RaboResearch - Economic Research

Country Report India

Country Report


India flag

The market anticipation of Fed QE tapering has sent the Indian rupee to record lows. However, India is not a blameless victim. It struggles with fundamental issues constraining economic growth, large twin deficits and a declining investor confidence on the back of inadequate economic reforms.

Strengths (+) and weaknesses (-)

(+) Growing working age population

In the coming years, India could enjoy the benefits of a growing working age population, the so-called demographic dividend. This could give a boost to economic growth, especially in a world where several major economic blocks are facing an ageing population.

(+) Large, diversified economy

India has a large, diversified economy, which limits its vulnerability to external shocks. Even though the agricultural sector employs the majority of the population, the large services sector accounts for almost two-thirds of GDP.

(-) Infrastructural bottlenecks and difficult business environment

Infrastructural bottlenecks are estimated to reduce GDP growth by one to two percentage points per year. Businesses also face hurdles in the form of red tape, corruption and state intervention.

(-) Political fragmentation

There is currently little common ground in the parliament and even within the ruling coalition consensus is often out of reach. The fragmented politics, in which regional topics often dominate over national issues, hinder decisive government action. 

Key developments

1. External and internal imbalances put India on top of hit list

In May, the US Fed Chairman Bernanke suggested that the Fed will start tapering (i.e. lower the pace of asset purchases) as the economy recovers. In response, investors started selling off assets in high risk markets. Countries with large current account and fiscal imbalances have been particularly vulnerable, including India. The Indian rupee has lost 20% of its value against the US dollar since May due to reduced inflows of portfolio and foreign direct investment. The government’s response has so far been rather weak (pointing to the reforms that have already been taken rather than announcing new ones) and at times confusing (introducing capital controls for residents, which stoked fears among foreign investors). However, what is really needed are reforms to boost potential growth rate, curb inflation and reduce the twin deficits.

Figure 1: Depreciation in countries with large current account and fiscal deficits
Figure 1: Depreciation in countries with large current account and fiscal deficitsSource: IMF and EcoWin
Figure 2: Foreign exchange reserve covers at acceptable levels
Figure 2: Foreign exchange reserve covers at acceptable levelsSource: EIU

The bout of negative news items and falling asset prices have not helped the already faltering investor confidence in India, which is expected to have a negative effect on economic growth. Moreover, the rupee depreciation could put upward pressure on the already high level of inflation. The fall of the rupee has already put an end to the central bank’s easing cycle. Therefore, on the back of flagging investor confidence, tight monetary conditions and inflation eating into consumers’ spending capacity, economic growth is expected to slow further from 5.0% last year to below 5% this year (FY 2013-14). The April-June quarter showed a disappointing 4.4% yoy growth figure, even though growth in that quarter was hardly affected by the more recent deterioration of economic sentiment. The current monsoon, which is progressing well, could support economic  growth and inflation (or more likely the government subsidy bill) somewhat of a break this year. However, a quick return to the 7%+ growth figures seen a few years ago is unlikely.

2. But repeat of the 1991 crisis not expected

In 2012, India’s current account deficit was 5% of GDP, the largest in India’s history. This deficit is expected to shrink only marginally this year. The demand for oil, India’s main import product, is not expected to abate much, despite the decision to raise administered diesel prices in January 2013. Also the demand for gold, the second largest import product, is not likely to decrease substantially. The measures to curb gold imports are not able to counter the desire for gold with inflation running high. Next to the current account balance, the fiscal balance is not expected to improve much in the near term either. During the recent monsoon session, the parliament approved a landmark, multi-million Food Security Bill, while actions to increase tax revenues or decrease other subsidies are not expected in the run up to the 2014 elections. The government has committed itself to an ambitious budget deficit target of 4.8% of GDP this fiscal year.

Despite the expectation that the twin deficit will persist and that sweeping reforms are unlikely, India does not seem to be heading for a repeat of the 1991 balance-of-payments (BoP) crisis. While several factors look familiar (large twin deficits, sliding rupee), the starting point of the Indian economy is stronger nowadays and the currency is not fixed as it was back then. The foreign exchange (FX) reserves, which dropped to three weeks of imports at its lowest point in 1991, are still at reasonable levels. FX reserves cover more than 5 months of imports and over 300% of India’s short-term debt. Moreover, the external financing requirements are estimated at about USD 200bn in 2013, compared to an estimated FX reserves of USD 265bn end-2013. However, although a BoP crisis is not near, India has become more vulnerable. An unexpected spike in oil prices or a few inept policy reactions, for example, could put the country at risk.

3. New central bank governor welcome, but not enough

A positive development in India has been the appointment of Raghuram Rajan, a former chief economist of the IMF, as per September 2013. His appointment was welcomed by the market and on his first day at the helm he announced a comprehensive plan to liberalize the banking sector and reduce the high level of state control. After his big bang entry, Rajan’s next step will be to implement the plans and present a credible strategy to deal with inflation and the sliding rupee – investors will need more to return to India than Rajan’s appointment. Moreover, many of the reforms that are needed are beyond the central bank’s reach and need government action. Given the upcoming general elections (in May 2014 at the latest), decisive action is not expected soon. At the moment, neither of the two largest parties, Congress and BJP, are expected to win a clear victory and a rather weak coalition is therefore more likely than not. Possibly a third front coalition, led by one of the stronger regional parties, could bank on the weakness displayed by Congress and the BJP. Even in such a scenario it is expected that the political fragmentation will continue.

Factsheet of India
National facts of IndiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

India is an extremely diverse country with large regional differences, a huge gap between rich and poor, and very diverse economic sectors. The average income in India was about USD 1,500 in 2012 (USD 3,900 in PPP terms). India’s Planning Commission reported that in 2011-12, 25.7% of the rural population and 13.7% of the urban population lived below the national poverty lines (which are lower than the World Bank standard of USD 1.25 per day). This has been an impressive decline from the 41.8% and 25.7% recorded in rural and urban areas, respectively, in 2004-05. Although India is still home to more undernourished and poor people than all of sub–Saharan Africa, the progress on poverty reduction has been impressive  when taking India’s fast population growth into account. While many countries face a shrinking and/or ageing population, India benefits from a growth in the working-age population in the coming decades. This could be a catalyst for growth but also a source of social unrest.

India has a federal structure and many subjects have been delegated to state governments. At the central level, the Indian National Congress (Congress or INC) and BJP are the main parties. However, there are also many regional parties that have seats in the national parliament. As these parties deal with the situation in their home constituency, the priorities can differ much at the national level. There is frequent social unrest and occasional violence in some part of the country. Often these areas have a strong tribal presence and/or religious tension. The agricultural sector is very important to the rural community. Although it only produces 18% of GDP, about two thirds of the population depends on this sector for its livelihood. At the other end of the spectrum there is the world class IT sector, which is a major driver of the services sector. The services sector accounts for more than 60% of GDP.

Economic indicators of India
Economic indicators of IndiaSource: EIU

India’s financial or fiscal year (FY) runs from April through March. EIU generally follows this fiscal year in the figures presented in the table above. Figures for FY 2012 relate to April 2012 – March 2013.


naar boven