Wounded economy eyes new Government

Wounded economy eyes new  Government

Dr Ashwani Mahajan

Given the bad state of Indian economy currently, 2013 will definitely go down as annus horriblis is the history of Indian economy. Instead of growth rate being 10 per cent, and inflation under 5 per cent, we have the reverse in UPA’s ten year rule. The GDP growth is under 5 percent, and the inflation is well over 10 percent – the largest among emerging economies. The hopes are now from the new government in Delhi, who it is believed will take affirmative steps to revive the economy.

 In the financial year 2012-13, trade deficit was nearly 11 percent of GDP, whereas Current Account Deficit (CAD) was 4.8 percent of GDP. Along with this a large chunk of debt payable in the immediate future made the payment crisis even more worst. Result was heavy depreciation of Indian rupee- The rupee dollar exchange rate reached rupees 68.85 per US$ on August 28, 2013, from rupees 54.39 per US dollar at the end March, 2013.

However, economy facing acute foreign payment crisis got a sigh of relief after recording merely $4.2 billion of current account deficit and $33 billion of trade deficit in the third quarter of the financial year 2013-14, which is between October and December 2013. An improvement in exchange rate is also seen, presently exchange rate is rallying around rupees 60 per US dollar.

It is notable here that, during the same quarter in the last financial year, the country witnessed $31.9 billion of CAD and $58 billion of trade deficit.   But now, the CAD has started showing improvement in the second and third quarter of the year 2013-14 and, has reached nearly one percent of GDP, which is big relief for an economy facing acute payment crisis.  As the pressure on Rupee relaxed, the demand for dollar came down.  The Rupee improved to 60 per US dollar by end of March 2014, and it is expected to have many positive effects on the Indian economy.

First of all, it would ease inflation. Today imports comprise nearly 28 percent of GDP.

A weak rupee make the import process costlier, which in turn cause inflation, directly and indirectly, as costlier imports mean increase in  the prices of imported goods, directly consumed or imported raw materials, intermediate goods and fuel, used as inputs, and  this increases cost of production. If CAD continues to be constrained, it will help in containing inflation; Burden of repayment of principal and interest on loans taken by Indian companies globally would reduce, and; Credit rating of the country would improve, which would help raising loans internationally at lower interest rates.

Due to reduction in CAD in the last two quarters, the improving strength of rupee has uplifted the share markets.  The Sensex crossed the psychological barrier of 22000 by second week of March, 2014. This brightened the mood of the markets and the investors. However, it still remains to be answered what steps will sustain this happiness in due course? For getting answer to this question, we will need to understand the basic factors which led to the crisis in payments and knowing, how’ll the economy get out of these factors in near future. Imperative to understand is that the booming mood in the markets is because of the expectation of the new government that will be formed in Delhi after the general elections in April and May, 2014; which it is believed would take decisions favouring development and counter inflation, corruption, and slowdown in growth etc. with better policies.

How CAD declined?

In the year 2012-13 and before that, imports of gold and silver had been rising fast. It may be noted that in the year 2012-13, a total of $ 53.7 billion of gold was imported. However, in the third quarter of the financial year 2013-14, hardly $3.1 billion of gold was imported into the country. If this continues, in the year 2013-14, not more than $28 billion of gold imports would be there. If we look into the cause of reduction in gold imports, we find that this reduction was made possible by increasing tariff and other restrictions. These barriers helped restraining legal import of gold; but, it has also led to increased smuggling of gold, which had become a forgotten phenomenon. According to World Gold Council, nearly 150-200 tones of gold are being smuggled into India. There is pressure on the government to reduce tariff on gold imports, to check smuggling. It is expected, once these barriers are abolished, it may increase gold imports through official channels in future.

Another reason for relief in CAD is improvement in performance on export front in the last two quarters. Main factors contributing to encouraging performance of exports are -increase in exports of engineering products, ready made garment, marine products, chemicals and raw steal. Improving health of USA and EU in the last few years has also  been causing a boost in our exports. Along with this, the prices of crude oil, which were continually rising in the past, have also remained nearly static in the past few months. FDI and FIIs inflows have also increased. Though there has been a significant outflow of foreign exchange due to repayment of loans, in the immediate past, due to various factors mentioned above, there has been a significant increase of nearly $19 billion in our foreign exchange reserves in the last quarter. It is notable that our foreign exchange reserves declined by 10.4 billion in the same quarter in the last financial year. It is expected that CAD would be limited to nearly $ 45 billion (less than 2 percent of GDP) in 2013-14, as per the statement of Finance Minister in his Budget speech, against 4.8 percent of GDP in the last financial year.

But this relief is not sustainable. Government is under tremendous pressure to reduce import duty on gold which has reached 10 percent now, to discourage smuggling. If import duty is reduced, import of gold may go up and so will the CAD.

All Eyes on next government

The UPA has left the economy in shambles and the new government that will take charge in Delhi will see tough times turning it around.  Since there is no improvement in manufacturing sector in the past two 2-3 quarters and GDP growth is expected to remain low at nearly 4.5 percent in this financial year, there are no signs of easing of inflation and therefore reduction in interest rates. Therefore, the economic policies of the future government – to contain inflation and reduce interest rates, to encourage infrastructure and other investments and consumer demand will have to be worked judiciously.  For sincere efforts are required to take the economy on the path of development-free from the populist policies of distributing doles from exchequer to garner votes.

(The writer is aAssociate Professor, Dept of Economics, P.G.D.A.V. College (University of Delhi):ashwanimahajan@rediffmail.com)