The Indian economy is passing through a crucial phase and developments in the second half of the current financial year will decide the Finance Ministry’s ability to improve things significantly next year. Luckily industry has reported encouraging growth in April-August. The average rise in industrial production has been 5.8 per cent in these five months against 4.76 per cent a year ago. What is noteworthy is the performance of the manufacturing sector, which could raise output by 10.40 per cent in August against 1.69 per cent in the same month last year.
The uptrend is expected to be sustained in the coming months as the core sector too has done well. As exports also are expected to recover in October-March, growth in industrial output for the whole year may be 9 per cent against 3.4 per cent in 2008-09. Last year, the recession in the U.S. and elsewhere had hit the industrial and external sectors.
In October-March, industrial output had declined consistently except in November, mainly due to the dismal performance of export industries. The performance so far this year has been heartening as latest reports suggest a strong revival in domestic demand for various consumer products. The services sector also is expected to aid GDP growth with a contribution of around 9 per cent.
Setback in agriculture
The agriculture and allied industries sector, however, has fallen back. The output of food and cash crops in the 2009-10 season will be much lower than in 2008-09 when there was a record output of foodgrains. The estimates for the current season of the Agriculture Ministry and the National Economic Advisory Council (NEAC) are based on different perceptions.
The NEAC places foodgrain production at 233 million tonnes against the Agriculture Ministry’s 221 million tonnes. It is also felt that the yield of oilseeds and sugarcane will be much lower than the NEAC’s assumption. In any case, there will be a negative contribution of 1.5 per cent by the sector to GDP growth. However, the overall progress of the economy will be satisfactory in 2009-10 in the context of a projected contraction of the global economy.
The performance would have been more impressive but for the sharp setback on the trade front since October last year. However, it is significant that exports only dropped by 13.8 per cent in September this year against 34.2 per cent in April. A positive growth is likely in October-December though it remains to be seen whether this will fully make up for the setback of earlier months.
In view of the favourable expectations from the industrial and external sectors and hopes of a rebound in agricultural output in 2010-11 season, the GDP growth in 2010-11 is placed even higher at 8 per cent. The decline in export earnings has, of course, not seriously upset the balance of payments position. The larger current account and trade deficits of past year could be fully met with available foreign exchange assets. This of course declined by over $57 billion in 2008-09 without making allowance for revaluation adjustments. On the other hand, since April this year, reserves have risen by roughly $ 25.34 billion up to October 30.
With likely reserves of around $300 billion by March next year and a weakening dollar against other major currencies, the Finance Ministry as well as the RBI have thought it desirable to reduce dollar holdings. The gold content is thus being increased by 200 tonnes to 557.8 tonnes by taking advantage of the opportunity to buy from the IMF.
These purchases involved using $6.7 billion out of reserves even though the purchase price is only slightly below the current market quotation in rupee terms. While it is not clear how much will be the rise in gold prices from the current levels, the RBI will still have the benefit of lower average prices in respect of earlier holdings. These, of course, have been revalued and the holdings of 357.8 tonnes had a value of $10.80 billion as on October 30. This will go up substantially after the recent purchase.
Cautious credit policy
The external sector will not in any case witness a repetition of the happenings of 2008-09. The monetary authorities have nevertheless been cautious in their recent mid-year review of credit policy as there was anxiety not to disrupt the recovery process.
The inflation rate is expected to rise to 6.5 per cent plus by March next while efforts are under way to present more realistic price indices. Changes in this rate will be on a monthly basis henceforth with a new base year. The effective CRR will be higher than 5 per cent as its coverage will be over a larger area and there will be a net increase in the funds immobilised because of the inclusion of certain provisions left out earlier.
Apart from the increase in the provision against advances to the commercial realty sector an indirect effort has been made to curtail money supply by discontinuing with immediate effect the special refinance facility for banks and special term repo facility for banks (for providing funds for mutual funds), non-banking financial companies, and housing finance companies).
The cut in statutory liquidity ratio has also been restored to 25 per cent. This will not have any immediate adverse impact as the actual SLR was higher than the new stipulation. Also, the investment-deposit ratio of banks was 33.11 per cent, according to the latest statement.
The implied reversal of the RBI’s retreat from dearer money should not however result in a hike in key interest rates as well as CRR during the next quarterly review. This is because borrowing by the Central and State governments will still be sizable in the coming months especially as the State governments have to mobilise large resources.
Net market borrowing by the Centre may also exceed the target because of a slowdown in tax revenues and increased subsidies.
Since industry will have to borrow more from banks for working capital and raise loans for expediting expansion and new schemes and export credit also may go up, a liberal approach should be adopted by the RBI in spite of the looming threat of inflation rate rising to 6.5 per cent and above against the earlier RBI projection of 5 per cent.
The Finance Ministry for its part has given the assurance that the stimulus package will not be withdrawn until it becomes clear that the economy has overcome all its troubles.
The Finance Minister will of course have a challenging task in cutting the fiscal deficit to 5.5 per cent from 6.8 per cent in 2009-10; it may even rise to 7 per cent if the efforts to reduce non-Plan expenditure do not yield tangible results.