Falling growth, rising inflation, deprecation of rupee, rising current account deficit, foreign funds outflow, political instability are the buzzword that hallmark the Indian economy now a days.
The Indian economy managed to show resilience and continue to grow at moderate pace during the major economic recession of 2008 which hit economies such as the US, UK, Germany, France, Italy and Japan. The strong fiscal position in 2007-2008 allowed the Indian government to announce an Rs 75,000-crore farm debt waiver and meet the generous Sixth Pay Commission award. Subsequently, the government was also able to cut taxes and announce other measures to stimulate demand in the global crisis period. This lead positive impact on the domestic economy and subsequent recovery of the global economy with loose monetary policy and government spending contributed a considerable growth to India.
However, rising headline inflation post crisis have caused severe pain to policy markers. In an attempt to combat inflation, the RBI has raised rates 13 times so far, with effective policy tightening at 525 bps (with the repo rate currently at 8.5 percent). However, inflation remained high and GDP has slowed from 9%.
As per latest data, the Q2 FY 12 GDP growth slowed below 7% while industrial and service sector have started witnessing negative growth. The more is expected to come in the form of further slowdown in industries and services during 3rd and the 4th quarter as global economy is poised for another recession in 2012. The 3rd and the 4th quarter are the traditionally high output period for India.
If India struggles and sees growth falling under 6%, it is possible that there may not be any fiscal stimulus to bring back growth to government’s target. The Finance Minister Mr. Mukherjee pointed out that the government already on the brink of missing fiscal deficit target of 4.6% of GDP could not provide any stimulus to pump prime the economy as it did in 2008-09. "I am not in a position to provide that level of fiscal stimulus that we provided in 2008-09. But certain policy changes can improve the situation little bit which we are doing," he said.
In fact, the government revenue collection is poor this time around and we may not achieve the target set for FY 12. India may to meet the direct tax collection target of Rs. 5.85 trillion for FY 12. The Q3 FY 12 saw companies headquartered in Mumbai paid only 10% higher advance tax. The advance tax collection for the quarter ending December from 100 leading tax-paying companies based out of Mumbai is almost 35% of all-India corporate tax kitty.
Apart from tax revenue, government’s target for disinvestment (Rs 40,000 crore) for FY 12 looks dismal due to volatile market conditions. So far, it has managed to collect only Rs 1,145 crore from Power Finance Corporation’s follow-on public offer. The government is now looking at other options such as buyback of shares by PSUs, super normal dividends from PSU’s etc.
It is quite evident that fiscal situation is seriously tight and the Cabinet has passed the food security bill which many argue as a vote bank politics for upcoming elections. The bill plans to give legal entitlement of cheaper food-grains to 63.5% of the country's population. As per food minister, the total financial liability to implement the law would be Rs 3.5 lakh crore as funds would be required to raise agriculture production, create storage space and publicity among others. The food grain requirement would go up to 61 million tonnes from 55 million tonnes. However, many argue that the bill will have a financial liability of almost 2lakh crore in a year and may reach 6lakh crore in three years.
The financial burden of the bill could be met by cutting down expenditure in other sectors or by fresh government borrowing. If go along with critic’s view on financial liability of the bill, it will shoot the figure of government debt. India’s debt/GDP ratio is well above 80% and we may be heading towards the triple digit in coming years. We are still better off than Greece which debt/GDP ratio might me above 120%.
Though the socialistic principle of the government seems right, I doubt it will result in a major change in bottom line of the country due to various structural problems. The implementation of the act with proper identification of beneficiaries and effective delivery will be a difficult process. There is vested interest along the value chain and state level intervention is highly required. The reason that people go hungry in India is not because there’s no food available but because they’re too poor to afford it or that the state-sponsored provision of that food is so corrupted as to effectively deny access.
If anyhow the government succeeds and food grains are distributed to the government defined poor, it will provide strong disincentives for work and productivity. After all, if somebody is offering to give free food, why would one bother to get a job and earn income to feed him? This is called the problem of “moral hazard” in economics in which a welfare program leads to perverse incentives.
With this huge commitment for a cereal-based food security programme, there is a likelihood of neglecting agriculture. There can be no sustainable food security without sustainable agriculture. Investments in agriculture have to be increased and policy space should be provided for larger private investments.
One of the most important things to look out is the procurement of 60-62 million tonnes of food grain means adding 10 to 12 million tonnes from current procurement levels. States like Punjab, Haryana, Andhra and the new ones, Chhattisgarh and Orissa which supply major food grains to government may find difficult to provide additional delivery. It seems Uttar Pradesh, Bihar and West Bengal have to step in, but the question is can they produce enough surplus to meet the demand from government?
I doubt this is the right time as the global economy is at the brink of recession and domestic economy has started slowing down. The bill will directly impact private trade and also induce inflation. One must have observed that government has been consistently telling that fighting inflation is a key priority; such policy will act negatively towards it. It will fuel food inflation, unproductive use of resources.
Despite strong Khariff production this year, food prices have not eased due to consistent increase in the minimum support prices (MSP) for procuring grain. With the Food Security Bill, the govt is going to be procuring more and more grain every year. That means is will keep raising MSP.
And, what about the Fiscal Responsibility and Budget Management Act, 2003? The main purpose of the bill was to eliminate revenue deficit of the country and bring down the fiscal deficit to 3% of the GDP by March 2008. It has failed till 2008 and also going to fail FY 12 target rate. It is likely that fiscal deficit as a % of GDP may reach towards 9-10% if the bill is passed along with slowing down of government revenue.
The country has not seen a major reform in recent times and the current deadlock on FDI in retail shows, economic reform is in stall. If India wants to grow at the pace of last decade, then we must embrace progressive reforms and focus on the current macro economic problems.
The present status of Indian economy is far better than that of 1991 crisis, but few numbers are highly comparable. In 1991, current account deficit was more than 2.5% of GDP and now it is expected to reach above 3.5% in FY12. Fiscal deficit was 8% of GDP during 1990-1991, and it is around 5.5%, but has a possibility of rising further. In 1991 speech the FM said, rising fiscal deficit is ““a cause for serious concern.” He said “It should be our objective to progressively reduce the fiscal deficit of the Central Government…and to reduce the current account deficit in the balance of Government…and to reduce the current account deficit in the balance of payments.”
WPI inflation was 12.1% in the year ended March 31, 1991. The FM said, “Inflation hurts everybody, more so the poorer segments of our population.” And now it is below 10% after holding above the double digit for couple of months.
However, forex reserves are better off than 1991, where the government could have financed imports for one week or 15 days. Now, we have better import cover of around 8-9 months stands above $300 billion.
The imminent fear for the Indian economy is external situation apart from the prevailing domestic issues. The debt crisis in the EU area which may propel global liquidity crisis along with rising Crude Oil prices may hurt emerging nations like India. If middle-east situation destabilize further with a possible Iran war then we may see Crude oil @ $150 or $200 per barrel. Hope EU debt crisis find a solution, India comes with progressive reform and Middle East political tension reduces. Anyways, time will tell us the real story……
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