India’s macro troubles are back. If they ever went away, that is. A rush of data shows the two deficits back into danger zone, still-high retail inflation and stagnant industrial output. It’s not surprising that the normally upbeat finance ministry lowered its gross domestic product (GDP) growth expectations to 5.5-6%: there is little sign of an upturn; to the contrary, the alarm bells are ringing once again.
The pesky twins—fiscal and current account deficits—refuse to settle down. In October, the trade gap expanded for the fifth consecutive month to a shocking, all-time high of $21 billion on the back of resurgent imports, which have started rising once more from higher oil prices, improving non-oil imports and returning gold appetite. Meanwhile, exports continue to weaken although at a slower pace. This lifts the trade deficit to 12% of GDP in the second quarter. It’s a fair question if the current account deficit in 2012-13 will be any lower than last year’s 4.2%. Equally legitimate is apprehension about financing: more than two-thirds of the deficit depends upon short-term, portfolio flows. Markets matter, therefore.
The fiscal situation darkened because spectrum auction revenues fell short by more than one-third of that expected; the outcome has affected expectations from forthcoming asset sales too. Given the critical dependence upon non-tax revenues, `70,000 crore, for meeting the revised financing gap (5.3% of GDP), fears of overshooting are palpable as tighter spending will not do much to shrink the balance. Markets matter here as well.
Consumption, the key factor in the GDP math so far, is slowing as consumer goods production in September showed. Overall, industrial output growth contracted 0.4% annually, against an expected expansion of 2.8%, while investment remained lifeless with a severe contraction in capital goods. Read along with net exports, there are no drivers to propel growth ahead. Weaker consumption at this point will further amplify the downturn in private investment. The critical point here is: why is industrial output not growing despite significant capacity additions in the past few years? A reasonable guess is that high inflation has eroded price competitiveness, making imports a cheaper, easier option.
Against this backdrop, moderating wholesale price inflation in October—to 7.5% year-on-year, with lower core inflation, 5.2% from 5.6% in September—is surely a positive development. Two caveats before celebrating the slowing inflation momentum: Subsequent revisions cannot be ruled out; sample that August inflation data was revised up to 8% from 7.6%. Plus, retail-price inflation inched up marginally to 9.8% in October.
Clearly, something has to give in this situation. It will be the currency for its fragilities are serious enough to raise investor concern. The slightest trigger or an adverse shock could shake the confidence of markets, on which the twin deficits are mortally dependent. Serious, sustained policy responses to check inflation and promote public and private investments are required to readjust the macroeconomic equations. Then too, growth response will come with a lag. One must settle for a low growth period meanwhile.
Renu Kohli is a New Delhi-based macroeconomist; she is currently lead economist, DEA-Icrier G20 research programme and a former staff member of the International Monetary Fund and Reserve Bank of India.