State of economy 2013

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State of economy 2013

  1. 1. Current State of the Indian EconomyCautious optimism for the futureFebruary 2013www.deloitte.com/in
  2. 2. 2The Big PictureThe Indian Economy has experiencedits worst slowdown in nearly a decadeon the back of global contractionaryheadwinds, domestic macro-economicimbalances and policy reversals on thefiscal front, 2012 has been a challengingyear for the economy. The year startedwith news that the previous fiscal’sfourth quarter GDP had dropped to5.5%. That coupled with low growth,macro-economic issues such as highfiscal deficit, expansionary subsidies andworsening current account balance hasadded to the slowdown.The 2011-12 Budget had proposedto amend the 1961 income taxlaw by introducing retrospectivetax adjustments and General Anti-Avoidance Rules (GAAR). These stepswere viewed negatively by foreigninvestors. Subsequent downgradingof the Indian economic outlook from‘stable’ to ‘negative’ by a major ratingagency, led to continued downwardpressure on the investment climate.Additionally, as fiscal conditionsworsened over the year, exportnumbers were revised in light of datadiscrepancies leading to a widening ofthe current account deficit.In the second half of the fiscal, theGovernment proactively intervenedwith phased reforms to stabilize theeconomy. Measures were taken toreduce subsidies (oil, fertilizers) whichwould in turn lower the fiscal deficit.The Government also took concreteactions to attract foreign directinvestment (FDI) and strengthen therupee. However, the impact of thesepolicy reforms remains uncertain inthe short term. Concerns continueto exist over the current accountdeficit scenario, prevailing supply sideconstraints, inadequate infrastructureinvestments and long term policydirections.In face of a perceivably weak macro-economic climate, a well-plannedeconomic revival policy is required tosteer the Indian Economy back on thegrowth path. Even though the longterm prospects of the economy lookpromising, cautious optimism is thetone in the short to medium term.Global LinkagesPerformances of advanced economiescontinue to weigh on India’s growthstory.The World Economic Forum’s annualmeeting for 2013 was held in Davos,Switzerland in January 2013, bringingtogether more than 2,000 top businessleaders, international political leaders,
  3. 3. Current State of the Indian Economy Cautious optimism for the future 3Economic opportunity is dwindling. While reforms havebeen initiated, further action to create infrastructure, boostsavings and generate growth will be welcomeselected intellectuals and journalists todiscuss the most pressing issues facingthe world. The IMF, in its update ofWorld Economic Outlook, lowered theworld GDP growth projections by 0.1%each for 2013 & 2014 as compared tothe October 2012 projections. This is onaccount of downside risks that continuein light of renewed setbacks in the Euroarea and continued risks of excessivefiscal consolidation in the United States.In particular, the Euro-zone facedconsiderable fiscal strain in the faceof an austerity driven recession during2012. The Euro-zone manufacturingactivity contracted for a 17th monthconsecutively in December, accordingto a key survey of business managers.Indian exports to Euro-zone, whichconstitute around 17% of the totalexports, appear to be impacted dueto the decreasing demand from Eurocountries. In the first nine months of2012-13, a 10% contraction in exportshas been observed when compared tothat over a similar period in the previousyear. Moreover, despite the fact that theUS government was able to formulatea solution to mitigate a dreaded fiscalcliff, near term risks continue to persist.This makes the global environmentin the coming years more uncertainand exporters might find it morechallenging.A note of optimism appears to surfacefor the Indian service providers withthe recently concluded free tradeagreement on services and investmentbetween India and ASEAN countries.Furthermore, gradual recovery inJapanese economic conditions alongwith recent rebound in China’smanufacturing sector is expected toimprove trade conditions in the region.-1012345678World AdvancedEconomiesEmerging &DevelopingEconomiesEuro Area United StatesOutput Growth Rates in % (Current & Expected)2010 2011 2012 2013
  4. 4. 4The Indian environmentThe current state of the economy makesit necessary for the government to putin place a robust and implementableplan of action for its revival. Theeconomy has experienced a consistentfall in the quarterly GDP growth sincethe beginning of 2011, alarminglyhigh levels of twin deficits viz. CurrentAccount Deficit (CAD) and fiscal deficitas well as worrying volatility in theinflow of foreign investments. Thoughinflationary pressure has receded inthe last quarter of 2012, it still remainsabove the target level of Reserve Bankof India (RBI). This along with otherworrying economic indicators has putthe Indian economy in a challengingpathway in the short term. Budget2013 provides an opportunity to regainfocus by adhering to the path of fiscalconsolidation and take appropriatepolicy initiatives outlining the timelyrecovery of the Indian economy.Strengthening fundamentals andboosting growth inducing investmentsis the foremost consideration at thisstage.In order to understand the current stateof the economy, we discuss the variousaspects of economic performance ofthe country in 2012, in the followingparagraphs.The fiscal situationThe Government has found it difficult tocontain expenditure despite proactivereforms to boost the slowing economy.The Government revised its fiscalconsolidation roadmap in October2012. As per the revised roadmap,the fiscal deficit of the central govern-ment will be reduced in a calibratedway from the targeted 5.3% of GDPin FY 2012-13 to 3.0% of GDP by FY2016-17. The revision proved chal-lenging as the actual fiscal deficit faredat 5.9%.Further, the combined fiscal & revenuedeficits had already reached 79% &85% of budgeted targets by end ofDecember 2012. Major contributors tohigh levels of deficits this year includelower tax collections due to lower than6.0Fiscal Consolidation Target6.54.95.95.34.84.23.63.001234567Fiscal Deficit as % of GDP
  5. 5. Current State of the Indian Economy Cautious optimism for the future 5expected economic activity (reachingonly 63% of annual target in 9 months)and dismal PSUs disinvestmentcollections (accounting only 27% ofannual target in 9 months) as againstpersistent unplanned governmentexpenditure, which has already reached72% of target.Recently announced initiatives by theFinance Minister to cut down unplannedexpenditure including subsidies arelaudableDespite these worrying trends,recently announced strong initiativesby the Finance Minister to cut downunplanned expenditure, includingsubsidies are laudable. An achievementof fiscal surplus of INR 8,227 croresduring December 2012 sends apositive signal about Government’s
  6. 6. 6The real sectorMoving on to the other fundamentalaspects of the economy, the decliningtrend in the GDP growth is provingto be another major concern for thegovernment at the moment. After adisappointing growth rate of 5.4%in the first half of 2012-13, the yearlyestimates for 2012-13 have been down-graded and it is now expected to growat only around 5%. The country’s GDPgrowth at 5.3% in the second quarter isone of its lowest quarterly growth ratesin the last decade and annual growth of5% will be the lowest since 2002-03.The industrial sector, usually sizingmore than one fourth of the total GDP,performed significantly below par thisyear with growth of mere 1% duringthe first half of 2012-13 as against4.6% in first half of 2011-12. Theunder-performing manufacturing sector,particularly the capital goods industries,poses a real challenge for the country.Though subdued investment activitymay play a spoiler, systematic imple-mentation of National ManufacturingPolicy as well as rise in external demandwill play a critical role in reviving indus-trial growth.In the agricultural sector, good wintercrop sowing prospects are expectedto overcome the negative effect of adeficient summer crop output. Theyearly output is likely to be better thanthe 2.1% growth achieved in firsthalf of 2013, though overall the yearis expected to close at a lower levelcompared to earlier years.4.08.17.09.5 9.6 9.36.78.4 8.46.55.2-246810GDP Growth Rates (%)willingness of adhering to its targets.However, policymakers need to makesure that the significant cut backs inpublic expenditure do not compromisethe quality of fiscal adjustment &development prospects in the long run.
  7. 7. Current State of the Indian Economy Cautious optimism for the future 7A larger concern exists on the servicessector which has moderated during2012. With “trade, hotels, transport,storage and communication” animportant sub-sector in servicesperforming the worst, various indicatorsof services sector activities such ascargo handling, civil aviation & railwayfreight etc. suggest further weakeningof growth. Additionally, the uncertainglobal outlook is likely to affect servicesexports adversely.On the GDP expenditure side, growthin private consumption has moderatedduring 2012-13 due to high inflationcoupled with low income growth. Whileinvestments have remained flat onaccount of issues such as project costoverruns and regulatory delays, grosscapital formation has also decreasedin the economy. Sectors such asroad transport and highway, power,petroleum, railways, coal etc. continueto suffer due to lack of policy clearancesand more importantly funds. It may takea while before the impact of retail sectorreforms and policy initiatives to removeinfrastructure bottlenecks and inducefurther investments are felt across theeconomy. However, there are early signsthat the Indian economy may havebottomed out the growth.Overall, besides domestic pressures,with global recovery likely to remainmuted in the near future, economicrevival in India will be a challenge. Allround efforts in removing impedimentsin business activity and instilling investorconfidence will be necessary to revivesectoral growth.Manufacturing and the mining sectorneeds urgent revival throughimplementation of the NationalManufacturing Policy and removal ofregulatory hurdles
  8. 8. 8The external sectorThe other part of the “twin deficitproblem” relates to the Current AccountDeficit. The CAD to GDP ratio reacheda highest ever level of 5.4% in Q2 of2012-13, heightening concerns aboutthe sustainability and financing of trade.At the helm of worsening CAD forthe current year is the burgeoningtrade deficit. During the period Aprilto December 2012, both exports (US$214 billion) and imports (US$ 361billion) declined. With a sharper drop inexports than imports, the trade deficithas surged to US$ 147 billion in the first9 months as against US$ 137 billionof last year. Major decline in exportsgrowth is an effect of sluggish globaldemand and an uncertain macro-economic environment. In January2013, the World Economic Outlook hasprojected the world trade volume togrow at 3.2% in 2012 as compared togrowth of 12.6% in 2010 and 5.8% in2011, clearly showing the drop in globaldemand. On the import side, the declinein non-oil imports is largely off-set byinelastic growth in petroleum, oil andlubricants (POL) imports, contributingalmost 35% of total imports.During the month of December 2012,the Government announced exportpromotion measures like extensionof interest subvention schemes,-0.4-1.2 -1-1.3-2.3-2.8 -2.7-4.2-4.6CAD/ GDP (%)
  9. 9. Current State of the Indian Economy Cautious optimism for the future 9broadening scope of Focus MarketScheme and Focus Products Schemeetc. However, despite these measures,exports recovery will primarily dependon the level of global economic activity.Furthermore, export diversificationpolicies have not been significantlyeffective. For example, demand forIndian goods in developing countriessuch as those in Asia and Africa havedropped recently.Balance of Payment statistics showthat capital inflows have improved in2012-13 and in fact have financedthe expanding CAD. While net FDIinflows moderated to US$ 14.7 billionduring April-November 2012 (asagainst US$ 19.6 billion last year), netFII inflows have shown a significantuptrend reaching US$ 11.2 billion in2012. These robust FII inflows seemto be largely the outcome of improvedsentiments about the Indian economyin the second half of the year drivenby recent reforms announced by thegovernment in September 2012. Thesereforms include, inter alia, liberalizedFDI norms for the retail, insurance andpension sectors, a roadmap for fiscalconsolidation and an increase in FIIlimits in the corporate and governmentdebt markets among others.The external debt has witnesseda steep rise in second quarter of2012-13, reaching US$ 365 billionfrom US$ 345 billion at the start of thefinancial year. This is mainly on accountof surge in non-resident externalrupee denominated deposits due tobetter returns and surge in ExternalCommercial Borrowings in responseto the government incentives. Hence,though adverse CAD conditions haveprevailed, the recent spate of reformshave helped the Rupee maintaining itsstability against US$ in the last quarterof 2012.Inflation & Monetary conditionsFor most of the period of 2012-13,the Wholesale Price Inflation (WPI) hasremained around the mark of 7.5%. Itreached as high as 8% in August 2012and then revised down to 7.2% byDecember2012, further moderating to6.62% in January 2013.Inflation moderation has been fasterthan expected in the third quartertouching a three year low. However,
  10. 10. 10food inflation continues to remainelevated along with fuel & power.Gradual moderation of internationalcommodity prices on account ofdecrease in crude oil prices and easingof geo-political tensions in the MiddleEast have helped in moderatingdomestic inflation. The RBI has recentlymade a downward revision of thebaseline WPI projection for March2013 to 6.8%, an optimistic projectionconsidering the past trend.While the downward trend in wholesaleinflation is a welcome sign, retailinflation remains elevated. Retailinflation surged to 10.6% in Decemberfollowing readings of 9.9%, 9.8% and9.7% respectively in last three months.Both, food and non-food componentsof retail inflation index suggestpersistent inflationary pressure. Weexpect that supply side reforms will easethis pressure in the medium term.Following an aggressive 50 basis pointrate cut in April 2012, the RBI hasbeen fairly cautious in conducting itsmonetary policy through 2012-13.The RBI chose to keep the ratesunchanged in all its monetary policyannouncements till December 2012.RBI did, on the other hand, reduce thecash reserve ratio and the statutoryliquidity ratio in order to maintainadequate liquidity in the economy.However, as GDP growth continueddeclining and inflationary pressuresstarted to recede in the second half of2012-13, the RBI consented by reducingthe policy repo rate by 25 basis pointsfrom 8% to 7.75% in January 2013.This is the first repo rate cut in over 9months. RBI subsequently also reducedthe cash reserve ratio by 25 basis pointsfrom 4.25% to 4%.This monetary policy action is expectedto result in consequent reduction inthe interest rates. However, it remainsto be seen if and how much a 25 basispoint reduction will encourage banksin passing on a significant benefit toconsumers.4%5%6%7%8%9%6%7%8%9%10%11%ReporateInflationInflation & Repo Rates (%)Inflation Repo Rate
  11. 11. Current State of the Indian Economy Cautious optimism for the future 11OutlookThe Indian economy is about toexperience one of the slowest growthyears in nearly a decade. In realizationof this, a push for reforms was madein September 2012 bringing a sense ofcautious optimism. However, the impactof reforms has remained muted till date.Global economic uncertainties have nothelped the case for domestic growtheither.A drop in savings and investmenthas exacerbated the CAD and fiscaldeficit scenario. India had achievedan improvement in domestic savingsfrom 26.5% of GDP in 2001-02 to36.8% in 2007-08 largely due to publicsavings and good macro-economicprospects. While a considerable portionof savings was eroded due to fiscalstimulus in meeting the financial crisis,a sustainable plan in putting savingsback on track never materialized.Consequently, worsening macro-economic environment particularly highinflation over the past couple of yearsand a depreciating rupee put a strain ondomestic savings resulting in householdshedging against this trend by investingin gold or similar products.During this period, corporate savingsalso fell in light of the wage pricespiral and reduced margins due to
  12. 12. 12high borrowing costs and supply sideconstraints. With the RBI maintaininghigh rates, corporate borrowing costsescalated and consequently investmentswaned. In addition, surplus funds inthe public system were utilized to fundthe government’s high fiscal deficitresulting in a “crowding out” of privateborrowings. Subsequently, investiblesurplus has virtually declined to itslowest in the past few years.Deep rooted macroeconomic imbalanceat this point can be corrected throughconcrete policy steps to revive growth.Addressing this will be crucial in theforthcoming Budget for 2013-14.The key concern at this point is the fiscaldeficit. Sustainable plans need to beconsidered to further reduce subsidies,widen the tax base, decrease otherexpenditure and augment revenuethrough public sector divestments.However, meeting targets may taketime. While the RBI focuses to containinflation, it is also important for it toconsider maintaining adequate liquiditylevels by reducing the statutory liquidityratio and repo rates while controllingthe cash reserve ratio. The twinaction of fiscal and monetary policiesis therefore expected to help raisesavings and promote investments in theeconomy. With increasing investments,growth is expected to follow suit.The efforts of the Finance Minister toinitiative strong reforms are laudable.Though the announcements ofreforms have helped in lifting investorsentiments, committed implementationof these reforms as well as introductionof further reforms will be required tomaintain confidence and show a pathto recovery. Budget 2013-14 presents agood opportunity for the Governmentto start the new fiscal year on a positivenote as the stakes slowly rise.Data in graphicalrepresentations arebased on reportspublished by IMF, RBI,Ministry of Finance,CSO and PlanningCommission
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