Quiet Desperation

Economic indicators continue to provide evidence of a slowing economy as a result of sticky inflation and falling expectations. At -3.5% in March, industrial production shrank, after delivering marginal growth of 2.8% in the last fiscal. The Government's official estimate of 7% GDP growth for FY13 already looks unachievable as industry will need to grow at over 7% to make this happen (assuming the services and agriculture sectors maintain their growth). This looks impossible, given that the slowdown is the steepest in capital goods (-21.3% in March), indicative of declining investments. This is corroborated by recent data released by the CSO which shows that Gross Fixed Capital Formation (GFCF) grew by just 3.5% in H1 2011-12 compared with 10.7% in the corresponding period of 2010-11. For the year, GFCF is expected to be 29% of GDP, 4% lower than the previous year.

A currency in free fall doesn't help. The Rupee recently touched 56/USD and even as the RBI's interventions may have helped, their effect will be limited and temporary. The fact is that India's macro economic fundamentals do not permit an alternate scenario currently. Large deficits on the current and fiscal accounts and the lack of any reform that could encourage capital inflows are strong downward pressure points. This is reflected in the USD 0.9 bn FII outflow in April. A global economy fazed by a worsening Euro zone crisis is another known bug bear, with the flight to the Dollar continuing across every economy. Rising NPAs in the banking sector that the IDW had alluded to two quarters ago complete this darkening picture. Asset quality (Gross NPAs/Gross Advances) has deteriorated across most banks; March 2012 figures indicate a YoY increase of 46%.

While Finance Minister Pranab Mukherjee, may recognise these challenges, regrettably, there are no easy short term fixes. India must cut back on wasteful expenditure while resolving supply side challenges that prevent new investments. The fiscal deficit has increased to 5.9% of GDP (it was 2.6% in 2008). More worrying, this is 68% of Government revenue. Over half the deficit is spent simply to service previous debt, and the rest on other committed expenditures like defence and social welfare programmes, which are hard to tinker with. It would take tremendous political will to reform this spending pattern - but even in the best case, the process would take a few years. In the immediate term, what can the government do? It can send categorical signals, and push reform where it can be pushed. Actioning banking licenses for the private sector is one potential option. Deregulating the prices of diesel and LPG, at least partially, is another. The continuation of market-distorting subsidies despite adequate evidence of their misuse and negative impact, has no justification - particularly when other ways to protect the interests of poorer sections of society, exist. Finally, there is the matter of providing a predictable and fair taxation regime. The Government's rigid position on retrospectively taxing cross border transactions (the Vodafone case) will at best bring in a short term of gain of USD 1.8 bn; at worst, it will undermine India's attractiveness as a country that can be trusted to do business with.

IMA's Q1FY13 BCPI reflects these sentiments and is down to an all-time low of 48.4. While sales growth remains in positive territory, profitability is low. This edition of the India Demand Watch draws attention to increasing stress levels on the count of inflation, exchange rates and capital flows. As a result, interest rates are unlikely to fall further in the short term and a recovery in growth will be slow and long drawn. For now, industry needs to hunker down and squeeze out costs, while maximising efficiencies wherever possible.