If the Indian economy grows by around 6.5 per cent this fiscal despite some decline in farm production, economic expansion would be lower than last year’s but quite reasonable as global financial crisis had considerably slowed down economic growth since September, 2008.
The total fiscal deficit will likely hit 10.1 percent of gross domestic product this fiscal, up from 8.6 percent last year and far higher than government targets.
The cost of primary food articles has shot up by a third, and the benchmark inflation rate is expected to reach 6 percent by March, higher than the central bank’s July prediction of 5 percent. The 22.7 percent shortfall in the summer monsoon rains will likely drive a 2 percent contraction in agricultural output.
Projected food grain production is 223 million tons, down from 234 million tons last fiscal year.
Food inflation and a growing government budget deficit, however, remain serious concerns for Asia’s third-largest economy.
Overall, the one disturbing element in the Indian economy is the behavior of inflation, according to C Rangarajan, chairman of the Prime Minister’s Economic Advisory Council. If inflation becomes very bad by year’s end, the stance of monetary policy will have to change from its highly accommodating position, he says.
Already experts are suggesting that considering the inflationary position, India should take a leaf out of US’s book by tightening its interest rate policy. If India does not follow a tighter regime, the spectre of stagflation looms.
There are some signs that India’s inflation is already taking a toll. Production of consumer goods is contracting even as industrial production surges, indicating that rising food prices and inflation elsewhere is crimping living standards.
India plans to borrow more than $90 billion in its fiscal year ending March. Its own banks are buying much of that and are being left with a real case of indigestion.
Ten-year Indian bond yields have risen by more than 2 percentage points this year, leaving banks with a potentially serious mark-to-market loss on their portfolios. This could crimp lending and, critically for India, banks’ appetite for further government issues.
Rangarajan has said that the central bank may stop buying up bonds, a welcome move given the fact that it’s a policy better suited to fighting deflation than the inflation that India actually faces.
Elsewhere, the legitimately good growth story has transfixed investors. The Sensex has more than doubled from its lows in early March and is now sitting at a 17-month high. Foreign investors have poured $13 billion into Indian shares since the beginning of the year, ironically about the same amount as they pulled out the previous year.
The Reserve Bank of India reviews policy on 27 October with financial markets already factoring in the risk that it may raise rates this year. India and South Korea are on track to be the first in the G20 to pull the trigger after Australia’s move last week.
The RBI slashed its key interest rate by 425 basis points to 4.75 percent between October 2008 and April and the government cut import and factory gate duties and boosted spending to shield India from the worst of the global downturn.
RBI Governor Duvvuri Subbarao, who took office in September 2008, has raised expectations of tighter policy although he said timing was uncertain. Still, he said the central bank would move before those in developed economies.
Some economists feel the RBI may start tightening by increasing its cash reserve ratio, which it slashed to 5 percent from 9 percent between October and January, to soak up some of the liquidity from investment inflows and to signal that a change in policy direction had begun.
While it is hard to argue with the idea that India has a bright long term future as a place for investment, the next little while looks tricky.