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Has India’s economic growth story been derailed?

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In Brief

The Indian economy showed remarkable resilience in the 2010-11 financial year.

It bounced back from crisis to the 9 per cent average growth rate of recent years.

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The April 2011 World Economic Outlook predicts that emerging economies, led by India and China, will continue to lead world growth. But despite appearances the dream of attaining double digit growth rates may not be so easily attainable. The slowdown in the industrial and services sectors in India suggests a bleak future for India’s growth trajectory. This does not bode well for targets of 9–9.5 per cent overall growth, 11–12 per cent manufacturing growth, and moderate head line inflation of around 5 per cent in the Indian government’s 12th plan period.

Recent monetary tightening, unavoidable given headline and core inflation levels, will affect credit flows to the commercial sector and overall investment activity in the economy, further slowing growth. The industrial sector has slowed down considerably in the last few months, and it would be too optimistic to expect a positive turn around soon. Declining FDI inflows during 2010–11 and low investor confidence have prompted overall declines in manufacturing, mining and electricity generation sectors, indicating decreased economic activity overall. The capital goods sector continues to decline at a high rate while basic and intermediate goods sectors have slowed down.

Factors driving decline include an increasing cost of production, increases in policy rates over the last few quarters, numerous scams and damage to the corporate credibility, increased oil prices, renewed debate over land acquisition and environmental clearances, and uncertainty over the future of nuclear energy following the crisis in Japan. One way to generate momentum in the industry and service sectors would be to carry out the important reforms promised in the 2011–12 Budget. Unfortunately, governance and corruption issues are delaying reforms and, in the absence of reform, investor confidence is falling.

More positively, agricultural output has experienced good growth in the last couple of quarters, which has reduced the price of food products. Food and vegetable prices have moderated in the last quarter of 2010–11, though there has been a persistent increase in non-food inflation, leading to increases in headline and core inflation. One would expect inflation to moderate given the high base last year and monetary tightening. However, further monetary tightening would force the banking sector to raise interest rates, increasing the cost of credit.

Some important infrastructure industries like coal, electricity and cement have also experienced slowdowns in recent months. The planning commission has reiterated the importance of infrastructure by raising the level of required investment in the sector to US$1 trillion in the 12th Five Year Plan, but it may be difficult to raise such resources. The government is anticipating almost half of the required investment to come from the private sector, but the private sector is yet to fully support the government’s infrastructure initiatives. For example, there is complete lack of private participation in railways, a major infrastructure sector. Therefore, the government needs to provide bankable infrastructure projects that will aggressively encourage private participation to boost employment-generating sectors like construction, and reduce supply side bottlenecks in the medium term.

The capital goods and construction sector may also have been affected by the increase of policy rates by 225 basis points since April last year. Though monetary policy can affect demand side factors in the short-run and help contain inflation, increases in interest rates will have adverse supply side impacts. Consistent increases in policy rates have already led to decreases in bank credit availability for the commercial sector. An expected rise in government borrowing caused by slowing revenues and the rise of subsidies will put further pressure on interest rates.

The increasing price of crude oil means it is only a matter of time until the government will increase petroleum prices or cut subsidies. Either option will cause further pressure on prices, add to the cost of production, and slowdown industry. Expectations of interest rate increases will do nothing to help already sluggish investment growth. Neither will land acquisition and environmental issues and the lack of meaningful action on big ticket reforms.

The service sector, which was the driver of growth through the 2008–09 crisis, has also showed signs of slowdown in the last few quarters. Decreased output in the industrial sector, along with low demand for India’s services has led to a decline in the growth rate of trade in services. Given the current situation, a moderation in growth across all sectors, including the service sector is expected. Overall, it will be difficult for the government to manage inflation while putting the economy back on a high growth trajectory of 9 per cent. The dream of a double digit growth rate is increasingly distant.

Pravakar Sahoo is an Associate Professor, Institute of Economic Growth, India. A version of this article was first published in The Hindu Business Line on 18th May 2011.

One response to “Has India’s economic growth story been derailed?”

  1. Indian economic growth is bound to decrease unless the government takes adequate measures in the oil sector, addresses numerous scams, eases the policy of land acquisition for industrial growth, sets up for nuclear energy and improves relations with neighbor countries. After the crisis in Japan, the installation of nuclear plants in any region will be doubtless opposed no doubt. Government has to provide huge monetary incentives for the region with simultaneous safety protection to slowly bring confidence to regions where nuclear facilities are being built. It is crystal clear that without nuclear plants India will be in an energy crisis for industrial growth. A country can not develop without the development of the adjacent regions. It is absolutely necessary to settle all kinds of problems to also bring peace in the region for industrial growth. Western countries will play their games in troubled waters but these games must be left aside.

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