Is the economy getting back on track?

What are the growth prospects for the current fiscal year?

While the finance minister sticks to the 9% growth rate for the current year, the ministry of finance seems more comfortable talking about 8.6%, and most non-official sources pitch for a below 8% growth rate. Quarterly trends show that GDP growth has steadily decelerated over the last four quarters, from 9.4% in the last quarter of 2009-10 to just 7.8% in the last quarter of 2010-11. The Index of Industrial Production numbers for the first two months of 2011-12 show just 5% growth rate in the initial months, the lowest since August 2010.

Why has growth slowed down?

RBI?s exit from its accommodative credit policy after October 2009 has seen policy rates being raised 10 times. While the repo rate has gone up by 275 basis points to 7.50% by June 2011, the reverse repo rate has been pushed up by 325 basis points to 6.50%, double the levels at the time of change in policy stance. This has pushed up interest rates all around. The base rate of major public sector banks has gone up to 9.25-10% (by end-June 2011) as compared to the 7.5-8% a year ago. Small and medium industries are the worst hit.

Has the change in monetary stance helped restrain inflation?

Despite the doubling of some of the policy rates, like the reverse repo rate, the impact on inflation has been muted. Quarterly numbers of the WPI show that although price increases have come down from the peak rate of 10.5% in the last quarter of 2010-11, the prices have continued to rise at around 9% in the last four quarters.

What are prospects of a pick-up in the current fiscal year?

High prices and the slowdown in growth of incomes has hit consumption and investments. National account numbers show that the share of private final consumption expenditure in the GDP, which peaked at about 60% of GDP in the third quarter of 2009-10, has slumped to 52.6% in the last quarter of 2010-11, the lowest in the last eight quarters. Any broad-based recovery would require a substantial pick-up in domestic consumption.

The numbers on investments in the economy are also not very encouraging. Quarterly numbers show that the gross fixed capital formation in the economy, which peaked at 32.7% in the fourth quarter of 2009-10, slipped to 27.7% over the next three quarters and has only recovered marginally to 29.6% in the last quarter of 2010-11. Only a substantial improvement in business confidence will enable a significant turnaround on the investment front.

Monthly numbers on the industrial investment proposals brought out by the Department of Industrial Policy and Promotion, however, show that the fall in the number of investment proposals has been stalled and the number of proposals has touched 411 in March 2011, a 13-month high. This trend is also reflected in the amount of investments proposed.

The only encouraging indicators are the FDI numbers, which show that inflows have picked up to $3.2 billion and $4.7 billion in April and May, respectively, with the latter number being the highest recorded over the last 14 months. The clearance given to the RIL-BP deal and the removal of the hurdles to the Cairn-Vedanta deal will further boost inflows in the coming months.

So, is it the external sector that is coming to the rescue?

This seems true to a large extent. The sharp increase in FDI flows indicates that foreign investors continue to believe in the India growth story and the blip in flows was mainly on account of the policy constraints, especially the government?s penchant for project-by-project clearance and the long delays in taking important decisions.

One should also note that a sector that has escaped the overall slowdown in the economy is the export sector, which showed buoyant growth month-over-month, even when domestic demand and production decelerated sharply over the year. Merchandise exports shot up by 37.8% to $246 billion in 2010-11, a substantial turnaround after the fall in exports in the previous year.

However, the slump in the domestic economy has hit imports. Numbers show that the non-oil imports have steadily decelerated in the recent months, from 30.2% in January 2011 to 16.7% in April this year, indicating that any substantial reversal in trends is unlikely.

Why does the domestic economy continue to sag?

One major reason is the policy paralysis. The scams in the different sectors, the go-slow policy on the reform front and the anarchy over the land policies have sent alarm signals all around and unnerved business sentiments. And the tightening of the monetary policies has hit business margins. The political stalemate, with the ruling coalition and the main opposition failing to agree on even previously agreed policies like the rollout of GST, has made matters even worse. And the government has been lethargic in even basic issues like pushing through important legislation.

For instance, in the last monsoon session, the two houses of Parliament could only manage 23 of the 29 sittings planned. And of the 34 Bills that were to be passed during the session, only 10 could make it through. Similarly, though 35 new Bills were to be introduced, hardly 14 could be managed during the session. So, it looks like it will certainly take a lot of hard work to bring the economy back on track.