India: Monthly Economic Report – June 2012

British High Commission New Delhi

Summary 

Growth slumps to 6.5% in 2011-12, even lower than the 2008 financial crisis.  Rupee hits an all time low of 56.4 INR/USD. Government blames Euro zone crisis and tight monetary policy.  But domestic policy uncertainty is the driving force, and any reforming signal is being met with widespread opposition. Parallels have been drawn to the 1991 crisis. Formidable reserves are a defence against that, but the negative perceptions are rising fast. All eyes are on the RBI, but it is now in a dilemma with plunging growth and sticky inflation, and also waiting for a political lead. 

Detail

Economy: Growth slumps

Growth slumped to a nine year low of 5.3%yoy in the January - March quarter surprising markets and the government. GDP growth for 2011-12 came in at 6.5%yoy, even lower than the 2008 crisis. The slowdown was led by lack lustre industrial production which slowed to 2.6% in 2011-12 from 6.8% in 2010-11. 

Policy: Some easing likely 

The RBI is now in a dilemma with plunging growth and sticky inflation. Inflation edged up to 7.3% in April from 6.9% in March driven largely by food prices. Food prices are likely to remain sticky, while rupee depreciation and hike in fuel prices will all add to inflation. Some policy easing is expected at the Reserve Bank of India’s (RBI) June 18 policy meeting but a reduction in cash reserve ratio (CRR) is currently more likely than a rate cut. 

In one reforming, but so far isolated move, on 23 May oil marketing companies supported by the government raised petrol prices by 11% (Rs 7.5/ litre). This was met with widespread strikes across the country. In a bid to allay criticism and partially helped by a decline in global oil prices, oil companies reduced prices by Rs2/litre on June 1. However widespread opposition has thwarted hopes of an immediate increase in other administered fuel prices which are crucial to curbing subsidies and the budget deficit.       

External Sector: Rupee slips to all time low; RBI measures have limited impact  

The rupee fell to an all time low of 56.4 against the US dollar in May; losing nearly 13.5% in 2012 – and more on weakening fundamentals at home than the Euro zone and other external factors which the Government prefers to blame. The RBI has sold US$ 20bn between September 2011 and February 2012 and another US$7-10bn since, but of little avail. Even measures to boost inflows such as increasing the interest rate ceiling on non-resident deposits and easing investment limits of foreigners in Indian government and corporate bonds have had limited impact on the rupee. 

In April 2012, exports grew by 3.2%yoy, up slightly from a contraction of 5.6% yoy in March. Imports slowed to 3.8% from 24.3%yoy in April. The slowdown in imports bodes well for the current account deficit. Although a depreciating rupee should help exports, lacklustre external demand will limit any upside.

Financial Markets: Markets under pressure

Equity markets came under pressure with the BSE Sensex falling 6% over the month. Slumping domestic growth, a depreciating rupee and uncertainty in the Euro zone were largely responsible for the volatility. Foreign Institutional Investors (FIIs) were net sellers in the Indian equity market in May.

The Indian government 10 year bond declined marginally to 8.5% levels from 8.7% at the end of April helped by open market operations (OMO) by the RBI and on hopes of a rate cut. FII’s were net buyers in the Indian debt market pumping in about US$0.6bn. 

Month Ahead: All eyes on the RBI; but government action more pertinent    

All eyes are now on the RBI’s June 18 policy meeting.  Some policy easing is expected; but the balance is tilted towards more liquidity easing measures –CRR cut – to curb the banking system liquidity deficit rather than a reduction in rates. However a rate cut cannot be ruled out.  RBI action in itself will do little to alleviate the current situation. As increasingly sharp national and international commentaries are making clear – the answer lies in Government policy, for which both domestic politics and weakening fundamentals are making options ever more difficult.

Disclaimer

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