Only three years ago, India was shaking off the effects of the global financial crisis better than most, with GDP growth exceeding 8% year-on-year in real terms. Today, the Indian economy is going through a surprise soft patch that cannot be blamed purely on externalities. GDP growth in the fourth quarter of 2012 fell to 4.5% and some investors started questioning its long-term growth potential.
It is clear that a degree of economic complacency, political mismanagement and corruption have played their role. Politicians have not done enough to end the bottlenecks that are holding back private investment: India currently ranks 132nd out of 185 countries in the World Bank’s Ease of Doing Business Index. Meanwhile, bloated government subsidies have exacerbated its fiscal and current account deficits.
It is not hard to see why some investors have become disheartened: The combination of stubbornly high inflation and the twin deficits (the current account deficit in Q4 2012 hit 6.7% of GDP, and the debt-to-GDP ratio stands close to 70%) has left policymakers with few cards to play.
Important Progress Is Being Made
However, India’s 12- to 18-month outlook appears to be turning a corner. After months of inaction, the administration under Prime Minister Manmohan Singh appeared to jolt into action last September, announcing a series of reforms. These included cutting the fuel subsidy, opening retail and aviation sectors to foreign investors, the sale of stakes in state companies, and a series of tax reforms. A new cabinet committee has been created to resolve disputes between ministries that have held up billions of dollars of investment projects, often for over 10 years.
These reforms will not be an overnight fix, nor will they be enough on their own, but they hint at bigger things to come. India’s stock market is up, and it has avoided, for now, a downgrade of its credit rating. The current account deficit rose to 3.6% in the first quarter of 2013, and first-quarter GDP rose 4.8% over the prior year.
More encouragingly, recent inflation data have shown a surprise decline: WPI inflation fell from 4.9% in April to 4.7% in May, and importantly, core inflation declined further to 2.4%. This gives the RBI much-needed room to maneuver and makes possible a 50bp cut in the repo rate.