The Indian economy in the next decade

In June 1991, the government of India pawned 67 tons of gold to the Bank of England and the

Union Bank of Switzerland to shore up its dwindling foreign exchange reserves. The U.S. dollar was in great demand. By November 2009, after nearly two decades of reforms and globalization, the shoe was on the other foot. India bought 200 tons of gold from the International Monetary Fund (IMF), the country’s reserves stood at $285 billion — compared with $2 billion in 1991 — and the demand for “greenbacks” had dimmed.

These signs point to an upbeat outlook for the Indian economy in 2010, which, in the view of some observers, seems as bright as the gold the country has recently acquired.

The year could see more gold purchases; India needs to diversify its basket of foreign assets, 90% of which is still in U.S. dollars. But foreign exchange reserves — once closely monitored — are the least of the country’s problems right now.

At the top of the agenda is inflation and its trade-off partner — growth. “The evolving growth-inflation conditions will dictate the future course of action by the RBI (Reserve Bank of India),” Shyamala Gopinath, deputy governor of the RBI, said during a recent meeting in Bangalore.

Inflation has already reached worrisome proportions. Wholesale price inflation jumped to 4.78% in November, up from 1.34% in October. Food inflation, which affects the general population and influences voting behavior during elections, was 19% in December.

“Inflation will continue to be a serious issue,” says Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB).

“The stimulus is doubtless fuelling it in part, and there is no way of rolling it back…Inflation is likely to stay at present levels or worse for much of next year.”

High inflation means that the government may have to withdraw the stimulus package – introduced to counter the economic slowdown – sooner rather than later.

Another measure to control inflation is to curb liquidity. “Interest rates are likely to go up 1.5% to 2% over the year,” stated Sunil Bhandare, advisor for government and economic policies at Tata Strategic Management Group (TSMG), a management consulting firm.

“The increase will be on three considerations: inflation, the fiscal deficit and global interest rates, which are likely to increase in the next three to six months.

Chakrabarti of ISB believes interest rates have to rise, “but the government and RBI may be nervous about killing a fragile recovery.”

GDP Growth

Because of these imponderables, estimates of GDP growth vary widely. In the April-September quarter of 2009-2010, GDP rose a surprising 7.9%. Prime Minister Manmohan Singh says he sees a return to the days of 9%-plus growth next year (2010- 2011). The government’s own estimate for 2009-2010 is 7% to 8%. Given current trends, it may end up on the high side of that range.

Good news is unlikely to be heard on all fronts, however. “Exports will continue to lag,” says Chakrabarti of ISB. Bhandare of TSMG says export growth could be around 10% to 12% but “nowhere near the 20% that we saw earlier.”

Exports have turned the corner, depending on how you look at it. In November, exports rose 18.2% to $13.2 billion after 13 months of decline, but this was on a lower base. For the first eight months of 2009-2010 (April-November), exports were down 22.3%.

The fiscal deficit is another problem area. Thanks to the stimulus package, the deficit was estimated at 6.8% of GDP for 2009-2010.

According to the 2003 Fiscal Responsibility and Budget Management (FRBM) Act, the deficit was supposed to come down to 3% by 2008-2009 — but it did not. Will the deficit surpass the extra latitude given in this crisis year? According to government figures, the deficit for April-November was $65.7 billion, or 76.4% of the fullyear target.

“In 2010, governments will face the very difficult task of trying to restore fiscal discipline while also ensuring that withdrawals of stimulus measures do not kill off nascent economic recoveries,” reports the Economist Intelligence Unit (EIU).

It estimates India’s GDP growth at 6.5%, which would make it the ninthfastest growing country. China, at 8.7%, is ahead, but others leading the pack are small economies like Qatar (24.5%).

Stock Market Rollercoaster

The most-watched indicator by foreign investors is the Bombay Stock Exchange sensitive index (Sensex). This year has been a rollercoaster ride; the Sensex ended the year at 17,464, up 114% from a low of 8,160 in March. Foreign institutional investors (FIIs) have poured in $17.5 billion during the year.

The Sensex value is one number nobody in the government discusses, because it is speculation. “I don’t expect the Sensex to go up very significantly from current levels.

The stock market has recovered too fast in the current year, so the opportunity for further increase will be limited,” says Bhandare of TSMG. Chakrabarti of ISB sums up the economic picture, “Overall, in 2010 and beyond, the economy will continue to be strong on the domestic front.

The driver of growth will continue to be internal consumption, the aspirations of a large middle class and the spread of the income base across different segments of the economy.

We are now seeing the emergence of a much larger and far more powerful middle class with more buying power than ever before…The dampener to the economy, however, could come from the supply side. Food prices are a major concern.

Within this, the issue is not just of poor monsoons and poor food supply, but also of food management.”

Bhandare of TSMG offers his own perspective. “Three significant aspects stand out in the Indian economy at present:

The economy has shown tremendous resilience, there is a lot of flexibility and there is a great deal of tolerance among the Indian people — 20% food inflation should have normally led to great social discontent and people should have been out on the streets...[But] one has to make a few assumptions:

There will not be a repeat of a bad monsoon; there will not be another oil shock, and commodity prices will be reasonable; there will be no major dip in the international economy; and the government will abide by the policy reforms that it is promising.”