Three recent data releases preview a lengthy adjustment ahead. Industrial production, inflation and trade figures altogether present a mixed picture about the state of the economy. Given the prevailing external environment and weak monsoon, this could easily turn negative unless supported by a concerted policy push by the government.
First, industrial output showed a 2.5% year-on-year seasonally adjusted rise in May; economic activity improved sequentially too, but at a weak pace (1% month-on-month). While consumer demand was robust in annual terms (4.6%, seasonally adjusted), it weakened sequentially for the fourth successive month. Worryingly, investment demand observed from capital goods production continued its trend decline of almost a year now, save for the short rebound of January-March 2012.
Monthly trade figures confirm that net overall demand remains very weak. Exports contracted 4.2% in May at an annual rate; early estimates reveal this is followed by a further fall in June (5.5%). The fall in imports is far steeper: 7.4% year-on-year in May with a further slide in June (13.5%. Even as this narrows the trade deficit sharply ($10.3 billion from the $16.3 billion in May) indicating part-play out of the currency depreciation, it shows that the slowdown signs have become more significant. With no external support – the just released IMF outlook forecasts global growth will be slower in 2012 by 0.1% percentage points at 3.5% - it points to the crucial need to revive domestic demand.
The global situation spills over onto the capital account too. India is in desperate need of foreign capital inflow, which the IMF warns will remain highly volatile. Total net inflows from abroad were just $2.8 billion (sum of portfolio and direct investments, external borrowings and nonresident deposits) in May, but this includes $3.4 billion of overseas borrowings that are only approvals as of now; actual inflows under this head could be lower – relative average of January-March 2012 over October-December 2011 on actual balance of payments flow basis shows these could average as little as $800-900 billion monthly for April-June. June inflows of portfolio capital were just $209 billion, while July has seen cumulative net inflow of $1.6 billion so far.
Finally, provisional inflation data showed headline inflation moderating to 7.3% annually. Core inflation held steady, but its momentum accelerated; and food inflation further tightened its grip. This pretty much confines the space for a monetary response to address the flailing economy, suggesting the economic weakness needs counteraction from the government.
The policy effort to address taxation issues for foreign investors is a positive step in view of the stretched external position. The same however cannot be said for reviving domestic investments. With a precarious fiscal balance precluding a direct stimulus, the major challenge for the government is to switch public expenditure away from consumption towards public investments in a deficit-neutral manner. At this point, the only escape valve is to accelerate infrastructure investments through a major push to mitigate the ongoing adjustments in the economy and elicit its latent strength.
Renu Kohli is a New Delhi-based macroeconomist; she is a former staff member of the International Monetary Fund and the Reserve Bank of India.