The nature of information available today is highly volatile and imprecise. This has led to frequent revisions in outlook and also reduced the confidence in forward-looking economic prognosis and forecasts. Regular and sharp revisions in economic outlook, which started since the Lehman collapse in 2008, continued in 2011. In 2010, most forecasters were busy revising their growth forecasts upwards because of a stronger-than-expected rebound from the Lehman crisis. So the year 2011 began against a backdrop of robust growth. But every passing month witnessed a gradual dwindling of the market?s optimism, as the economic outlook consistently turned gloomier. This scenario held true for most economies, including India, where suddenly the environment has turned dismal enough to trigger a debate on the sustainability of even 7% growth in the coming year.
CRISIL recently revised its growth outlook for 2011-12 to 7% from 7.6% forecast a few months back and from 8.3% at the beginning of 2011. As we look back on 2011, the one key positive development has been the good performance of agriculture, which translated into a much needed relief from stubbornly high food inflation. Otherwise, in most other aspects?growth, currency, fiscal deficit, manufacturing output, investments or business confidence?matters have only worsened.
Even with a hazy crystal ball, the outlook is far from rosy, with little chances of any positive surprises. Escalating risks in the eurozone, demand-reducing impact of past interest rate hikes and emerging bottlenecks from slowed decision making in the government have cast a pall on the India outlook for 2012-13. Outlook for the next fiscal will be shaped by a variety of factors?some within our control and some outside our influence.
Let us first review factors beyond our control. There is no escaping the adverse developments in Europe, where risks have risen sharply due to the absence of political dynamism needed for credible solution to the sovereign debt problems. The risks in Europe spread from the peripheral countries like Greece to stronger nations like Spain and Italy; tremors were also felt in France and Germany. These risks have now spread to the financial institutions that hold the bonds of these sovereigns, whose ratings have been either downgraded or are under threat of a downgrade. The resultant deleveraging by the financial institutions in Europe can deepen the recession in the region, endangering global financial stability and growth in 2012. If a full blown European crisis can be equated to a movie, it would not be amiss to say that we have seen a trailer since August 2011 when the rupee began its plunge. Being a current account deficit country, India will remain vulnerable to fluctuations in foreign inflows and currency volatility.
The interest rate hikes in 2011 were fuelled by high and stubborn inflation. After staying above 9% for almost 22 months, inflation is now beginning to soften, mainly because of the sharp decline in food inflation. The other two components?fuel and manufacturing at 15.5% and 7.7%, respectively, in November 2011?are not displaying any signs of easing. The trend in food inflation in 2012 will critically depend on monsoons. In the last 6 years (2005-06 to 2010-11), food inflation has been at an average of 10.3% per year. While the demand for food has risen, our agricultural production pattern remains largely unchanged; hence, any reversal in the long-term trend of persistently high food inflation seems unlikely. So, food inflation will remain a risk in 2012. Fuel inflation continues to be suppressed and will remain a worry as global commodity and crude prices have not declined as much as the economic fundamentals have due to liquidity. Also, the weak rupee has offset the limited gains from movements in global prices of commodities. Manufacturing inflation is likely to soften as slowing demand will restrict the pricing power of companies. Even if inflation comes down to 7% by March, it still remains above the comfort threshold of RBI to cut interest rates aggressively.
Will the rupee, which has plunged almost 20% since August 2011, reverse its direction in 2012? This will largely depend on the turn of global events, particularly in Europe. If the eurozone continues to muddle through, but avoids a deep recession/disorderly default, the risk appetite of foreign investors will not be seriously impaired. In addition, sharply depreciated rupee and beaten down equity markets will make investments into India attractive. I believe that rupee will appreciate against the dollar from current levels in 2012. A positive action on the economic reform front will be key to boost investor confidence and help strengthen the rupee further.
Now let us look at some factors that are within our control. First, to reverse the trend of high food inflation on a sustainable basis, the government should link its expenditures on safety net schemes like MGNREGA with improvement in agricultural productivity and monitor it closely. This should be done in conjunction with a broad restructuring of government expenditures to create fiscal space to spend more on agricultural development without stretching the fiscal deficit. The 2012-13 Budget will be an appropriate opportunity to do this. Such credible moves will help tame inflationary expectations as well.
The Indian economy will gain tremendously from a fresh dose of reforms at this juncture. Eliminating bottlenecks in mining, fast tracking the Land Acquisition Bill, the goods and service tax implementation and clearance of important projects will go a long way in improving the current investment climate. Opening up the retail sector for FDI participation, which has now been pushed back, will also act as a positive move for the economy. In 2012, these measures can help prevent the slide in growth. In the long term, they will help improve the fundamentals of the economy and enhance its supply potential and competitiveness.
The author is chief economist, CRISIL. These are his personal views