004-05=100) and wider coverage of commodities. As per this WPI series, the year-on-year inflation moderated to 8.5 per cent in August 2010 and 8.6 per cent in September 2010 after remaining in double digits during March-July 2010. The year-on-year primary food inflation moderated from 21.4 per cent in May 2010 to 15.7 per cent in September 2010. Though in case of protein-based food items such as pulses, milk, eggs, fish and meat, inflation peaked to 34 per cent in May 2010.
In case of non-food manufactured products (weight: 55.0 per cent) inflation increased from (-) 2.0 per cent in September 2009 to a peak of 5.9 per cent in April 2010, before moderating to 5.0 per cent in September 2010.
India GDP grew 8.8 per cent in Q1 of 2010-11. The normal South-West monsoon is expected to be good for both kharif and rabi crop. Industrial growth has been robust and the year-on-year increase in the index of industrial production (IIP) during April–August 2010 averaged 10.6 per cent. Exports have grown 27.6 per cent during the first half of 2010-11 over the corresponding period of last year. Private corporate sector sales rose by 24 per cent in Q1 of 2010-11. Service sector has also remained buoyant this year as well.
The currency growth has been higher than deposits growth, lowering money supply growth. The negative real interest rates on deposits have induced depositors to both hold currency and invest in non-financial assets, including gold and real estate.
There has been a significant increase in credit to large industries, especially power and infrastructure. The total flow of financial resources from banks, non-banks and external sources to the commercial sector during the first half of 2010-11 was higher at 4,85,000 crore, up from 3,29,000 crore during the same period of previous year.
Both the increases in lending rates by the banking system and liquidity conditions are consistent with the monetary policy stance of reining in inflation.
Domestic equity prices firmed up significantly in recent weeks due to large inflows from foreign institutional investors (FIIs), driven by better domestic growth prospects and a surfeit of global liquidity. The forex market, which witnessed a significant increase in net inflows beginning September 2010, has remained orderly with the rupee showing two-way movements in the range of `44.03 – `44.74 per US dollar during October 2010.
After realising large sum in spectrum auction, tax revenues and disinvestment, the Government announced that it would pare its market borrowing by `10,000 crore in the second half of the financial year. The Government in consultation with the Reserve Bank also announced the repurchase of government securities amounting to `28,553 crore maturing during 2010-11.
Having the fiscal deficit under control is good when the government is dealing with an inflationary situation. Though focus on expenditure restructuring as on revenue augmentation, recurring expenditure commitments should not be made against one off revenues such as from disinvestment and the quality of adjustment should not be lost sight of.
Due to moderation in exports growth because of sluggish global economy and import growth accelerated because of strong domestic recovery, both the trade deficit and the current account deficit (CAD) widened in Q1 of 2010-11. A CAD above 3 per cent of GDP is difficult to sustain over the medium-term. The first challenge, therefore, is to rein in the deficit over the medium-term and finance it in the short-term. The medium-term task has to receive policy focus from both the Government and the Reserve Bank. The short-term task is to see that the current account is fully financed while ensuring that capital flows are not far out of line with the economy’s absorptive capacity and that the component of long-term and stable flows in the overall capital flows is high.
(Based upon quarterly review of RBI’s monetary policy)
iSikkim will review the state of Indian economy in the current global context in a 10 part series. This is part two of the series.
Next in this series: Outlook and Projections