Domestic factors add to India’s woes

Lowest growth in a decade, plummeting rupee, slow industrial output, weakening investors’ confidence, and a blunt warning by global rating agency Standard & Poor’s that India is at the risk of losing its investment grade rating are things India can hardly rejoice at.

Clearly, things are not going right for Asia’s third-largest economy.

In the first quarter of this year, India recorded a dismal 5.3 percent growth, the value of the rupee fell by more than a quarter since the US rating downgrade in August last year, and industrial output stood at 0.1 percent as of April.

All these figures are enough to scare the government, industry and investors, especially foreign institutional investors.

According to industry insiders, there has been a significant capital outflow in the past few weeks.

As to the sliding rupee, analysts say the prevailing eurozone crisis is partly to blame, but to a large extent it’s caused by domestic factors like rising inflation, stalled decisions on reforms, and growing current account deficit which rose to 4.3 percent of gross domestic product at the end of the third quarter ended December. This compares with 2.3 percent in the same period in the previous financial year.

According to experts, India has greater exposure to the eurozone than to the United States.

“The sharp fall of the rupee is the result of European banks selling their exposures in developing markets,” says Soumya Kanti Ghosh, director of economics and research at the Federation of Indian Chambers of Commerce and Industry (FICCI). “But it cannot be construed as the sole reason.

“One of the direct reasons for this fall is inflation. India’s imported inflation continues to be at double digits.”

Moreover, Ghosh says, there has been considerable capital outflow from India and the slowdown in the reform process has significantly hit investors’ confidence.

He adds that the downside of the depreciation of the Indian currency is that it may trigger capital outflows and gyrations in them. This may in turn induce volatility in stock markets and delay export proceeds from outside India, resulting in a vicious cycle of lower exchange rate and lower capital flows.

The government must also address issues like trade deficit if the fall of the rupee is due to weak fundamentals, he says.

“The upside argument for the decline in the rupee’s value is the possibility of this acting as an enabling factor for exports. However, in a situation of declining exports and global economic slowdown, that seems difficult,” says Ghosh.

It is also feared that the weakening rupee may mean that a number corporate houses which have borrowed overseas may have to bear a bigger burden as the cost of repayment may rise significantly with the depreciating rupee.

Bilateral trade between China and India may also suffer.

“We import a lot from China, and now that import has become more expensive, there is a likelihood of import figures falling in the current quarter,” says Mohammed Saqib, secretary-general of India China Economic and Cultural Council.

“Generally, a fall in the rupee helps boost exports. But in China’s case, we hardly export anything.”

Finance Minister Pranab Mukherjee, who hopes for significant turnaround by the end of the current year, has admitted that India’s economy is going through a critical stage.

“Global slowdown due to unfolding of eurozone sovereign debt crisis has, inter alia, impacted the Indian economy through deceleration in exports, widening of trade and current account deficit, decline in capital flows, fall in the value of the Indian rupee, stock market decline and lower economic growth,” Mukherjee told the Indian parliament recently.

“The eurozone crisis, downturn in external demand resulting in slowdown in exports, currency volatility and current account deficit have also affected our economy.”

FICCI President R.V. Kanoria likens the state of affairs to “natural calamities or external threats”.

In a press statement he said, “There has to be a clear recognition on part of the ruling parties and the opposition that we are in a crisis situation. Natural calamities or external threats unite us. Economic calamities can be just as devastating and require a similar response. We urge the national polity to stand united and strengthen the hands of policymakers to act proactively and decisively.”

Kanoria said excessive monetary tightening, delays and uncertainty over key economic legislation, project delays on account of factors, including stalled environmental clearances, need to be urgently resolved. Problems related to land acquisition, prolonged pause in reforms and an atmosphere of bureaucratic unwillingness to take decisions also need to be addressed. Kanoria also emphasized the “deterioration in the state of public finances”.