Macro Overview

ANUP SINHA*#

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The Global Economy

The global economy has been plagued by a number of problems that have proved difficult to resolve with the standard measures available to policymakers across the world. The USA has still to exhibit signs of sustained recovery from the financial meltdown, though its performance does indicate that the recession may have bottomed out. The sovereign debt crisis in the Euro zone has yet to be decisively tackled, with the fear of a full-fledged financial crisis giving way to a chronic problem of inadequate bailouts, fiscal difficulties and a weak financial system. The emerging and developing countries are facing a variety of problems related to slowing down of economic growth and activity. Sluggish external demand, high rates of inflation, exchange rate fluctuations arising from the volatility of capital flows have been some of the economic woes afflicting a number of these countries. In some economies, high fiscal deficits and very low interest rates have left little room for policy interventions. High unemployment rates and low investor confidence levels have been symptomatic of the global economy since 2008. Food prices have been rising, both due to buoyant demand as well as supply constraints, especially in developing countries. Fuel prices have been increasing not only due to demand factors, but also due to many serious geopolitical factors affecting a number of oil producing economies, particularly the political uncertainty over Iran. Non-oil commodity prices are expected to soften in the face of an overall slowdown in the global economy, thereby easing, but not entirely eliminating, the stubborn inflationary pressures faced by many emerging economies including India.
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The sovereign debt crisis in the Euro zone has yet to be decisively tackled, with the fear of a full-fledged financial crisis giving way to a chronic problem of inadequate bailouts, fiscal difficulties and a weak financial system.

Anup Sinha is Professor of Economics, Indian Institute of Management

Calcutta. The author is indebted to Jasveen Kaur and Sarthak Maiti for editorial assistance and preparation of tables and charts.
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According to the IMF, the growth of the volume of world trade will also be slower for 2012 at 3.8%, lower than

The International Monetary Fund (IMF) has, in its World Economic Outlook update (IMF, 2012) published in January 2012, reduced all growth rate projections made in September 2011 (IMF, 2011). The IMFs projection for the growth rate of world output is now revised to 3.3 per cent for 2012, lower than its September projection of 4 per cent, and less than the growth achieved in 2011 at 3.8 per cent. According to the IMF, the growth of the volume of world trade will also be slower for 2012 at 3.8 per cent, lower than the September projection of 4 per cent, and significantly less than the figure for 2011 at 6.9 per cent. The trend of overall performance of the global economy has been one of decline compared with the post-crisis year of 2010 as can be seen from Table 1.
TABLE 1 Overview of the World Economic Outlook Projections (percentage change unless noted otherwise) Year over Year ProjecDifference tions from September 2011 WEO Projections 2011 2012 2012 3.8 1.6 1.8 1.6 0.9 0.9 6.2 4.1 9.2 7.4 2.9 6.9 31.9 17.7 2.7 7.2 3.3 1.2 1.8 0.5 1.7 0.6 5.4 3.3 8.2 7.0 3.0 3.8 4.9 14.0 1.6 6.2 0.7 0.7 0.0 1.6 0.6 1.0 0.7 0.8 0.8 0.5 0.6 2.0 1.8 9.3 0.2 0.3

2010

the September projection of 4%, and significantly less than the figure for 2011 at 6.9%.

World Advanced Economies United States Euro Area Japan United Kingdom Emerging and Developing Economies2 Russia China India Brazil World Trade Volume (goods and services) Commodity Prices (U.S. dollars) Oil 3 Nonfuel (average based on world commodity export weights) Consumer Prices Advanced Economies Emerging and Developing Economies2 Note:

Output1

5.2 3.2 3.0 1.9 4.4 2.1 7.3 4.0 10.4 9.9 7.5 12.7 27.9 26.3 1.6 6.1

1 The quarterly estimates and projections account for 90 per cent of the world purchasing-power-parity weights. 2 The quarterly estimates and projections account for approximately 80 per cent of the emerging and developing economies. 3 Simple average of prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. The average price of oil in U.S. dollars a barrel was $104.23 in 2011; the assumed price based on futures markets is $99.09 in 2012 and $95.55 in 2013. Source: World Economic Outlook Update, January 2012, IMF.

The downside risks in the global economy arise from a number of sources. First of all, reports on the opinions of the world economic leaders meeting in Davos indicated that there was a consensus in identifying the Euro zone as the global economys most vulnerable spot. The need for sovereign bailouts and bank funding pressures in the Euro zone were perceived to be immediate risks. The compulsions of fiscal consolidation would have a dampening effect on short-term demand and growth. This, coupled with a steady deterioration in the quality of bank assets, could have a negative impact on the Euro zone economies, and also be contagious for the world through the usual transmission channels of trade and capital flows. A slowdown in the Euro zone economies could increase capital flows into the economies of the USA and Japan, as investors may find government debt in those countries more attractive. This additional inflow would, however, appreciate the dollar and the yen against the euro and tend to moderate their growth. A medium-term fiscal consolidation plan is still not clear in the euro economies. Hence, a substantial increase in the projections of public debt in the large economies could trigger turbulence in global bond and currency markets. Secondly, a slowing down of the emerging economies for a variety of factors, including lower external demand and higher domestic inflation, could trigger loss of business and investor confidence. Many of these economies had experienced in times of buoyant demand a sharp rise in asset prices and credit growth. In some of these economies there had been an overestimation of the trend rate of output growth. A slowdown in financially vulnerable economies could lead to sudden stops in capital flows with damaging consequences. Finally, there are increased geopolitical risks in oil supply. The impact of a possible disruption of oil supply from Iran could be large since estimates of buffer stocks and spare capacity are not very optimistic. Saudi Arabia is the only economy with significant buffers, but it is believed that the economys production of oil is already at a 30-year peak for the past few years. There are disputes over a pipeline in South Sudan, embargoes on Syria, labour disputes and strikes in the oil fields of Yemen, and North Sea oil rigs have been closed for repairs. A quick estimate of the supply reduction is to the tune of 1.2 million barrels per day. Though the IMF has projected a fall in crude oil prices for 2012 made possible due to demand factors, the supply side risks are too immediate to ignore. The US Economy The US economys recovery path has been slow. In the last quarter of 2011 and the first two months of 2012, mixed signals have emerged from the economy. The last two quarters of 2011 showed higher than expected GDP growth. This was 2.8 per cent (annualised rate) in the last quarter of last year. Bank credit disbursement increased by US$130 billion in the last quarter of 2011, making it the biggest

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The need for sovereign bailouts and bank funding pressures in the Euro zone were perceived to be immediate risks. The compulsions of fiscal consolidation would have a dampening effect on short-term demand and growth. This, along with a steady deterioration in the quality of bank assets, could have a negative impact on the Euro zone economies.

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The sovereign debt crisis lingers on in the absence of decisive interventions to restore investor confidence and repair the balance sheets of European banks. However, there has been greater concern shown in terms of the decisions taken since October 2011.

increase in four years. The losses from loans incurred by banks have also fallen. Stress tests conducted by the Federal Reserve on major US banks have also yielded satisfactory results. Unemployment declined in the first two months in a row in 2012 to reach a three-year low, though the rate remained very high at 8.5 per cent. Stock prices have reached their pre-crisis levels, and consumer confidence has risen. Despite these pieces of reassuring news, there are worrying signals too. The housing markets are still sluggish with the CaseSchiller Index of house prices reaching a new low in December 2011. The demand for consumer durables fell by 4 per cent in January 2012 against an expected drop of only 1 per cent. There is a seasonal effect that works after the November-December festive season, but it was more severe than expected. Gasoline prices are up by 12.6 per cent. Income inequality has worsened too (The Economist, 2012d). During 2007 to 2009, the top 1 per cent of income earners saw a 36.3 per cent decline in their incomes while the remaining 99 per cent saw a decline of 11.6 per cent. During 20092010, the top 1 per cent saw a rise of 11.6 per cent in their incomes, while the bottom 99 per cent saw a rise of only 0.2 per cent. Given the little room left for further decline in nominal interest rates, the Federal Reserve may consider another round of quantitative easing through bond purchases. The bank has already committed that interest rates will remain very low till 2014. Fiscal management, on the other hand, is obviously more political in nature. The pressure for fiscal risk aversion may require a gradual tightening of fiscal policy that could negate the hesitant gains in output and employment. Euro Zone The sovereign debt crisis lingers on in the absence of decisive interventions to restore investor confidence and repair the balance sheets of European banks. However, there has been greater concern shown in terms of the decisions taken since October 2011. The bailout of Greece, for instance, is likely to be more painful now, and many observers believe that had action been taken earlier it would have been less costly. The troika that is now overseeing the bailout had their own reasons for the delay. The European Union had its own political dynamics in determining the sharing of the burden of the bailout required. The European Central Bank had an unduly rigid noninterventionist stance, and the IMF had indicated that it did not have adequate funds to finance the entire rescue package on its own. The support package for Greece, provided by the European Financial Stability Fund (EFSF) in October last year, was not adequate. The October package included a deal on bank recapitalisation (estimated at 106 billion euros), voluntary bond exchange (with 50 per cent discount) for private holders of Greek debt, and scale-up of the EFSF (440 billion euros) through bond insurance and Special Purpose Vehicles. The scale-up would be achieved by leveraging resources to

arrive at a total figure of 1 trillion euros. In December, the Euro area countries provided additional funding of 150 billion euros to the IMF for supporting further bailouts. The European Central Bank cut its policy rate and lent 489 billion euros in a single operation of three-year long-term repo, to over 500 Euro area banks. In January 2010, the IMF proposed to raise its funding potential by US$500 billion. Stress tests conducted by the European Banking Authority showed that the capital shortfall of German banks had trebled during OctoberDecember 2011 to 13.1 billion euros. In a similar trend, the combined Europe-wide capital deficit of banks rose from 106 billion euros to 115 billion euros. Since banks in almost all advanced economies (including the USA and the UK) have considerable exposure to distressed Euro area economies, the risk of a generalised contagion through the banking channel cannot be ignored. The pressures on the Greek government for fiscal austerity and other structural reforms had led to widespread protests and rioting in Athens. This, arguably, was the reason for some more rescue action suggested by the European leadership. In February 2012, further details of the debt restructuring process were announced. The debt swap mechanism was expected to take off 100 billion euros from the Greek debt. This was expected to bring down Greeces debt to GDP ratio to 120 per cent by the year 2020, down from the current debt to GDP ratio of 160 per cent. There remain questions about the ratio of 120 per cent being a sustainable one, but the choice was apparently driven by the numbers for Italian debt, assuming that the Italian debt burden was sustainable. The debt swap, one of the biggest in history, would imply that private bondholders would receive only 31.5 per cent of the principal value of their holdings. The new bonds would have lower interest rates and a longer maturity period of 11 to 30 years. Bondholders would receive a further 15 per cent in short-dated bonds backed by the Euro zones bailout fund. Hence bondholders would take a 53.5 per cent loss on the principal value of their initial holdings (see The Economist, 2012b). European bond markets in the month of February 2012 did not react sharply to either the announcement of the debt swap arrangement, or to the news of political violence in resisting austerity measures adopted by the Greek government. This has led some analysts to believe that the crisis has moved from an acute to a more chronic phase. This could just be a lull in the markets since there are a number of issues that make the implementation of the deal difficult. The voluntary nature of the debt swap deal is actually based on a piece of Greek legislation that makes it mandatory for all bondholders to comply, provided a large majority of bondholders volunteer to do so. The debt swap may be used from a retrospective date to ensure that a large majority of bondholders are identified as having volunteered to take lower valuations on their bonds. This is a cause of

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Stress tests conducted by the European Banking Authority showed that the capital shortfall of German banks had trebled during October December 2011 to 13.1 billion euros. In a similar trend, the combined Europe-wide capital deficit of banks rose from 106 billion euros to 115 billion euros.

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What is needed is an initiation of a process of fiscal integration with carefully calibrated fiscal consolidation. The role of the European Central Bank is critical in this context. Its role in monetary easing and facilitating a recovery in economic growth rates will be more important than ever in managing the transition during fiscal restructuring.

worry for sovereign debt holders in other parts of the Euro zone. It is also not evident how the Greek legislation could be binding for bondholders who are not Greek citizens or even residents. They could interpret the debt swap deal to be a credit event or a default, which would trigger the credit default swaps (CDS) into play. Standard and Poors has already downgraded Greek debt further to selective default by early March 2012 (see The Economist, 2012c). Greece is expected to experience a sharp downturn in economic activity once the full effects of the austerity measures and fiscal consolidation take place. The entire Euro zone is expected to shrink in 2012. Italy, Spain and Portugal will see a drop in GDP this year (The Economist, 2012a). The chronic lack of growth and many painful adjustments in spending dictated from Brussels and sometimes from Berlin could lead to more widespread unrest in Europe, going beyond the German-Greek trust deficit that has become evident in the past year. What is needed is an initiation of a process of fiscal integration with carefully calibrated fiscal consolidation. The role of the European Central Bank is critical in this context. Its role in monetary easing and facilitating a recovery in economic growth rates will be more important than ever in managing the transition during fiscal restructuring. In the short term, however, the increase in sovereign yields, the adverse effects of bank deleveraging, and the pains of austere spending programmes will continue to seriously plague Euro zone economies even if the euro crisis does not lead to any contagious financial turmoil. China China is experiencing a slowdown in its economic activity with the rate of growth being 9.2 per cent in 2011, down from 10.4 per cent in 2010. The IMF projection for Chinas growth is 8.2 per cent for 2012. The main reason for this slowdown lies in a slackening of external demand arising out of the global recessionary trend. However, the slowdown is not expected to be sharp leading to a hard landing. Moreover, with inflation contained around the target set by the Bank of China at 4 per cent, there is enough scope for fiscal and monetary policy measures to support economic growth. The purchasing managers index (PMI) recorded an increase from 50.3 in December 2011 to 50.4 in January 2012. Since both the numbers are above 50 (50 demarcates expansion from contraction), there is reason to indicate that China was expanding marginally faster than in December. The subindices for stock purchase and factory production have both shown improvements, though the external sector index has shrunk due to a slowdown in external demand arising from an uncertain global economic climate. In the first two months of 2012, data on fixed asset investments, retail sales, industrial output and bank credit off-take revealed that the slowdown in growth was milder than had been

forecast. The inflation rate in December 2011 was 4.1 per cent (continuing a five-month trend of reductions in the rate). It, however, increased (reversing the trend) to 4.5 per cent in January 2012 and fell again to 3.2 per cent in February 2012. This year January had a strong seasonal component because of the festive season of the Chinese lunar calendar New Year. The latest PMI figures available from China have confirmed the seasonal impact in the January figure. The PMI in February 2012 has fallen to 49.6. In March 2012, it has deteriorated further to 48.1. With inflationary worries abating, the Chinese policymakers have enough room in using expansionary monetary policy instruments if they so desire.

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In terms of the broad sectors of agriculture, industry and services, the performance of industry has been the worst, pulling the aggregate growth rate down. The growth of the index of industrial production has fallen to 3.6% as against 8.2% in 201011.

India in the World Economy

The broad trends in the major economies of the world described above would be expected to have an impact on India too. Contrary to expectations of a 9 per cent growth rate during the Budget presentation of 2011, the Indian economy is now estimated to grow at less than 7 per cent during 201112. In terms of the broad sectors of agriculture, industry and services, the performance of industry has been the worst, pulling the aggregate growth rate down. The growth of the index of industrial production has fallen to 3.6 per cent as against 8.2 per cent in 201011. Agricultural growth is expected to be slightly below expectations, at 2.5 per cent in 201112 against 7 per cent achieved in the previous year. It may be noted that the 7 per cent growth in the previous year was unusually high, and hence the 2.5 per cent figure for 201112 must be set against this fact. Food grains production is estimated to grow to 250.4 million tonnes from 244.8 million tonnes in 201011. This figure would be an all-time high for the economy. The services sector continues to be buoyant, growing at the rate 9.4 per cent in 201112 as against 9.3 per cent in 201011. The rate of inflation did soften a bit compared with last year but remains worryingly high. The WPI 52-week average inflation has fallen to 9.1 per cent as against 9.6 per cent in 201011, and the inflation rate measured by the consumer price index for industrial workers, the CPI (IW), has fallen from 10.4 per cent in 201011 to 8.4 per cent in 201112. The current account deficit has deteriorated from 2.7 per cent of GDP to 3.6 per cent of GDP in 201112. Fiscal indicators have not improved as per the budgetary expectations regarding fiscal consolidation. Gross fiscal deficit is estimated at 4.6 per cent of GDP in 201112 as against 4.8 per cent in the previous year. Revenue deficit has worsened from 3.2 per cent of GDP in 2010 11 to 3.4 per cent of GDP in 201112. The key indicators of the economy for the last two years are shown in Table 2. The External Sector The Indian economy had been able to quickly overcome the negative effects of the financial crisis of 200809 as far as international

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TABLE 2 Key Indicators Data Categories and Components 1 GDP and Related Indicators GDP (current market prices) Growth Rate GDP (factor cost 2004-05 prices) Growth Rate Savings Rate Capital Formation (rate) Per Capita Net National Income (factor cost at current prices) 2 Production Foodgrains Index of Industrial Production b (growth) Electricity Generation (growth) 3 Prices Inflation (WPI) (52-week average) Inflation CPI (IW) (average) 4 External Sector Export Growth (US$) Import Growth (US$) Current Account Balance (CAB)/GDP Foreign Exchange Reserves Average Exchange Rate 5 Money and Credit Broad Money (M3) (annual) Scheduled Commercial Bank Credit (growth) 6 Fiscal Indicators (Centre) Gross Fiscal Deficit Revenue Deficit Primary Deficit
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Rs. crore 7674148QE 8912178AE % 18.8 16.1 Rs. crore 4885954QE 5222027AE % 8.4 6.9 % of GDP 32.3 na % of GDP 35.1 na Rs. Mn tonnes Per cent Per cent %change %change %change %change Per cent US$ bn. Rs./US$ %change %change % of GDP % of GDP % of GDP 53331 244.8 8.2 5.5 9.6 10.4 40.5 28.2 2.7 304.8 45.56 16.0 21.5 4.8i 3.2i 1.8i 60972 250.4a 3.6c 9.4c 9.1d 8.4d 23.5d 29.4d 3.6e 292.8f 47.70g 14.4h 16.4h 4.6j 3.4j 1.6j

GDP figures for 201112 are advance estimates; QE Quick estimates; na: not available. a Second advance estimates. b The Index of Industrial Production has been revised since 200506 on base (200405=100). c AprilDecember 2011. d April 2011 to January 2012. e CAB to GDP ratio for 201112 is for the period AprilSeptember 2011. f At end-January 2012. g Average exchange rate for 201112 (April 2011February 2012). h Provisional (up to January 27, 2012). i fiscal indicators for 201011 are based on the provisional actuals. j Budget estimates. Source: Economic Survey 201112.

trade was concerned. In 200910, exports and imports had fallen by 3.5 per cent and 5 per cent respectively, but bounced back to positive growth rates of 40.5 per cent and 28.2 per cent in 201011. Indias share of global exports rose from 0.7 per cent to 1.4 per cent, and the

share in global imports grew from 0.8 per cent to 2.1 per cent in 2010, according to the WTO. During the first half of 201112, exports from India grew at the rate of 40.6 per cent, a rate that was higher compared with the figure for the first half of 201011. From October, however, growth has decelerated with the growth rate for November being a negative 0.5 per cent. The rates for December 2011 and January 2012 were positive but low at 6.7 per cent and 10.1 per cent, respectively. The export sectors that have done well in 201112 are petroleum and oil products, gems and jewellery, engineering goods and cotton fabrics, electronics and drugs. Exports and Imports The deceleration in exports was due to the overall slowdown of international trade. Austerity measures undertaken in the advanced economies have been the main reason for this slowdown. Despite the fact that Indias trade dependence on the advanced economies has come down with greater diversification of markets and destinations, an overall gloomy outlook for trade cannot but adversely affect Indias exports along with that of most other emerging and developing nations. Indias imports during 201112 (AprilJanuary) grew at the rate of 29.4 per cent. Petroleum, oil and lubricants (POL) registered a growth of 38.8 per cent during this period, and non-POL of 25.7 per cent. Gold and silver imports alone grew by 46.2 per cent. Non-POL imports and non-bullion imports, which together may be considered to represent domestic demand for capital goods and intermediates, grew by 21.7 per cent. It may be noted that the import demand for oil is relatively inelastic with respect to changes in international prices and exchange rates. With international oil prices registering increases, the average international price of the Indian oil basket rose by 38.6 per cent during AprilDecember 201112. There has been an unusual increase in the demand for gold during the same period. Despite gold prices having risen, the quantum of gold imported has increased too. Investments in gold and bullion are not considered productive investments. They are speculative in nature, and hence may explain the duty levied on gold imports in the Budget proposals announced by the Finance Minister in March 2012. India has, since the financial crisis of 200809, made attempts at reducing her dependence on advanced economies for exports as well as imports. The share of Asia in Indias trade has increased from 33.3 per cent in 200001 to 57.3 per cent in the first half of 201112. The USA has been displaced by the UAE as Indias largest trade partner followed by China. While this trend has certainly helped the economy weather global fluctuations in economic activity better, it would be unwise to expect that a global slowdown would have negligible effects on the performance of Indias international trade. Table 2 and Table 3 show the latest figures for merchandise trade and the balance of payments.

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Despite the fact that Indias trade dependence on the advanced economies has come down with greater diversification of markets and destinations, an overall gloomy outlook for trade cannot but adversely affect Indias exports along with that of most other emerging and developing nations.

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TABLE 3 Indias Merchandise Trade (US$ billion) Item AprilDecember 201011 201112 Absolute Growth Absolute Growth Absolute Growth (%) (%) (%) 2 3 4 5 6 7 250.1 41.4 208.7 369.8 104.0 265.8 119.7 57.1 39.9 46.8 38.6 28.2 19.4 32.0 173.0 28.3 144.7 269.1 75.2 193.9 96.1 49.2 36.0 45.3 32.8 29.8 22.0 33.1 217.6 43.9 173.7 350.9 105.6 245.3 133.3 71.6 25.8 55.0 20.1 30.4 40.4 26.5 201011 (P)

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1 Exports Of which: Oil Non-oil Imports Of which: Oil Non-oil Trade Deficit Non-oil Trade Deficit P: Provisional. Source: DGCI&S.

TABLE 4 Major Items of Indias Balance of Payments (US$ billion) 201011 (PR) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Goods Exports Goods Imports Trade Balance(1-2) Services Exports Services Imports Net Services (4-5) Goods & Services Balances (3+6) Primary Income, Net (Compensation of Employees and Investment Income) Secondary Income, Net (Pvt. Transfers) Net Income (8+9) Current Account Balance (7+10) Capital and Finance Account, Net (Excl. changes in reserves) Change in Reserves (-) increase/(+) decrease Errors & Omissions -(11+12+13) 250.6 381.1 130.4 131.7 83.0 48.7 81.8 17.3 53.1 35.8 46.0 62.0 13.1 3.0 7.5 2.8 2.1 2.7 3.6 201011 (PR) Q2 Q3 52.0 89.0 -37.0 31.1 19.2 11.9 25.1 4.8 13.0 8.2 16.9 21.6 3.3 1.4 9.5 3.1 2.1 4.4 5.6 66.0 97.4 31.4 38.8 26.3 12.5 19.0 4.6 13.4 8.8 10.1 14.0 4.0 0.1 6.8 2.7 1.9 2.2 3.0 201112 Q1 (PR) Q2 (P) 74.4 116.1 41.7 33.3 17.9 15.4 26.3 4.4 14.8 10.4 15.8 22.5 5.4 1.3 9.0 3.3 2.3 3.4 4.9 76.6 120.5 43.9 34.0 18.5 15.5 28.4 4.7 16.2 11.5 16.9 18.4 0.3 1.2 9.6 3.4 2.5 3.7 4.0

Q1 55.2 87.2 -32.0 26.5 16.7 9.7 22.3 3.5 13.1 9.6 12.6 17.2 3.7 0.9 8.3 2.5 2.5 3.3 4.5

Q4 77.4 107.4 30.0 35.3 20.7 14.6 15.5 4.5 13.6 9.1 6.3 9.1 2.0 0.8 6.1 3.0 1.9 1.3 1.9

Memo Items (As percentage of GDP): 15. Trade Balance 16. Net Services 17. Net Income 18. Current Account Balance 19. Capital and Finance Account, Net Note:

Total of subcomponents may not tally with aggregate due to rounding off. P: Preliminary. PR: Partially Revised. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

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The Current Account Deficit The overall impact of Indias exports and imports this year (201112) has led to a worsening of the trade balance. The trade deficit for 201112 (AprilJanuary) stood at US$148.7 billion, which is 40.4 per cent higher than that for the corresponding period of 201011. The net invisibles surplus (AprilSeptember 2011) stood at US$52.9 billion, higher than the US$39.3 billion for the same period of 201011. All major types of invisibles such as services, transfers and income showed an increase in 201112. The current account deficit (CAD) increased from US$29.6 billion in the first half of 201011 to US$32.8 billion in the first half of 201112. The widening of the CAD from 3.4 per cent of GDP in the first quarter of 201112 to 3.7 per cent of GDP in the second quarter of 201112 is a source of concern for the economy, especially in terms of financing the deficit. The rupee did depreciate sharply in the third quarter of 201112, but export demand being sluggish and import demand in India being price inelastic, the shortterm outlook for the CAD is not likely to improve. Indeed, there could be further worsening if the receipts from the export of software and Indian IT services decline along with income from other business services and investment income. This possibility cannot be ruled out with economies like the USA trying very hard to increase domestic production of services and cutting back on outsourcing with the increasing use of non-tariff barriers such as tighter entry visa restrictions. Capital Flows The worsening CAD would have to be financed by larger capital inflows. Net capital flows (see Table 5 and Table 6) increased in the first half of 201112 to US$41.1 billion, up from US$38.9 billion in the first half of 201011. Foreign direct investment (FDI) increased from US$7.0 billion in the first half of 201011 to US$12.3 billion in the first half of 201112. External commercial borrowings (ECB) also increased from US$5.7 billion to US$10.6 billion in the same period. Net inflows of portfolio investments (FII) and American depository receipts and global depository receipts, however, declined in the first half of 201112 as compared with the same period of 201011. The decline was substantial, from US$23.8 billion to US$1.3 billion. Hence, net capital inflows as a proportion of GDP also declined from 5 per cent to 4.5 per cent. The slackening of the rate of capital inflows into India is indicative of risk aversion of international investors. There was some improvement in FDI flow, though not as much as initially expected. This flow might have been stronger had the legislation on FDI in retail business not run into difficulties in Parliament. With a declining trend of FII and a slower-than-expected growth of FDI, the financing of the CAD would have to depend on debt instruments like ECB and nonresident Indians deposits. The Reserve Bank of India (RBI) raised the

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The rupee did depreciate sharply in the third quarter of 201112, but export demand being sluggish and import demand in India being price inelastic, the short-term outlook for the CAD is not likely to improve.

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TABLE 5 Net Financial Account (US$ billion) AprilJune AprilJune 2011 (PR) 2010 (PR) 1 1. Direct Investment (net) 2. Portfolio Investment (net) 3. Other Investment 4. Reserve Assets Financial Account (1+2+3+4) 2 7.9 2.3 12.6 5.4 17.4 3 3.5 3.5 10.4 3.7 13.6 July September 2011 (P) 4 4.4 1.4 15.2 0.3 17.9 July September 2010 (PR) 5 3.6 18.7 0.7 3.3 18.3

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The increase in ECB flows may augur well from the point of view of financing the CAD, but a medium-term increase in dependence on international debt instruments may not be the most preferred option in a global financial system marked by quick and widespread changes in market sentiments.

P: Preliminary. PR: Partially Revised. Source: Macroeconomic and Monetary Developments: Third Quarter Review 2011 12, Reserve Bank of India.

TABLE 6 Capital Flows in 201112 (US$ billion) Component 1 FDI to India* FDI by India FIIs (net) ADRs/GDRs ECB Inflows (net) NRI Deposits (net) 201112 (AprAug) 201112 (SepDec) (Monthly Average) 2 3 4.9 1.0 0.4 0.1 1.3 0.5 3.2 0.8 0.1 0.1 0.6 1.2

* April-November. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

ceiling on ECB and the latest Budget proposals allow for ECB in new areas such as small real estate projects. The actual inflows of ECB may well depend on risk perceptions of European and other banks with global operations. Risk aversion is likely to persist, implying the possibility of a rise in the cost of borrowing in the international market. The increase in ECB flows may augur well from the point of view of financing the CAD, but a medium-term increase in dependence on international debt instruments may not be the most preferred option in a global financial system marked by quick and widespread changes in market sentiments. The Exchange Rate The US dollar continues to be treated as a safe haven by global investors. This means that any reduction in risk tolerance would lead to

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a flight to the dollar, thereby creating pressures on many emergingeconomy currencies. This force, coupled with a higher CAD and reduced capital inflows, led to a depreciation of the Indian rupee. The real effective exchange rate (REER) based on 6-, 30- and 36-currency baskets recorded a sharp depreciation in the third quarter of 201112. In the current fiscal year 201112, the Indian rupee depreciated (on a month-to-month basis) by 12.4 per cent. In March 2011, the rupee was 44.97 per US dollar, and by January 2012 it stood at 51.34 per US dollar, having peaked at 54.23 per US dollar on December 15, 2011. Between March 2011 and December 2011, the Indian rupee had depreciated 11.5 per cent against the pound sterling, 9.1 per cent against the euro, and 18.7 per cent against the Japanese yen. Indian companies with significant exposure to international borrowing may find the cost of rolling over of debt higher than before. This likelihood, along with the volatility of the nominal exchange rate, may imply large balance sheet impacts for them. Another implication of the worsening of Indias current account deficit and a slowing of capital inflows was reflected in an increase of Indias external debt. Indias external debt stock was at US$326.6 billion (see Table 7) at the end of September 2011, which was 6.6 per cent higher than the stock at March-end 2011. The increase in external debt was primarily due to the rise in ECB and other short-term debt. Of the total of US$326.6 billion, long-term debt was US$255.1 billion (78.1 per cent of the total). The remaining was short-term debt.

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Indian companies with significant exposure to international borrowing may find the cost of rolling over of debt higher than before. This likelihood, along

TABLE 7 Indias External Debt (US$ billion) Item End-Mar End-Jun End-Sep 2011 PR 2011 PR 2011 P Variation (End-Sep 2011 over End-Jun 2011) Amount Per cent 5 6 0.2 1.0 0.2 1.0 5.3 0.6 0.1 6.1 3.1 9.1 0.5 3.7 2.4 5.3 5.6 1.1 9.3 2.4 4.5 2.9

with the volatility of the nominal exchange rate, may imply large balance sheet impacts for them.

1 1. 2. 3. 4. 5.

3 49.4 26.3 6.4 18.7 93.8 52.9 1.6 249.0 68.5 317.5

4 49.1 27.3 6.2 19.7 99.0 52.3 1.4 255.1 71.5 326.6

Multilateral 48.5 Bilateral 25.8 International Monetary Fund 6.3 Trade Credit (above 1 year) 18.6 External Commercial Borrowings 88.9 6. NRI Deposits 51.7 7. Rupee Debt 1.6 8. Long-term (1 to 7) 241.4 9. Short-term 65.0 Total (8+9) 306.4

P: Provisional. PR: Partially Revised. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

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The overall performance of Indias external sector was thus marked by a worsening of the current account, weakening of capital inflows and a depreciation of the

The debt of the Government (sovereign debt) was at US$79.3 billion, with the rest of the total stock of debt held by non-government entities. Though by the end of 201011 the external debt to GDP ratio was at a manageable 17.8 per cent, the year 201112 is likely to end with a marginal worsening of the reserve cover of imports and the ratio of short-term external debt to total external debt. The worsening international trade and capital flows situation had an impact on Indias foreign exchange reserves too. Indias foreign exchange reserves initially rose in 201112 and then declined. The reserves reached an all-time high at end-August 2011 at US$322.0 billion. However, at end-January 2012, the reserves stood at US$292.8 billion. At March-end 2011, the reserves were US$304.8 billion. The net decline of US$12 billion in a period of 10 months has been partly due to the active intervention of the RBI in the third quarter of 201112 to prevent rapid depreciation of the rupee against the US dollar, and partly due to the valuation effects of a depreciating euro against the dollar. Since a large proportion of the reserves is now held in the form of euro-denominated assets, the depreciation of the euro is significant in the valuation changes brought about in the RBIs balance sheet. The overall performance of Indias external sector was thus marked by a worsening of the current account, weakening of capital inflows and a depreciation of the currency. International prices had their effect on imports, and the higher volatility of capital flows reflected the uncertainties in global markets. Given these trends, it would hardly be surprising to find production and demand in the Indian economy also show signs of a slowdown. We now turn to take a look at the trend of production in the Indian economy during the year 201112.

Growth in Output

currency. International prices had their effect on imports, and the higher volatility of capital flows reflected the uncertainties in global markets.
Sectoral Growth As far as GDP growth at factor cost (at 200405 prices) was concerned, the performance of the economy was below par, with mining and quarrying the worst performer with a negative rate of growth in 201112. Agriculture and allied sectors, manufacturing, and construction have all registered lower rates of growth in 201112 than in 201011. Even financial and business services have grown at a lower rate. As a result of these lower sectoral rates of growth, the growth rate of GDP at factor cost has fallen significantly from 8.4 per cent in 2010 11 to an estimated 6.9 per cent in 201112. This rate, as mentioned above, is also far less than the estimate of the growth rate of 9 per cent on which budgetary calculations had been made. Table 8 shows the sectoral rates of growth for some of the major sectors of the economy discussed above. Table 9 shows the quarterly rates of sectoral growth over the past two years, up to the third quarter of 201112. It can be seen that the third quarter performance of agriculture and allied sectors in

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TABLE 8 Rate of Growth of GDP at Factor Cost at 20042005 Prices (per cent) 201011QE Agriculture, forestry & fishing Mining & quarrying Manufacturing Electricity, gas & water supply Construction Trade, hotels, transport & communication Financing, insurance, real estate & business services Community, social & personal services GDP at factor cost
QE Quick Estimate; Source: CSO. AE

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201112AE 2.5 2.2 3.9 8.3 4.8 11.2 9.1 5.9 6.9

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Advance Estimate.

TABLE 9 Sectoral GDP Growth (200405 prices) (per cent) Item 1 Agriculture & allied activities Industry Mining & quarrying Manufacturing Electricity, gas & water supply Services Construction Trade, hotels, transport, storage & communication, etc. 3.3 Financing, insurance, real estate & business services 3.4 Community, social & personal services 4. GDP at factor cost
# Revised Estimates. Source: CSO.

201011 # Q1 2 6.6 7.8 5.8 8.3 5.7 9.2 8.1 10.3 9.9 7.0 8.5 2.4 9.7 7.4 10.6 5.5 10.1 7.7 12.1 9.8 8.2 8.8

201011 Q2 Q3 3 4 5.4 7.3 8.0 7.8 2.8 9.2 6.7 10.2 10.0 7.9 8.4 9.9 6.2 6.9 6.0 6.4 8.6 9.7 8.6 10.8 5.1 8.3

Q4 5 7.5 5.3 1.7 5.5 7.8 8.6 8.2 9.3 9.0 7.0 7.8

201112 201011 201112 Q1 Q2 H1 H1 6 7 8 9 3.9 6.7 1.8 7.2 7.9 8.9 1.2 12.8 9.1 5.6 7.7 3.2 2.8 2.9 2.7 9.8 8.7 4.3 9.9 10.5 6.6 6.9 3.7 8.5 7.7 9.1 4.1 9.6 7.2 11.1 9.9 8.0 8.6 3.6 4.7 0.5 4.9 8.9 8.8 2.7 11.3 9.8 6.1 7.3

1. 2. 2.1 2.2 2.3 3. 3.1 3.2

201011 was an outlier with respect to the trend. Industry as a whole, as well as each of the major sub-sectors under industry, shows quite a bit of variation. On the other hand, services (both business services as well as social services) exhibited stable growth rates. While most observers would expect agriculture to show greater variation than industry, since the former is still largely dependent on the monsoons, it is surprising to note the variations in industrial performance. Two quick observations are in order. In the last year (2010 11), there was a reversal of global recovery from the financial

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meltdown of 200809 resulting in unexpected variations in external demand. This, however, cannot be the entire explanation since Indias dependence on international trade, though growing, is still not significant enough. Internal bottlenecks (more of a structural nature) would be equally, if not more, important explanations. Domestic infrastructural constraints like inadequate and poor-quality power or bottlenecks in the availability of some critical input like coal can moderate growth, as can a slowing down of domestic demand. The performance of Indian industry has fallen far below expectations and cannot be entirely explained by the changing external factors alone. Agriculture The share of agriculture and allied sectors in GDP fell from 14.5 per cent in 201011 to 13.9 per cent in 201112. Agriculture alone accounted for 12.3 per cent of the share. While this decline in share is consistent with the trend, the actual importance of agriculture lies in its significance as an employer of people who gain income and sustain livelihoods from this sector. Hence a robust performance of this sector is essential for inclusive growth. Yet the sector remains vulnerable to the vagaries of the monsoons, the south-west monsoon in particular. In 201112, the south-west monsoon was 1 per cent above the long period average. Hence the economy has been lucky to clock a food grain production of around 250 million tonnes, even above the level reached last year (201011), which was an outstanding year of agricultural performance of 7 per cent growth. The logistics of implementing the proposed National Food Security Bill (the Bill is yet to be passed by Parliament though budgetary provisions have been made according to the Budget speech of the Finance Minister) will imply some overhauling of the public distribution system (PDS) and also perhaps procurement policies. The Budget has given some signals, in terms of incentives and allocations, about the importance of additional storage capacity for food grains and the urgent necessity of developing a cold chain for carrying perishable produce (fruits and vegetables in particular) from the farmer to the retail markets. The stock position of food grains on February 1, 2012 was 55.2 million tonnes, of which 31.8 million tonnes comprised rice, and 23.4 million tonnes wheat. This stock, according to the latest Economic Survey (Government of India, 2012a), is adequate for the targeted public distribution system (TPDS) and may help bring headline inflation down. Industry As mentioned earlier, industrial growth measured in terms of the index of industrial production (IIP) shows fluctuating trends. Table 10 shows the IIP figures for 201011 along with figures for April November 201011 and AprilNovember 201112 for sectoral and usebased classification for industries. It can be seen from the table that all

The Budget has given some signals, in terms of incentives and allocations, about the importance of additional storage capacity for food grains and the urgent necessity of developing a cold chain for carrying perishable produce from the farmer to the retail markets.

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TABLE 10 Index of Industrial ProductionSectoral and Use-Based Classification of Industries (per cent) Industry Group Weight in IIP 2 Growth Rate Apr-Mar 201011 3 Apr-Nov 201011 201112 P 4 5

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1 Sectoral Mining Manufacturing Electricity Use-Based Basic Goods Capital Goods Intermediate Goods Consumer Goods (a+b) a) Consumer Durables b) Consumer Non-durables General P: Provisional. Source: CSO.

14.2 75.5 10.3 45.7 8.8 15.7 29.8 8.5 21.3 100.0

5.2 9.0 5.5 6.0 14.8 7.4 8.6 14.2 4.3 8.2

7.0 9.0 4.5 5.4 18.2 8.1 8.0 14.6 2.9 8.4

2.5 4.1 9.5 6.2 1.0 0.3 4.9 5.3 4.6 3.8

Of the 22 subsectors comprising the manufacturing sector, eight subsectors registered negative growth rates during the period April November 201112. The top five industries with a combined weight of about 23% grew at 14.7% and contributed 78.3% to overall growth of the sector.

growth rates moderated barring electricity (in the sectoral classification) and basic goods and consumer non-durables (in the usebased classification). Negative growth rates were clocked in capital goods and intermediates. Overall growth (AprilNovember 201112) stood at 3.8 per cent against the previous figure of 8.4 per cent during the same period of 201011. In the sectoral category, the particularly poor performance of mining was due to the many legal issues that emerged in the governance of this sector. This could reflect a short-term (contractionary) impact of stricter governance to create more longterm, sustainable benefits. Manufacturing sectors growth rate declined from 9.0 per cent in AprilNovember 201011 to 4.1 per cent in the same period of 201112. Of the 22 sub-sectors comprising the manufacturing sector, eight sub-sectors registered negative growth rates during the period AprilNovember 201112. The top five industries with a combined weight of about 23 per cent grew at 14.7 per cent and contributed 78.3 per cent to overall growth of the sector (see Chart 1). Core Industries and Infrastructure The eight core industries experienced a deceleration in growth at 0.5 per cent in January 2012 as against the rate of 6.4 per cent in January 2011. During the period AprilJanuary 201112, the cumulative growth rate was 4.1 per cent as compared with 5.7 per cent during the corresponding period of 201011. Four of the eight sectors,

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CHART 1 Growth Concentration in the Manufacturing Sector

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Barring refinery products and electricity, all the other sectors registered lower growth, with coal and natural gas registering negative rates of growth.

Source:

Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

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namely coal, cement, fertilizers and electricity, showed positive growth during January 2012, while the other four comprising crude oil, natural gas, refinery products and steel registered negative growth. Capacity utilisation dropped in steel, cement, fertilizers and thermal power, while the level of utilisation increased only marginally in petroleum and refinery production. This is shown in Table 11. Chart 2 shows the performance of the infrastructure sectors for the period AprilNovember 201112 as compared with the performance for the same period in the year 201011. Barring refinery products and electricity, all the other sectors registered lower growth, with coal and natural gas registering negative rates of growth. The poor performance of coal has become a binding constraint for increasing (or even maintaining) thermal power generation. The poor performance of coal is attributed to issues of governance and

TABLE 11 Capacity Utilisation in Core Sectors (per cent) Sector 1 Finished Steel (SAIL+VSP+Tata Steel) Cement Fertiliser Refinery Production-Petroleum Thermal Power 200910 2 90.7 82.0 93.6 107.4 77.7 201011 3 92.0 76.0 94.5 109.3 75.1 201112* 4 88.1 72.0 93.7 110.7 71.2

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* Data pertain to AprilSeptember 2011. Source: Capsule Report on Infrastructure Sector Performance, Ministry of Statistics and Programme Implementation, Government of India.

The poor performance of coal is attributed to issues of governance and regulations regarding environmental degradation. There was excessive rainfall too in many coal mining areas that hampered

CHART 2 Sector-wise Growth in Infrastructure Industries

Source:

Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

production.

regulations regarding environmental degradation. There was excessive rainfall too in many coal mining areas that hampered production. Services The share of services in Indias GDP at factor cost increased from 55.1 per cent in 201011 to 56.3 per cent in 201112. The largest sub-sector in this category is trade, hotels and restaurants. The advance estimates of the rate of growth of the services sector for the year 2011 12 is 9.4 per cent. This growth rate has always been above the rate of growth of GDP since 199697, except for the year 200304. However,

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Among the components of aggregate demand, investment spending slowed down as did consumption expenditures (both private and public) and net exports.

with a general deceleration in growth and economic activity, the quarterly break-up of the services sector growth displays a slowdown in momentum as seen in Table 9. For the first three quarters of 201112, the rate of growth declined from 10 per cent to 9.3 per cent to 8.9 per cent. In the services group, telecommunications, civil aviation and construction industries registered lower growth mainly due to lower credit availability from banks arising from their risk aversion to bad loans in these activities. The services sector, along with agriculture, remains a significant source of employment, and hence its growth momentum is important from this consideration. The emerging picture of the growth of production was below expectations, especially in the industrial sector of the economy. This would be explained by a changing composition and deceleration in aggregate spending in the economy. It is to this issue that we now turn.

The Expenditure Side

The overall moderation of demand has been due to a number of factors. External demand for Indian goods and services was actually quite buoyant in the beginning of the year, but slowed down considerably in subsequent months. The export figures of the Government of India have come under some cloud of controversy though, around a possible over-reporting of the rate of growth due to some software glitch. Internal demand slowed down too. Among the components of aggregate demand, investment spending slowed down as did consumption expenditures (both private and public) and net exports. This is evident from the last two columns of Table 12. There was excess capacity built up earlier, and with current demand declining, the gap between potential output and actual output increased. Consumption
TABLE 12 Expenditure Side GDP (200405 prices) (per cent)

Item 1

201011 # 2 Q1 3

201011 Q2 Q3 4 5

Q4 6

201112 Q1 Q2 7 8

201011 201112 H1 H1 9 10

Real GDP at Market Prices Total Consumption Expenditure (i) Private (ii) Government Gross Fixed Capital Formation Change in Stocks Net Exports
# Revised Estimates. Source: CSO.

8.8 8.0 8.6 4.8 8.6 7.4 15.3

(Growth Rates) 9.1 8.6 9.2 7.7 9.1 8.5 7.4 7.5 9.5 9.0 8.6 8.0 6.7 6.4 1.9 4.9 11.1 10.3 7.8 0.4 9.3 6.5 5.1 4.6 33.3 14.2 52.6 34.8

8.5 6.7 5.7 5.6 6.3 5.9 2.1 4.0 7.9 0.6 4.7 1.5 21.5 35.0

8.9 8.8 9.2 6.5 10.7 7.9 23.0

7.6 5.6 6.1 3.1 3.5 3.1 6.9

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expenditure also took a hit from stricter monetary management that led to higher costs of borrowing in interest-rate sensitive items of expenditure. The overall growth rate of GDP at (200405) market prices declined from 8.9 per cent in the first half of 201011 to 7.6 per cent in the first half of 201112. The advance estimate for the annual rate for 201112 is 7.5 per cent, down from 9.6 per cent in the preceding year. It is estimated that a 1 percentage point drop in gross fixed capital formation shaves off 0.2 percentage points from output, and a 1 percentage point drop in the growth rate of the world economy takes off 0.3 percentage points from the growth rate of the nonagricultural GDP of India. For a number of reasons, both global economic activity and domestic investment slowed down. Investment as a proportion of GDP had been on a relative decline in the past couple of years. This year the poor performance of the global economy might have induced additional investment pessimism. According to the RBI (see Reserve Bank of India, 2012), there has been a sharp decline in investment intentions of the corporate sector. Investment in new projects dipped. A press report (The Economic Times, 2012) citing data from the Centre for Monitoring Indian Economy (CMIE), showed the decline in new investment proposals in 201112 to be substantial. New proposals from the private sector declined from Rs. 11.49 lakh crore in 2010 to Rs. 6.03 lakh crore in 2011, a decline of 47.79 per cent. Similarly, the corresponding figures for government investment proposals were Rs. 7.39 lakh crore and Rs. 4.43 lakh crore respectively, registering a decline of 40.04 per cent. The combined decline in investment proposals (both private and government) was to the tune of 44.57 per cent. Many companies were reportedly shelving new projects, not merely due to rising costs of borrowing, but also due to a perceived absence of clarity in many economic policies. Project finance data obtained from banks and financial institutions reveal a 77 per cent decline in total outlay on new projects in the second quarter of 201112 as compared with the same period of the preceding year. For the corporate sector, revenue growth was lower than expenditure growth (mainly on account of cost inflation), which made profit margins fall. The IT sector was an exception, but with projections of global growth rates been pruned, the trend may not continue in the forthcoming future. Large companies did witness some sales growth, but margins were squeezed. Smaller companies experienced pressures on both sales and profits. As is evident from Table 13 and Table 14, operating profits as well as profits-after-tax declined, while interest payments rose significantly. The health of the corporate sector would be reflected in the behaviour of the financial markets too.

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The combined decline in investment proposals (both private and government) was to the tune of 44.57%. Many companies were reportedly shelving new projects, not merely due to rising costs of borrowing, but also due to a perceived absence of clarity in many economic policies.

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TABLE 13 Corporate Sector: Financial Performance Item 1 No. of Companies (Year-on-year growth rates Sales 25.8 19.9 Expenditure 30.5 21.2 Raw Material 39.1 21.7 Staff Cost 15.8 20.2 Operating Profits (PBDIT) 16.1 8.8 Other Income* 13.6 52.3 Depreciation Provision 20.9 17.3 Interest Payments 30.7 6.3 Profits after Tax 3.8 9.8 Q1 2 201011 Q2 Q3 3 4 201112 Q1 Q2 6 7

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2023 in per cent) 18.2 20.5 20.3 22.8 20.6 27.2 21.5 20.3 11.7 15.9 13.0 24.1 13.9 14.5 22.9 32.9 11.2 13.4

22.6 23.1 27.9 20.1 11.3 41.5 9.0 22.0 9.4

19.3 22.9 23.4 18.0 0.6 31.7 9.8 47.5 13.0

* Other income excludes extraordinary income/expenditure if reported explicitly. Note: Growth rates are percentage changes in the level for the period under reference over the corresponding period of the previous year for common set of companies. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

TABLE 14 Corporate Sector: Financial PerformanceSequential Item Common Companies (QoQ Growth in per cent) Q1 FY11 Q2 FY11 Q3 FY11 Q4 FY11 Q1 FY12 Q2 FY12 over Q4 over Q1 over Q2 over Q3 over Q4 over Q1 FY10 FY11 FY11 FY11 FY11 FY12 2 3 4 5 6 7 2023 5.2 3.6 4.4 2.2 1.9 43.8 1.3 15.9 10.4 6.3 5.0 2.0 8.4 2.3 36.1 1.0 3.3 8.4 5.5 5.6 9.0 2.2 6.6 21.8 3.2 7.6 1.9 13.1 14.8 17.5 5.5 7.8 28.2 8.2 7.9 14.1 3.3 3.3 3.1 3.3 5.5 2.0 3.7 8.4 13.4 3.4 4.9 1.4 5.8 -8.4 28.7 1.9 18.3 13.6

1 No. of Companies Sales Expenditure of which Raw Material Staff Cost Operating Profits (PBDIT) Other Income Depreciation Interest Profits after Tax

Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

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Financial Markets
Equity Markets Global uncertainty and the slowdown in economic activity had their impact on the Indian currency and equity markets. A rising current account deficit and slowing net capital inflows together put pressure on the exchange rate. Indian equity market indices showed a decline during the year with corporate profit expectations lower than before, and with FII outflows. The corrections in equity markets reduced the price to earnings ratio (PE) from 17.6 at end-March 2011 to 16.9 at end-December 2011. In early 2012, equity markets appeared to reverse the declining trend, though it may be too early to confirm the turnaround. In an effort to widen the class of investors allowed access to the equity market, Qualified Foreign Investors (QFI) were allowed to directly invest in Indian equity markets from January 2012. Given the deteriorating sentiments arising out of the slowdown, resource mobilisation through public issues fell sharply. From AprilDecember 2011, the equity segment of financial markets saw net sales by FIIs to the tune of Rs. 43.8 billion. This was reversed in January 2012 with FII net purchases of Rs. 54 billion. On the other hand, during April December 2011, there was a net purchase of mutual funds (MF) by the FIIs to the tune of Rs. 42.2 billion. Debt Markets In comparison with equity markets, the debt market appeared better so far as FII preferences were concerned. The FII limit had been raised for this segment, and the risk adjusted rate of return was higher for certain debt instruments. The debt market in the current year (201112) saw a large dose of government market borrowing, over and above the anticipated target set in the Budget. However, yields on government securities did not harden. In fact, there was a softening of the yields brought about by a couple of factors. The first reason was that the FII limit on the holding of such securities had been enhanced, increasing the demand for bonds. Secondly, the RBI pursued open market operations (OMO) to inject liquidity. Up to January 20, 2012, the RBI had purchased, through OMO, government securities to the tune of Rs. 719 billion. Hence, unlike the currency and equity markets, the market for money and government securities was not affected to any significant extent by changing global factors. This accounted for the stability shown by interest rates during the third quarter of 201112 despite the October rate hike, interest rate deregulation, and large government borrowings. The yields on auction treasury bills (TB), however, hardened by December 2011, reflecting the very sharp rise in the Governments short-term borrowings. Recent developments have increased the importance of strengthening and stabilising capital flows into India. In this context,

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A rising current account deficit and slowing net capital inflows together put pressure on the exchange rate. Indian equity market indices showed a decline during the year with corporate profit expectations lower than before, and with FII outflows.

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the ECB policy was modified to allow a higher all-in-cost ceiling for such borrowings. The proceeds raised were to be brought back to India immediately after the acquiring of such resources. This was to be in force till March 31, 2012. It would be reviewed after that date. This could have a positive effect on the financing of infrastructure projects. These are usually big ticket projects with long gestation lags. In India, there is a heavy dependence on bank finance for such loans. Access to external sources would enhance the range of possibilities in the absence of a well developed corporate bond market in India. Housing Credit As one of the lessons learnt from the sub-prime crisis in the USA, and the fact of the growing importance of the real estate market in India, policymakers have been keeping a closer watch on developments in this segment of the financial market. In a climate of decelerating credit off-take from the banking sector, housing loans continued to show increases in the rate of growth. The number of transactions in the housing market fell reflecting a fall in demand, but housing prices remained rigid, reflecting the sellers pricing power in this sector. According to the RBI, developers typically hold land banks and delay the launch of new projects to retain control over prices. The preceding discussion on demand and profitability and their reflection in equity markets suggests that the corporate sector would be viewing inflationary pressures as one key reason for cost pushes and reductions in margin. Widespread and persistent inflation not only left producers worried, but it affected consumers too. The demand for food and fuel being relatively inelastic, inflation would force them to switch expenditures away from manufactured goods and services. We now turn to a discussion of the behaviour of prices during the year.

In a climate of decelerating credit off-take from the banking sector, housing loans continued to show increases in the rate of growth. The number of transactions in the housing market fell reflecting a fall in demand, but housing prices remained rigid, reflecting the sellers pricing power in this sector.

Inflation
Global Trends High rates of price inflation continued to affect the performance of the Indian economy throughout 201112. The inflation was partly because of international reasons affecting oil and commodity prices, and partly due to the structural features of the Indian economy, particularly in agricultural supplies. While the worst phase of inflation might appear to be over, there is no reason to believe that it will come down to tolerable levels in the near future. Though inflation has been a global phenomenon operating through international food, fuel and some commodity prices, the actual incidence of inflation has not been uniformly severe. The advanced economies have, due to their own recessionary downturns, not experienced much inflationary pressure compared with the emerging and developing economies of the world. The reason why observers believe that the worst international inflationary pressures are over is the expectation of a further weakening

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of demand and economic activity in the advanced economies and a slowdown in growth rates of the emerging economies during the fiscal year 201213. Decelerating commodity price inflation will soften consumer price index (CPI) inflation. This trend is likely to prevail despite sustained easing of monetary conditions in attempts to support recovery in these economies. The fast-growing developing economies will continue to feel the pressure of inflation through demand growth and their own domestic structural supply bottlenecks, but the severity is likely to be less than last year. Throughout the third quarter of 201112 global commodity prices have softened somewhat (though levels continue to be high). Crude oil prices, however, have been sticky for a number of reasons as mentioned earlier in the first section on the global economy. The price of crude oil climbed 30 per cent in 201112 compared with the preceding year. Global food prices too have moderated in 201112 with the FAO Food Price Index 13 per cent below its all-time high value in February 2011. Information about global food supplies and stocks are reassuringly better, and hence the inflationary pressures on food prices are not expected to increase. Like commodity and oil prices, it may be noted that food prices are also very high in terms of levels. In 201112, international prices of metals and some other raw materials imported into the Indian economy rose rapidly and then moderated towards the end of the year. The effect of the moderation in price inflation might have been more significant had not the Indian rupee depreciated by a significant amount just when international prices were moderating. Inflation in India Headline Wholesale Price Index (WPI) inflation remained stubbornly high and persistent in 201112, averaging around 9 per cent. In April 2011 it was 9.7 per cent, touching double digits in September 2011, and then softening to 6.6 per cent in January 2012. One major reason for the headline inflations stickiness has been the rise in primary article prices (such as those of vegetables, eggs, fish and meat) driven by a moderation in the growth of the marketed surplus of primary articles. A possible reason behind this could be higher demand by producers whose incomes have been rising. WPI inflation has also been affected by rising international commodity prices (especially metals and chemical products), and the rising crude petroleum prices. The pass-through of the depreciation of the rupee (from August 2011) has offset to a large extent the moderation in global prices, even with the pass-through being partial due to the administered price mechanism and associated subsidies offered on oil products. Table 15 shows the WPI inflation rates by major heads for the period AprilJanuary 2010 11 and for the same period of 201112. Comparing the two periods, it can be seen from the table that while the inflation rate for primary articles moderated from 18.41 per cent in AprilJanuary of 201011 to 9.91 per cent for the same period

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Information about global food supplies and stocks are reassuringly better, and hence the inflationary pressures on food prices are not expected to increase. Like commodity and oil prices, it may be noted that food prices are also very high in terms of levels.

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TABLE 15 Annual Average Inflation by Major Heads in WPI (per cent) Commodities All commodities Primary articles Food articles Non-food articles Minerals Fuel & power Coal Mineral oils Electricity Manufactured products Food products Beverages, tobacco & products Textiles Wood & wood products Paper & paper products Leather & leather products Rubber & plastic products Chemicals & their products Non-metallic mineral products Basic metals, alloys & products Machinery & machine tools Transport, equipment/parts Weight 100.00 20.12 14.34 4.26 1.52 14.91 2.09 9.36 3.45 64.97 9.97 1.76 7.33 0.59 2.03 0.84 2.99 12.02 2.56 10.75 8.93 5.21 201011 (AprJan) 9.55 18.41 16.75 20.49 26.74 12.24 5.07 16.03 5.74 5.46 4.26 7.08 11.05 4.03 4.84 0.92 5.98 5.00 2.59 8.10 2.73 2.96 201112 (AprJan)P 9.11 9.91 7.15 12.27 24.15 13.67 13.26 17.12 1.17 7.58 7.35 11.81 9.51 8.00 5.94 1.76 6.82 8.74 5.52 11.12 3.11 3.54

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The growing imports of non-fuel items increase the vulnerability of inflation rates to changes in the exchange rate through depreciation.

P: Provisional. Source: The Office of the Economic Adviser (OEA), Department of Industrial Policy and Promotion (DIPP).

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in 201112, the fuel and power group registered an increase from 12.24 per cent to 13.67 per cent for the period under comparison. It can also be seen that the inflation rate for manufactured goods increased from 5.46 per cent to 7.58 per cent in the same period. Within this category, the sharpest rise has been in food products and basic metals. This is also indicative of the fact that the more price-volatile components in primary articles, and fuel and power, were not the sole culprits anymore; core inflation (manufactured goods) has also begun to rise. The growing imports of non-fuel items increase the vulnerability of inflation rates to changes in the exchange rate through depreciation. This possibility is shown in Table 16. This reverses a trend observed in 201011 and reveals inflation as a more economy-wide phenomenon in the last year. This is also evident from Chart 3, which clearly shows the increased contribution to inflation by the manufactured goods group (increasing from 35 per cent contribution to 49 per cent contribution) in 201112 as compared with 201011. The contribution to inflation by the fuel and power group could

TABLE 16 Imports and WPIRisk of Depreciation Induced Price Pressures Items Weight of the Item in WPI (2004 05=100) 1 Petroleum, crude & products Iron & steel Transport equipment Electrical machinery except electronic Machinery except electric & electronic Vegetable oils fixed (edible) Fertilizers Coal, coke & briquettes, etc. Organic chemicals Artificial resins, plastic materials, etc. Manufactures of metals Inorganic chemicals Pulp and waste paper Non-ferrous metals Electronic goods Pulses Gold Note: 2 10.26 8.30 5.21 4.17 3.05 3.04 2.66 2.09 1.95 1.86 1.31 1.19 1.02 1.00 0.96 0.72 0.36 Share of the Imported Item in Total Imports 201011 3 28.65 2.63 3.10 1.04 6.45 1.77 1.87 2.65 3.14 1.86 0.90 0.98 0.31 1.10 7.19 0.42 10.97 201112 (AprSep) 4 31.43 2.20 1.81 1.00 6.35 2.06 1.66 3.68 2.87 1.52 0.81 1.11 0.28 1.16 7.22 0.35 12.24

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The average Indian basket of crude oil increased from US$85.09 in 2010 11 to US$109.97 by December 2011.

The items presented in col. 2 and 3 & 4 may not exactly correspond, given differences in classification of items in WPI and Imports. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

CHART 3 Contribution to WPI Inflation by Major Groups (per cent)

Fuel 19% Manufactured 35%

Primary 46%

Fuel 23% Manufactured 49%

Primary 28%

2010-11

2011-12

have been more acute had not the administered price system in mineral oils been in place. The average Indian basket of crude oil increased from US$85.09 in 201011 to US$109.97 by December 2011. The passthrough of this price rise was reflected in the increase in the nonadministered prices of aviation fuel, naphtha and bitumen. The nonadministered prices went up by about three times more than the rise in

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TABLE 17 Comparative Movement of Oil Price and Exchange Rate since July 2011 July 2011 Fortnight Change (January 1 in 15, 2012) Per cent 3 4 110.9 52.5 5827.1 1.4 18.2 16.6

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1 Crude OilIndian Basket (US$ per barrel) Exchange Rate (Rupee/Dollar) Crude OilIndian Basket (Rupee per barrel) Note: 2 112.5 44.4 4995.8

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The major contributions to food inflation in 201112 came from manufactured food products and edible oils, apart from fish, meat, eggs, and milk.

The composition of Indian Basket of Crude Oil represents Average of Oman & Dubai for sour grades and Brent (Dated) for sweet grade in the ratio of 67.6:32.4. Source: Petroleum Planning and Analysis Cell.

administered prices of mineral oils in the same period. Table 17 shows the changes in oil prices and the effect of depreciation of the Indian rupee, between July 2011 and mid-January 2012. Food Inflation The WPI food inflation has also dropped significantly from 20.2 per cent in February 2010 to 1.6 per cent in January 2012. The major contributions to food inflation in 201112 came from manufactured food products and edible oils, apart from fish, meat, eggs, and milk. The moderation of food inflation is due to the operation of a base effect. The main drivers of food inflation mentioned above continue to exhibit high rates of inflation. The food inflation break-up according to broad categories is shown in Table 18.
TABLE 18 WPI-based Year-on-Year Inflation in Major Subgroups (per cent) Foodgrains Weight Apr 2010 Apr 2011 May 2011 Jun 2011 Jul 2011 Aug 2011 Sept 2011 Oct 2011 Nov 2011 Dec 2011P Jan 2012P 4.09 11.05 2.15 2.61 2.08 2.53 3.33 3.91 5.48 4.59 4.11 4.08 Fruits & vegetables 3.84 14.32 26.48 15.23 7.49 11.62 18.29 15.06 13.48 8.96 14.89 21.83 Milk 3.24 27.91 2.87 6.11 11.52 10.77 9.41 10.28 11.12 10.91 11.02 12.16 Eggs, meat, & fish 2.41 38.61 11.14 6.59 9.88 9.56 10.42 11.88 12.43 11.40 11.88 18.63 Sugar 1.74 24.55 3.45 5.53 7.53 3.96 6.28 7.38 7.31 6.18 4.34 2.25 Edible oils 3.04 0.09 13.47 15.47 15.80 14.76 14.72 13.87 12.93 11.82 11.52 9.59

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P Provisional. Source: OEA, DIPP.

Consumer Price Index Movements Apart from food inflation, inflation measured by the various Consumer Price Indices (CPI) also moderated by January 2012. This is shown in Table 19. The CPI (IW) inflation (for industrial workers) declined from 9.41 per cent in April 2011 to 5.32 in January 2012. The CPI (AL) inflation (for agricultural workers) also declined from 9.11 per cent to 4.92 per cent in the same period. Similarly, the CPI measure for rural labour fell from 9.11 to 5.27 per cent. The dip in the inflation rates for January 2012, however, should be viewed with some caution because of the base effect already mentioned. According to the RBI, the wages of unskilled workers in many parts of rural India have increased at a rate faster than the rise in the CPI (RL). While rising real wages (particularly for unskilled rural workers) are desirable from the point of view of economic development and social welfare, it ought to be kept in mind that a rise in wages outstripping the rise in productivity could add to inflationary pressures. In a reversal of an earlier trend, WPI inflation and various measures of CPI inflation are now showing greater convergence. The reason behind this is the fact that food inflation has softened, and food items carry very large weights in all the indices. This trend is evident from Table 20, which shows the rates of food inflation from January 2011 to January 2012 along with the weights in each of the four indices shown.

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While rising real wages are desirable from the point of view of economic development and social welfare, it ought to be kept in mind that a rise in

TABLE 19 Annual Inflation as per Different Price Indices (per cent) Month 2010 11 April May June July Aug Sept Oct Nov Dec Jan Feb Mar Average 10.88 10.48 10.25 9.98 8.87 8.98 9.08 8.20 9.45 9.47 9.54 9.68 9.56 WPI 2011 12 9.74 9.56 9.51 9.36 9.78 10.00 9.87 9.46 7.47 6.55
P P

wages outstripping
CPI-RL 2010 2011 11 12 14.96 13.68 13.02 11.24 9.66 9.34 8.45 6.95 8.01 8.69 8.55 8.96 10.01 9.11 9.63 9.14 9.03 9.71 9.25 9.73 9.14 6.72 5.27

CPI-IW 2010 11 13.33 13.91 13.73 11.25 9.88 9.82 9.70 8.33 9.47 9.30 8.82 8.82 10.45 2011 2010 12 11 9.41 8.72 8.62 8.43 8.99 10.06 9.39 9.34 6.49 5.32 14.96 13.68 13.02 11.02 9.65 9.13 8.43 7.14 7.99 8.67 8.55 9.14 10.00

CPI-AL 2011 12 9.11 9.63 9.32 9.03 9.52 9.43 9.36 8.95 6.37 4.92

the rise in productivity could add to inflationary pressures.

P Provisional; CPI: Consumer Price Index; IW: Industrial Workers; AL: Agriculture Labour; RL: Rural Labour. Source: OEA, DIPP.

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TABLE 20 Food Inflation based on the WPI and CPI-IW/AL/RL (per cent) Feb 2011 6.8 7.7 7.1 6.9 Mar 2011 6.8 8.3 7.2 7.3 Apr 2011 9.0 8.2 7.3 7.1 May 2011 8.1 7.6 7.5 7.5 Jun Jul Aug Sep Oct Nov 2011 2011 2011 2011 2011 2011 8.0 6.9 6.8 6.8 8.2 6.3 6.4 6.4 9.2 7.3 7.1 6.9 9.1 8.3 6.5 6.7 9.3 8.7 6.8 6.8 7.9 7.6 5.9 5.9 Dec Jan 2011 2012 2.6P 2.0 2.4 2.4 1.6P 0.5 0.3 0.5

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Weight Jan Finance2011 (%) 2011

WPI A P R 24.31 0 110.3 IL.2 2 CPI-IW 46.20 10.2 CPI-AL 69.15 7.5 CPI-RL 66.77 7.5

P Provisional. Source: OEA, DIPP; Labour Bureau.

In the context of discussing the need for more reliable statistics, it may be worthwhile to have a de-seasonalised measure that can take adequate care of the seasonality element in prices.

In the context of the discussion on inflation, it may be noted that the Cabinet Committee on Economic Affairs has approved a change in inflation reporting. WPI shall be, henceforth, reported on a monthly basis only. The weekly reporting will be discontinued. The higher frequency of reporting was supposed to allow policymakers keep a more vigilant eye on price trends, but it has been found that this required more frequent revision of figures once final data was availableindicating that the higher frequency of reporting was leading to more statistical noise. CPI reporting, conforming to international practice, will continue to be on a monthly basis. In the context of discussing the need for more reliable statistics, it may be worthwhile to have a de-seasonalised measure that can take adequate care of the seasonality element in prices.

Monetary Policy and Management

Between Containing Inflation and Supporting Growth From fiscal 201011 the RBI was beginning to harden its anti-inflationary policy stance. The dominant objective of monetary policy was to contain inflation and inflationary expectations. Between March 2010 and January 2012, the RBI increased the repo rate 13 times with a cumulative hike of 375 basis points. Food inflation in India is difficult to control by monetary instruments alone because of the critical importance of supply-side factors that constrain market availabilities. Moreover, advanced economies sustained their easy money policy by injecting large doses of liquidity into financial markets, and continuing with their low interest rate regimes, in their bid to counter recessionary trends. These two factors alone would make the fine-tuning of an anti-inflationary monetary policy difficult, adding to the uncertainties in the length of time lags and the extent of policy impacts. By December 2011, however, the RBI appeared to be ready to reverse its anti-inflationary stance. There had been some moderation in inflation rates and a slower rate of growth of the economy. Hence the repo rate was kept unchanged at 8.5 per cent and

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the reverse repo rate at 7.5 per cent post-December 2011. In January 2012, the cash reserve ratio (CRR) was reduced from 6.0 per cent to 5.5 per cent to ease liquidity and facilitate economic growth. In March 2012, the CRR was pruned by another 75 basis points to 4.75 per cent in the anticipation of a set of worsening IIP figures to be released. Policy Modification The last year witnessed a change in the operating procedure of monetary policy with the weighted average overnight call money rate made the operating target. The repo rate would now be the only independent policy variable, with the reverse repo rate pegged at 100 basis points below the repo rate. A new facility called the Marginal Standing Facility (MSF) has been instituted whereby scheduled commercial banks are allowed to borrow overnight at their discretion up to 1 per cent of their net demand and time liabilities (NTDL) at 100 basis points above the repo rate. Hence, monetary policy would be conducted in the corridor of 200 basis points with the repo rate set in the middle. In February 2012, the RBI aligned the bank rate with the current MSF rate of 9.5 per cent. This operational change would make for easier targeting, and monetary policy surprises would be reduced with the repo rate as the only policy rate. The RBI also deregulated the interest rate that could be paid by banks on savings bank deposits. The rate would be uniform for deposits up to Rs. 1 lakh, but with differential interest rates for deposits above that limit. It was expected to bring the savings deposits more into tune with changing market conditions, but perhaps more importantly,
TABLE 21 Movements in Key Policy Rates in India201112 (per cent) Effective Since 1 May 3, 2011 June 16, 2011 July 26, 2011 Sept 16, 2011 Oct 25, 2011 Dec 16, 2011 Note: Repo Rate 2 7.25 7.50 8.00 8.25 8.50 8.50 (+0.50) (+0.25) (+0.50) (+0.25) (+0.25) Cash Reserve Ratio 3 6.00 6.00 6.00 6.00 6.00 6.00

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By December 2011, however, the RBI appeared to be ready to reverse its antiinflationary stance. There had been some moderation in inflation rates and a slower rate of growth of the economy. In January 2012, the CRR was reduced from 6.0% to 5.5% to ease liquidity and facilitate economic growth.

1. Repo indicates injection of liquidity. 2. As announced in Monetary Policy Statement 201112, the reverse repo rate is pegged at a fixed 100 bps below repo rate, and rate of interest on Marginal Standing Facility (MSF) will be 100 bps above the repo rate. 3. Figures in parentheses indicate change in policy rates in percentage points. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

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to improve the transmission of monetary policy allowing greater flexibility to banks to set their own interest rates. Table 21 shows the changes in repo rate and CRR till December 2011, since the inception of the new policy. Liquidity Management The RBIs management of liquidity in the economy had three distinct phases to it. January 2011 to end-March 2011 was a period of severe liquidity pressure with large government cash balances and imbalances in deposit and credit growth rates. The second phase was from April 2011 to mid-October 2011 when there was moderate liquidity pressure and the injection of liquidity was within the comfort zone of the RBI. Since mid-October 2011, the third phase has been characterised by a period of renewed liquidity pressure arising from the foreign exchange market operations of the RBI to stem the depreciation of the Indian rupee. This pressure was managed by standard means of additional repo and OMO. Since November 2011, the liquidity deficit has remained above the RBIs comfort zone of 1 per cent of NDTL of banks. Banks have been holding government securities at levels 5 percentage points above the statutory requirements. According to the RBI, this provides a pool to tap into, through OMO, to inject more liquidity if needed. Money Supply Currency had grown sharply in 201011 in the climate of inflationary conditions setting in, and buoyant growth rates of the economy. This growth decelerated in 201112 as the opportunity cost of holding money increased with higher interest rates. There has been a switch from currency to time deposits attracting higher rates of interest. This trend has been pronounced in 201112. The tight money policy of the RBI also led to a deceleration of reserve money and currency growth. However, the rate of growth of broad money supply (M3) remained above the target trajectory set by the RBI. The source of the rise in broad money supply was driven by increases in the net RBI credit to Government through OMO and liquidity adjustment facility (LAF). It can be observed from Table 22 that though reserve money growth in 201112 was significantly lower at 3.1 per cent as compared with the preceding years 8.7 per cent, the growth rate of broad money fell only marginally from 11.1 per cent to 10.8 per cent during the same period. It can also be seen that while the growth rate of net RBI credit to Government increased from 7.7 per cent to 12.7 per cent between 201011 and 201112, the growth of bank credit to the commercial sector actually fell from 16.0 per cent to 10.5 per cent, reflecting a rise in the need to finance a larger fiscal deficit by the Government and the perceived need to curb the growth of bank credit by increasing the cost of borrowing through the anti-inflationary policy measures of the RBI.

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Since November 2011, the liquidity deficit has remained above the RBIs comfort zone of 1% of NDTL of banks. Banks have been holding government securities at levels 5 percentage points above the statutory requirements.

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TABLE 22 Monetary Indicators Item Outstanding FY variations Y-o-Y Variations Amount (per cent) (per cent) (Rs. billion) Dec 30, 201011 201112 Dec 31, Dec 30, 2011 2010 2011 2 3 4 5 6 14,200.5 71,986.8 9,779.9 62,184.0 7,093.9 55,090.1 22,351.1 46,817.9 15,905.6 8.7 11.1 13.2 10.8 0.2 12.6 7.7 16.0 5.3 3.1 10.8 7.0 11.4 1.2 13.3 12.7 10.5 14.2 22.5 16.9 19.1 16.6 13.5 17.1 17.3 23.9 1.0 13.0 15.6 12.6 16.2 1.4 18.9 24.4 15.6 17.9

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1 Reserve Money (M0)* Broad Money (M3) Main Components of M3 Currency with the Public Aggregate Deposits of which: Demand Deposits Time Deposits Main Sources of M3 Net Bank Credit to Govt. Bank Credit to Commercial Sector Net Foreign Assets of the Banking Sector Note:

There was a decelerating trend of non-food credit growth across all the sectors such as industry, personal loans, services and agriculture. This

1. Data are provisional. 2. * Data pertain to January 13, 2012. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

Banking Trends As far as the banking sector was concerned, there was a decelerating trend of non-food credit growth across all the sectors such as industry, personal loans, services and agriculture. This was not surprising since it was consistent with the policy stance of the RBI. The deceleration in non-food credit growth was particularly sharp in public sector banks, reflecting their risk aversion by the holding of government securities in excess of the statutory liquidity ratio (SLR) requirements. Since the public sector banks are the largest banks, the slower credit growth would pull down aggregate credit growth significantly. Private sector banks have also registered a slowdown in the growth rate of non-food credit, but not as much as the public sector banks. From Table 23 it can be seen that the rate of growth of credit flow in private banks was 18.5 per cent in December 2011 (year-onyear variations), down from 28.2 per cent the preceding year. For public sector banks the figure for December 2011 was 15.0 per cent, down from 24.1 per cent the preceding year. Apart from the quantitative figures of credit growth, a qualitative deterioration has been observed in bank credit. For the banking sector, during the past two years, the growth rate of gross non-performing assets (gross NPAs) has remained high even when there was robust growth in the economy.

was not surprising since it was consistent with the policy stance of the RBI. The deceleration in nonfood credit growth was particularly sharp in public sector banks.

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TABLE 23 Credit Flow from Scheduled Commercial Banks (Amounts in Rs. billion ) Item Outstanding as on Dec 30, 2011 1 1. 2. 3. 4. Public Sector Banks* Foreign Banks Private Banks All Scheduled Commercial Banks 2 32,129 2,300 8,166 43,656 Variation (y-o-y) Dec 31, 2010 Dec 30, 2011 Amount Per cent Amount Per cent 3 4 5 6 5,418 315 1,515 7,408 24.1 19.8 28.2 24.5 4,190 392 1,274 6,003 15.0 20.6 18.5 15.9

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In AprilDecember 2010, the share of non-bank sources in the flow of finances to the commercial sector was 43.0%. Now the share stands at a much higher 53.9%.

Note:

1. Data as on December 30, 2011 are provisional. 2. *Excluding Regional Rural Banks. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

TABLE 24 Flow of Financial Resources to the Commercial Sector (Rs. billion) Item 1 April-March April-December 200910 201011 201011 201112 2 3 4 5 7,110 5,286 2,956 2,330 12,396 5,391 4,064 2,257 1,806 9,454 4,253 4,972 2,539 2,433 9,225

A. Adjusted Non-food Bank Credit (NFC) 4,786 B. Flow from Non-banks (B1+B2) 5,850 B1. Domestic Sources 3,652 B2. Foreign Sources 2,198 C. Total Flow of Resources (A+B) 10,636 Memo Item: Net resource mobilisation by Mutual Funds through Debt (non-Gilt) Schemes 966

367

300

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Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

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Table 24 summarises the flows of financial resources to the commercial sector. The decelerating trend for the year 201112 is noticeable. It is also evident from the table that the relative importance of non-bank sources has increased compared with the preceding year. In AprilDecember 2010, the share of non-bank sources in the flow of finances to the commercial sector was 43.0 per cent. Now the share stands at a much higher 53.9 per cent. The movement of bank interest rates has been consistent with the policy measures adopted by the RBI, with deposit rates, base rates and median lending rates all moving upwards. This is seen in Table 25.

TABLE 25 Deposit and Lending Rates

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Sep 2011 5

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Dec 2010 2

Mar 2011 3

Jun 2011 4

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(per cent)

Dec 2011 Finance 6

I. Domestic Deposit Rates (13 year tenure) i) Public Sector Banks 7.008.50 ii) Private Sector Banks 7.259.00 iii) Foreign Banks 3.508.50 II. Base Rate i) Public Sector Banks 7.609.00 ii) Private Sector Banks 7.009.00 iii) Foreign Banks 5.509.00 III. Median Lending Rate* i) Public Sector Banks 8.7513.50 ii) Private Sector Banks 8.2514.50 iii) Foreign Banks 8.0014.50

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8.009.75 7.7510.10 3.509.10 8.259.50 8.2510.00 6.259.50 8.8814.00 9.0014.50 7.7014.05

8.259.75 8.0010.50 3.5010.00 9.2510.00 8.5010.50 6.259.50 9.5014.50 9.2515.00 7.7014.50

8.559.75 8.0010.50 3.509.75 10.0010.75 9.7011.00 6.2510.75 10.5015.25 9.0015.25 9.1314.75

8.559.75 8.0010.50 3.509.75 10.0010.75 10.0011.25 6.2510.75

* Median range of interest rates at which at least 60 per cent of business has been contracted. : Not available. Source: Macroeconomic and Monetary Developments: Third Quarter Review 201112, Reserve Bank of India.

Fiscal Policy Developments during 201112

Fiscal Stress The Budget estimates for 201112 had been made on the assumption of a 9 per cent rate of growth for the Indian economy. This was, arguably, a highly optimistic expectation. The reasons now being cited for the slowdown are primarily external in nature, arising out of a worsening international climate for economic activity. However, as had been argued in this journal in a previous issue, the signals had been discernible at the time of the last Budget. Food and fuel prices increased more than what had been anticipated, and that put subsidy outlays under quite a bit of pressure. On the other hand, lower-than-expected industrial profits reduced budgetary receipts (tax collections), thereby putting fiscal and revenue deficits under pressure from both the expenditure as well as receipt sides of the Budget. With markets turning pessimistic due to the economic slowdown, the disinvestment target also became unrealistic. It was not an opportune time for fiscal consolidation. In fact, the need might have been for the fiscal easing to continue for a further period. However, deficits were already high and growing, leaving little room for expansionary measures to counter a sluggish private sector. With so much attention on the Euro zone sovereign debt crisis, every government would be concerned about managing its debt so as not to perturb bond market sentiments. Caught in this dilemma between the need to consolidate deficits and the need to support growth in the short term, policymakers could do neither in any decisive manner.

Lower-than-expected industrial profits reduced budgetary receipts, thereby putting fiscal and revenue deficits under pressure from both the expenditure as well as receipt sides of the Budget.

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The budgetary revised estimates for food subsidy increased by 20.2% compared with the Budget estimates for 201112. Similarly, the increased expenditure for fertilizer subsidy was 34.4% higher than the budgeted estimate.

Impact on Revenues For the period AprilDecember 201112, the revenue deficit was already at 93.1 per cent and the fiscal deficit at 92.3 per cent of the Budget estimates. For the same period, tax revenues were 5 percentage points lower than the Budget estimate. Corporation taxes had grown only at 6 per cent against the budgeted rate of growth of 20.2 per cent due to lower profits, higher refunds and a much lower growth (than expected) in excise duty collections. Total expenditure was budgeted to grow at the rate of 4.9 per cent. However, in the first nine months of 201112, expenditures had already grown by 13.9 per cent. Expenditure Trends The expenditure increase was very largely due a rise in the subsidy outlays. The budgetary revised estimates for food subsidy increased by 20.2 per cent compared with the Budget estimates for 201112. Similarly, the increased expenditure for fertilizer subsidy was 34.4 per cent higher than the budgeted estimate. The revised estimate for the oil subsidy expenditure was almost three times the Budget estimate, increasing by 189.7 per cent. Total subsidies went up by an astonishing 50.7 per cent compared with the Budget estimate. As a result of these developments, borrowings increased and budgetary cuts were made on other social sector outlays, economic services and Plan expenditures. The revised estimates for total non-debt receipts decreased to 54.1 per cent of the Budget estimate. Market loans, on the other hand, went up by 27.2 per cent and there was an almost eight-fold increase in short-term borrowings when compared with the Budget estimates for 201112. Total debt went up by 39.1 per cent from the Budget estimates during 201112, as per the revised estimates presented in this years Budget. Certain categories of expenditures suffered from the cutbacks. Non-Plan revenue expenditure under the broad category of social services (which includes education and health) was reduced by about 4.5 per cent compared with the Budget estimate. Similarly, economic services were cut by 6.7 per cent. Even defence services under non-Plan revenue expenditure were pruned by 4.4 per cent. Other non-Plan capital outlay suffered a cutback of 27.2 per cent. Total non-Plan capital expenditure fell by 7.6 per cent from the Budget estimate for 201112. Total Plan expenditure was also pruned by 3.4 per cent. Deficits Little wonder that the Union Government could not meet its mid-year Fiscal Responsibility and Budget Management (FRBM) benchmarks. Increasing pressures on the revenue deficit also put a brake on the ability of the Government to undertake capital expenditures. The Budget estimates for 201112 had accounted for a deceleration in both revenue expenditures (as part of managing the

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overall fiscal deficit) and revenue receipts (since the financial year 201011 was considered to be an outlier in terms of revenue receipts arising out of the one-off telecommunication spectrum sales proceeds). During the year 201112, revenue expenditures grew more than projected and revenue receipts actually contracted. One other reason, quite independent of the worsening economic parameters, for the inability to manage budgetary targets, has been the political difficulties and procedural delays in implementing the Direct Tax Code (DTC) and the Goods and Services Tax (GST), streamlining the fuel subsidies and deregulating the pricing mechanisms in this sector. Table 26 shows the various deficits as a percentage of GDP. In 200708, the budgetary health (as measured by the deficits alone) appeared to be good with revenue and fiscal deficit at 1.1 per cent and 2.5 per cent of GDP respectively, with a primary surplus of 0.9 per cent. The next two years were indicative of the fiscal stimulus that was prompted by the financial meltdown in global markets. In 201011, a process of exiting the stimulus began with fiscal consolidation measures to contain deficits at more manageable proportions of GDP. The experience of 201112 belied this possibility with deficits ending up much above the anticipated figures. The Budget estimates (201112) for the revenue and fiscal deficits were 3.4 and 4.6 per cent of GDP, respectively. The revised estimates for the two figures now stand at 4.4 and 5.9 per cent of GDP, respectively. The Budget of 201112 had introduced a new definition of effective revenue deficit, which was supposed to reflect a more accurate measure of revenue deficit as resources that did not go towards capital asset creation. The reason was that a part of revenue expenditures was allocated to schemes that were used for creation of assets, not directly by the Union Government, but rather through disbursement, by the State Governments. This measure was estimated at 1.8 per cent of GDP in the Budget of 201112 out of a total revenue deficit of 3.4 per cent. The revised estimate for

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Increasing pressures on the revenue deficit also put a brake on the ability of the Government to undertake capital expenditures. During the year 201112, revenue expenditures grew more than projected and revenue receipts actually contracted.

TABLE 26 Trends in Deficits of Central Government Year Revenue Deficit Fiscal Deficit Primary Deficit

200708 200809 200910 201011 (P) 201112 (BE)

(as per cent of GDP) 1.1 2.5 4.5 6.0 5.2 6.5 3.2 4.8 3.4 4.6

0.9 2.6 3.2 1.8 1.6

BE : Budget Estimates. P: Provisional Actuals (Unaudited). Notes: The ratios to GDP at current market prices (CMP) are based on CSO National Accounts 200405 series. Source: Economic Survey 201112.

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this measure stands at 2.9 per cent of GDP out of a revised revenue deficit of 5.9 per cent of GDP.

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The Union Budget for 201213

The Union Budget for 201213 was presented by the Finance Minister on March 16, 2012. The past year had seen a sharp reduction in the projected growth rate of the economy for a number of reasons as discussed in the earlier sections. These factors, along with the opposition from alliance partners the UPA Government had to face in getting economic legislation passed in Parliament, made it a difficult year for Indian policymakers in the Union Government. The latest Budget (Government of India, 2012b) was formulated under these economically adverse and politically restrictive conditions. Neither global economic uncertainty nor political uncertainties of managing a heterogeneous coalition is expected to abate this year. Hence, the Budget stayed clear of any ambitious objective. The patterns of expenditure allocation and the tax structure remained virtually unchanged compared with the recent past. The fiscal deficit was anticipated to be brought down from the revised estimate of 5.9 per cent of GDP (up from the earlier Budget estimate of 4.6 per cent) in 201112 to 4.6 per cent in 201213. The Revenue Account The revenue receipts have been budgeted to increase from the revised estimate of 201112 by 22 per cent in nominal terms. The source of revenue gain is primarily the 2 percentage point increase in service tax (with a much larger base, covering many more services) and a 2 percentage increase in central excise duties, increasing from 10 per cent to 12 per cent, which is still below the pre-crisis rates of 14 percentage points. The uniform increase to 12 per cent would, presumably, help in the harmonisation process to transit towards the proposed GST. Direct taxes remained the same except for a minor revision in the exemption level beyond which personal income tax would begin to be levied. Tax revenue was expected to go up by 20 per cent from the revised estimate of 201112. The additional tax mobilisation could have been done through direct taxes, but it might have been politically unpopular in a bad year, and a hike in tax rates for corporate incomes could be seen as adding an extra dose of investor gloom in a year in which margins anyway were squeezed. However, it remains to be seen what the inflationary impact of the additional indirect taxes would be. Revenue expenditure growth was moderated to an increase of 10.6 per cent in the Budget estimate for 201213 as compared with the revised figures of 201112. Under the revenue expenditures, the total subsidies for food, fuel and fertilizers were restricted to less than the revised figure of 201112 by about 12 per cent. Other expenditure allocations were very similar to last years pattern. The biggest

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The revenue receipts have been budgeted to increase from the revised estimate of 201112 by 22% in nominal terms. The source of revenue gain is primarily the 2 percentage point increase in service tax and a 2 percentage increase in central excise duties.

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challenge for the Government in the forthcoming year would be to achieve its target of limiting subsidies to less than 2 per cent of GDP. The Capital Account Capital receipts indicated a target of Rs. 30,000 crore of disinvestment. Last years projection of Rs. 40,000 crore could not be achieved because of market sluggishness. The revised estimate for 201112 on this head was only Rs. 15,493 crore, which was much less than even 50 per cent of the budgeted amount. This year Rs. 30,000 crore still appears overambitious when there are no clear signals of a recovery from economic uncertainties. Over and above this, the politics of disinvestment decisions may be particularly difficult in a coalition in which consensus among partners is more a rarity than the rule. Total capital receipts are expected to remain almost equal to the revised figures for 201112 with less than 1 per cent increase. Capital expenditures have been budgeted to increase by a little over 30 per cent above the revised estimates for 201112. It can be seen from Table 27 that the revised estimate for capital expenditure was actually less than the Budget figures for 201112. Table 28 and Table 29 show details of receipts and expenditures as proposed in the current Budget. Plan expenditure on the capital account is slated to rise by about 20 per cent from the revised estimate of 201112 and total Plan expenditure (including on the revenue account) by about 22.1 per cent. While one can hardly argue against healthy allocations for capital expenditures, it may be kept in mind that whenever Governments expenditures on the revenue account have come under stress, the capital account spending has been pruned. With the figure for disinvestment looking unrealistic, and the figure for subsidies looking politically challenging, expenditure management may not be easy at all. If fiscal stress increases, the axe is likely to fall on capital expenditures. Three Specific Proposals It may be worth the while to mention three specific proposals made in the Budget. The first pertains to the increase in import duty on gold of some specified purity. Gold imports had gone up sharply during the past year, and have contributed to the increase in the current account deficit. The use of gold in India (the country being the largest consumer of gold) is wholly unproductive and hence any additional deterrence to its holding will improve the current account deficit. There will be another positive effect too. The expenditure switch away from gold would increase spending on domestic assets or goods. The second set of proposals pertained to coal. It was singled out for some duty reductions and coal companies were asked to have special contractual agreements with power plants. The reason for this has been the poor performance of the infrastructure sector as a whole, including coal. On the other hand, power did relatively well, but was increasingly being constrained by the lack of adequate fuel, mainly

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With the figure for disinvestment looking unrealistic, and the figure for subsidies looking politically challenging, expenditure management may not be easy at all. If fiscal stress increases, the axe is likely to fall on capital expenditures.

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TABLE 27 Budget at a Glance (Rs. crore) 2010 2011 Actuals 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. Revenue Receipts 788471 Tax Revenue (net to Centre) 569869 Non-Tax Revenue 218602 408857 Capital Receipts (5+6+7)$ Recoveries of Loans 12420 Other Receipts 22846 Borrowings and Other Liabilities* 373591 Total Receipts (1+4)$ 1197328 Non-Plan Expenditure 818299 On Revenue Account 726491 Of Which, Interest Payments 234022 On Capital Account 91808 Plan Expenditure 379029 On Revenue Account 314232 On Capital Account 64797 Total Expenditure (9+13) 1197328 Revenue Expenditure (10+14) 1040723 Of Which, Grants for Creation of Capital Assets 87487 Capital Expenditure (12+15) 156605 Revenue Deficit (171) 252252 (3.3) Effective Revenue 164765 Deficit (2018) (2.1) Fiscal Deficit {16(1+5+6)} 373591 (4.9) Primary Deficit (2211) 139569 (1.8) 2011 2011 2012 2012 Budget Revised Estimates Estimates 789892 664457 125435 467837 15020 40000 412817 1257729 816182 733558 267986 82624 441547 363604 77943 1257729 1097162 146853 160567 307270 (3.4) 160417 (1.8) 412817 (4.6) 144831 (1.6) 766989 642252 124737 551730 14258 15493 521980 1318720 892116 815740 275618 76376 426604 346201 80404 1318720 1161940 137505 156780 394951 (4.4) 257446 (2.9) 521980 (5.9) 246362 (2.8) 2012 2013 Budget Estimates 935685 771071 164614 555241 11650 30000 513590 1490925 969900 865596 319759 104304 521025 420513 100512 1490925 1286109 164672 204816 350424 (3.4) 185752 (1.8) 513590 (5.1) 193831 (1.9)

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Actuals for 201011 in this document are provisional. $ Excluding receipts under Market Stabilisation Scheme. * Includes draw-down of Cash Balance. Notes: 1. GDP for BE 20122013 has been projected at Rs. 10159884 crore assuming 14% growth over the Advance Estimates of 20112012 (Rs. 8912179 crore) released by CSO. 2. Individual items in this document may not sum up to the totals due to rounding off. 3. Figures in parentheses indicate deficit figures as perentage of GDP. Source: http://indiabudget.nic.in.

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coal for the thermal plants. Coal mining is passing through some serious regulatory changes, and the shortage this year could jeopardise growth in the entire core sector industries. Hence there has been special attention paid this year to the improved availability of coal.

TABLE 28 Receipts (Rs. crore) 2010 2011 Actuals REVENUE RECEIPTS 1. Tax Revenue Gross Tax Revenue 793072 Corporation Tax 298688 Taxes on Income 146587 Wealth Tax 687 Customs 135813 Union Excise Duties 138299 Service Tax 71016 Taxes on Union Territories 1982 LessNCCD transferred to the National Calamity Contigency Fund/ National Disaster Response Fund 3900 LessStates Share 219303 1(a) Centres Net Tax Revenue 569869 2. Non-Tax Revenue Interest Receipts 19734 Dividend and Profits 47992 External Grants 2673 Other Non-tax Revenue 147107 Receipts of Union Territories 1097 Total Non-tax Revenue 218602 Total Revenue Receipts (1a+2) 788471 3. Capital Receipts A. Non-debt Receipts Recoveries of Loans and Advances@ 12420 Miscellaneous Capital Receipts 22846 Total 35266 B. Debt Receipts* Market Loans 325414 Short-term Borrowings 7759 External Assistance (Net) 23556 Securities issued against Small Savings 11233 State Provident Fund (Net) 12514 Other Receipts (Net) 13315 Total 367162 Total Capital Receipts (A+B) 402427 4. Draw-down of Cash Balance 6430 Total Receipts (1a+2+3+4) 1197328 Financing of Fiscal Deficit (3B+4) 373591 Receipts under MSS (Net) 2737 @ excludes recoveries of short-term loans and advances from States, loans to Government servants, etc. 16833 * The receipts are net of repayments. Source: http://indiabudget.nic.in. 2011 2011 2012 2012 2012 2013 Budget Revised Budget Estimates Estimates Estimates

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932440 359990 172026 635 151700 164116 82000 1973

901664 327680 171879 1092 153000 150696 95000 2317

1077612 373227 195786 1244 186694 194350 124000 2310

4525 263458 664457 19578 42624 2173 59891 1169 125435 789892

3998 255414 642252 20125 50122 3477 49909 1105 124737 766989

4620 301921 771071 19231 50153 2887 91207 1136 164614 935685

15020 40000 55020

14258 15493 29751

11650 30000 41650 479000 9000 10148 1198 12000 2245 513590 555241 ... 1490925 513590 20000

343000 436414 15000 116084 14500 10311 24182 10302 10000 10000 13866 15862 392816 546644 447836 576395 20000 24664 1257729 1318720 412817 521980 20000 ...

11490

13745

11445

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TABLE 29 Expenditure (Rs. crore) 2010 2011 Actuals 1. Non-Plan Expenditure A. Revenue Expenditure 1. Interest Payments and Prepayment Premium 234022 2. Defence Services 92061 3. Subsidies 173420 4. Grants to State and U.T. Governments 49790 5. Pensions 57405 6. Police 27339 7. Assistance to States from National Calamity Contigency Fund/National Disaster Response Fund (NDRF) 4179 8. Other General Services (Organs of State, tax collection, external affairs, etc.) 16917 9. Social Services (Education, Health, Broadcasting, etc.) 35014 10. Economic Services (Agriculture, Industry, Power, Transport, Communications, Science & Technology, etc.) 28051 11. Postal Deficit 6162 12. Expenditure of Union Territories without Legislature 3775 13. Amount met from National Calamity Contigency Fund/ Contribution to National Disaster Response Fund (NDRF) 3900 14. Grants to Foreign Governments 2256 Total Revenue Non-Plan Expenditure 726491 B. Capital Expenditure 1. Defence Services 62056 2. Other Non-Plan Capital Outlay 23618 3. Loans to Public Enterprises 5834 4. Loans to State and U.T. Governments 85 5. Loans to Foreign Governments 6. Others 215 Total Capital Non-Plan Expenditure 91808 Total Non-Plan Expenditure 818299 2. Plan Expenditure A. Revenue Expenditure 1. Central Plan 232454 2011 2012 Budget Estimates 2011 2012 2012 2013 Revised Budget Estimates Estimates

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267986 95216 143570 66311 54521 30595

275618 104793 216297 55322 56190 33302

319759 113829 190015 64211 63183 35611

4525

4525

4620

18195 20862

19395 19709

21382 20784

25391 5018 3592

23702 5573 3735

24105 5727 3875

4525 2301 733558 69199 13212 496 85 ... 368 82624 816182

4525 2105 815740 66144 9617 593 75 250 303 76376 892116

4620 3114 865596 79579 23971 465 85 550 346 104304 969900

268287

252597

303528

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2010 2011 Actuals

2011 2012 Budget Estimates

2011 2012 2012 2013 Revised Budget Estimates Estimates

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2. Central Assistance for State & Union Territory Plans State Plans Union Territory Plans Total Revenue Plan Expenditure B. Capital Expenditure 1. Central Plan 2. Central Assistance for State & Union Territory Plans State Plans Union Territory Plans Total Capital Plan Expenditure TotalPlan Expenditure Total Budget Support for Central Plan Total Central Assistance for State & UT Plans TOTAL EXPENDITURE* DEBT SERVICING 1. Repayment of Debt** 2. Total Interest Payments 3. Total Debt Servicing (1+2) 4. Revenue Receipts 5. Percentage of 2 to 4

Finance

81778 79457 2321 314232 53496 11301 10291 1010 64797 379029 285950 93079 1197328 147793 234022 381815 788471 29.70%

95317 92168 3149 363604 67234 10709 9067 1642 77943 441547 335521 106026 1257729 104927 267986 372913 789892 33.90%

93604 91038 2566 346201 68809 11595 10067 1528 80404 426604 321406 105199 1318720 123929 275618 399547 766989 35.90%

116985 113170 3815 420513 87499

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There has been an

13013 11079 1934 100512 521025 391027 129998 1490925 124302 319759 444061 935685 34.20%

increase in the limit of tax-free infrastructure bonds. It would reduce the dependence of this sector on bank finance, and simultaneously improve the depth of the bond market in its ability to

* Excludes expenditure matched by receipts. ** The figures exclude discharge of all Treasury bills, discharge of Cash Management Bills, discharge of Ways and Means Advances including Overdraft, repayment under MSS and all Public Account Disbursements (except discharge of Special Securities issued in lieu of Subsidies). Source: http://indiabudget.nic.in.

The third issue pertained to infrastructure. There has been an increase in the limit of tax-free infrastructure bonds from Rs. 30,000 crore to Rs. 60,000 crore. The interest income earned on them is made tax-exempt. This would supposedly achieve two things. It would reduce the dependence of this sector on bank finance, and simultaneously improve the depth of the bond market in its ability to mobilise alternative debt finance. The additional income rebate given, till last year, to individuals beyond Rs. 1 lakh to Rs. 1.2 lakh in the event of infrastructure bond purchase, has been removed. The problems of infrastructure, however, may not be about widening the source of finances alone. It may be more about riskiness of such projects in terms of cost and time overruns. Changing the perception of investors by improved efficiency could contribute towards a long-term solution to what might appear as an inadequacy of finance alone.

mobilise alternative debt finance.

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Given all the changes discernible in the economy that point to a slowdown, the Budget numbers may be reflecting the best-case scenario. Any deviations down the way could result in further moderation of macroeconomic performance.

Deficit Management and Pending Reforms The proposed deficits have been pruned as compared with the revised estimates for 201112. The revenue deficit is set at 3.4 per cent of GDP as against the revised figure of 4.4 per cent of GDP in 201112. The effective revenue deficit (revenue deficit less grants that are disbursed to be used for certain capital asset formations) has been budgeted at 1.8 per cent of GDP as against the revised figure of 2.9 per cent of GDP for 201112. The fiscal deficit has been budgeted at 5.1 per cent of GDP as against the revised estimate of 5.9 per cent for 201112. Finally, the primary deficit is budgeted at 1.9 per cent of GDP as against 2.8 per cent of GDP in the revised figure for 201112. The effectiveness of this Budget may require the necessity of completing legislative action in a host of areas such as the DTC, the GST, the Food Security Bill, Banking regulation changes, subsidy distribution systems, and measures to enhance the flow of foreign direct investments. Apart from this large list of actions pending, creation of a public debt management office, long hanging, remains uncertain. All of these are politically sensitive issues, and State Governments and coalition partners of the UPA 2 could resist the creation of any consensus for decisive action on these fronts. The extreme political response to a minor revision in rail fares taken in the Railway Budget may be indicative of things to come later this year. The Budget figures have been drawn up, according to Finance Ministry sources, on the assumption of a 7.6 per cent GDP growth rate for the forthcoming year, an inflation rate of around 6.5 per cent, and an international oil price range of US$115 to US$120 per barrel. Given all the changes that are discernible in the economy that point to a slowdown, the Budget numbers may be reflecting the best-case scenario. Any deviations down the way could result in further moderation of macroeconomic performance.

Possible Scenarios for 201213

It may be worth the while to flag a few issues that are likely to be determining factors in the overall performance of the Indian economy. Four such issues are discussed; issues that could play out in different combinations and magnitudes, with very different kinds of impacts, but all contributing towards a deceleration of economic growth. Two of the issues are domestic in nature while the remaining two are international. Supply Shocks Indias moderation in economic growth occurred for a number of reasons. One of the important reasons was the very low growth rate in the industrial sector, especially in the infrastructure and core industries. Industries like coal will remain a problem with a number of complications relating to productivity, quality, pricing, imports, environmental damage, illegal mining and outright corruption. None of

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these can be solved overnight. Adverse supply shocks and production uncertainties will have an impact on all the core industries. Similarly, agricultural supply has been constrained (among a host of other factors) by the lack of adequate storage facilities and efficient, wasteminimising supply chains. Some action has been planned in this regard in the budgetary provisions. However, it may not be adequate, and any adverse shock in agricultural output (for instance, from lower-thanaverage monsoons) could be transmitted to the rest of the economy. Any worsening of any one (or a combination) of these factors would have a moderating influence on the planned growth rate of 7.6 per cent, not to mention the effect on inflation rates, which are expected to be at around 6.5 per cent. Subsidy Storms The second domestic factor is the swelling of the subsidy bill on food, fuel and fertilizers. It will be well nigh impossible for the current Union Government to manage subsidies in improved and efficient ways. There has been much talk of implementing direct transfers, rationalising the rates of subsidies, and implementing better targeting, but without any discernible impact. The proposed Food Security Bill, when worked out in a politically acceptable manner, is most likely to increase (to a large extent) the food subsidy. Though the Finance Minister has promised in Parliament that the Bill will be passed this year and a full provision for the additional subsidies have been made in the Budget, the numbers appear to be unconvincing. If subsidies swell, it will add to the pressure on revenue and fiscal deficits. The Government is already committed to renewing its efforts at fiscal consolidation. Hence, mid-year corrections would inevitably (in the event of rising subsidies) lead to an expenditure switching away from productive public investments. That would almost certainly have a moderating influence on economic growth. Geo-politics and Oil Shocks On the international front, the oil market and crude prices could be a source of worry. Most predictions are that crude prices would remain firm (albeit at high levels) in the face of lower demand from the renewed recessionary trend in the advanced economies, and the moderating growth in emerging economies. This argument is entirely from the demand side of oil markets. We had mentioned some geo-political uncertainties in major oil-producing economies, particularly Iran. In 2010, Iran accounted for 11 per cent of all crude oil imports by India. Irans share has been falling due to some problems pertaining to payment procedures, but it is still quite high. Iran, Saudi Arabia and other Middle East countries together accounted for 63 per cent of total imports of oil in 2010. Any perturbations in the delicate political balance would lead to adverse supply shocks. Any such shock would raise oil prices that are already at high levels. The impact on

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Mid-year corrections would inevitably (in the event of rising subsidies) lead to an expenditure switching away from productive public investments. That would almost certainly have a moderating influence on economic growth.

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India would be inflationary, and imply an adverse current account shock in the balance of payments. Oil and petroleum products being important intermediate goods in the economy, a significant rise in oil prices could also lead to production cuts affecting output in the economy. Supply shocks may emerge even from a marginally changed political climate in the oil producing states, and hence it might be unwise to ignore this possibility. Euro CrisisAcute to Chronic Pains Finally, the Euro zone has been identified by captains of industry at Davos to be the most important trouble spot in the global economy. The euro crisis and the problem of sovereign debt, however, appear to be much more under control with a series of measures taken by the European Central Bank. The markets are not as jittery as before and most European governments are convinced of the necessity of collective action to prevent the damage from spreading across Europe, and to the rest of the world. The hard numbers that measure vulnerability (like those revealed by stress tests done on European banks) tell otherwise about the European financial systems health. Hence, the Euro zone crisis is far from over. Market perceptions may change quickly in the event of the Greek default being defined as a credit event and credit default swaps (CDS) coming into operation. The impact on India would be difficult to anticipate precisely. Much will depend on the size of the shock. The trade effect is likely to be adverse with the Euro zone economies slated to grow much more slowly than last year. The general impact of worsening global financial markets would play out through capital outflows (the usual flight to safety into US dollars by international investors) and exchange rate depreciations. Labouring the Obvious Two rather obvious observations may be worth making at this point. The first is that, given the global macroeconomic picture, a growth rate of 7 to 7.5 per cent is very good indeed by absolute standards, made possible by the creation of domestic demand and new productive capacity. Compared with other emerging economies too, this performance would be seen as pretty impressive. The momentum of this growth might have been stronger had some legislations on domestic reforms been carried out and implemented. The core aim of many of the pending reforms is to reduce wastage and leakage in resource allocations and improve their efficiency. The politics of coalitions have prevented the realisation of a higher potential output for the economy. Lastly, since the sub-prime crisis and the global financial meltdown, the global economy is yet to fully recover to its pre-crisis levels, especially in the advanced economies of the world. However, in some years when the signals of recovery were positive, the actual performance worsened. In other years when the signs were gloomy, it

Oil and petroleum products being important intermediate goods in the economy, a significant rise in oil prices could also lead to production cuts affecting output in the economy. Supply shocks may emerge even from a marginally changed political climate in the oil producing states, and hence it might be unwise to ignore this possibility.

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ended with some hesitant recovery. The essential implication of this tendency is that the global economy is not yet on a path to sustainable recovery. Fluctuations around a low level of growth are being observed. In India, the timing of policy measures and the political strength to implement them have both been far from perfect. The only consolation may lie in the fact that it was not Indias frailty alone; it was shared by many other countries big and small. The question, however, is that are we looking at more of the same in the year to come?
Sources
Government of India (2012), Central Statistics Office (CSO) website (http:// mospi.nic.in), accessed in March 2012. Government of India (2012a), Economic Survey 201112, Ministry of Finance. Government of India (2012b), Union Budget 201213, Ministry of Finance. International Monetary Fund (2011), World Economic Outlook, September. International Monetary Fund (2012), World Economic Outlook Update, January 24. Reserve Bank of India (2012), Macroeconomic and Monetary Developments: Third Quarter Review 201112, January. The Economist (2012a), Print Edition Issue dated February 1824. The Economist (2012b), Print Edition Issue dated February 25March 2. The Economist (2012c), Print Edition Issue dated March 39. The Economist (2012d), Print Edition Issue dated March 1016. The Economic Times (2012), Print Edition Issue dated January 11, Kolkata.

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