Home / Opinion / Tentative signs of an economic recovery

There is growing optimism that the Indian economy has finally begun to turn the corner. Some evidence whether that is indeed the case will be available on Friday when the government releases data on gross domestic product (GDP) during the first quarter of the current financial year. Most economists expect economic growth to be around a percentage point higher than what it was in the last three months of the year ended March. It is quite likely that economic growth in the three months to June will be the highest in eight quarters.

Some indications of a cyclical recovery are already evident in the high-frequency data on industrial output, discretionary spending, exports and business confidence. Corporate financials are improving despite clear signs of excess leverage in certain segments. Strong capital inflows have allowed the Reserve Bank of India to rebuild its foreign exchange reserves. There has been a recovery in bank deposit growth. Inflation seems to be gradually trending downwards despite the sharp 0.5 percentage point jump in consumer price inflation in July because of high vegetable prices.

The global decline in commodity prices also offers relief for a commodity importer such as India. There is also some hopeful talk in the bond markets about the possibility of a sovereign credit rating upgrade.

Yet, it is too early to pop the champagne. There are three immediate concerns.

First, a percentage point increase in the growth rate will also mean a similar reduction in the output gap, a measure of slack in an economy. A smaller output gap could then lead to a rebuilding of inflationary pressures in the Indian economy.

Secondly, it is now quite clear that the US will exit its quantitative easing programme in October and will begin to increase policy interest rates sometime after the middle of next year. Higher US interest rates could lead to a new bout of global financial turbulence that India will have to manage, though it is now widely accepted that the country is far better placed to do so compared with the weeks of the emerging markets panic of July-August 2013.

Thirdly, the ability of the banking system to raise enough capital to provide for the mountain of bad loans as well as global regulatory requirements is still very weak. India needs to clean its banking mess before lenders can fund the next stage of the economic recovery.

The current improvement should be seen as the second stage of the Indian economic recovery. The first stage began in September 2013 after the rupee scare of the preceding months finally convinced the government to get serious about the twin fiscal and current account deficits. Raghuram Rajan also put inflation control at the top of the central bank’s agenda after he took charge of Indian monetary policy a year ago. The economy is far less fragile than it was then.

The second stage of the recovery is now underway. The strong mandate given by the electorate to Narendra Modi removed the tail risk of political instability from the minds of investors. The central bank has also recovered some of its lost credibility. Though the Modi government has as yet done far less than what was expected, it has done just enough to boost corporate confidence in the boardrooms, consumer confidence in the bazaars and investor confidence in the trading rooms.

The third part of the economic recovery is tricky. It is good that private demand has strengthened at a time when the government is committed to reducing its net spending through the budget. But the current cyclical uptick will not be able to become a full-blown economic recovery unless corporate investment recovers even as the government pushes ahead with structural economic reforms in important factor markets, the financial sector, energy and agriculture.

Will the Indian economy witness a full-blown recovery? Tell us at

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