The Economic Advisory Council to the Prime Minister has forecasted the GDP growth of India at 9% for the year 2011-12 compared with the CSO advanced estimates for the year 2010-11 at 8.6%.
The Council's July 2010 Economic Outlook had taken the view that the economy would grow by 8.5% in 2010-11 on back of the better than expected performance of the Indian economy in 2009-10.
In the event, growth in the first half of 2010-11 was higher at 8.9%. However, the Council felt that, in the second half, the rate of growth will be somewhat moderated.
This was supported by the CSO Advance Estimates for 2010-11, which has placed full year growth at 8.6%. This is marginally higher than the estimate the Council had made in July 2010.
The economic growth will be well supported by the good agricultural output. The Second Advance Estimate for 2010-11 shows that aggregate food grain output in 2010-11 is likely to be 232.1 million tonnes, which is slightly less than the record harvest of 234.5 million tonnes in 2008-09.
The kharif food grain production at 117.2 million tonnes will be a million tonnes lower than in 2008-09, while the Rabi output may be 1.4 million tonnes lower.
The recently released Second Advance Estimates for the year show strong growth in kharif food grain and oilseed output compared to 2009-10, but lower than that achieved in the bumper year of 2007-08 and 2008-09.
The estimates for the Rabi season are also favourable. This is supported by both, the good South West monsoon, as well as the comfortable status of our reservoir position. Rabi rice output is presently placed at 13.85 million tonnes, marginally lower than the record levels reached in 2007-08 and 2008-09.
This is primarily on account of the fact that there was rainfall deficiency in parts of eastern India particularly in Gangetic West Bengal, Bihar, Jharkhand and some parts of eastern Uttar Pradesh.
Overall rice output is now placed at 94 million tonnes, one of the largest ever harvests. The reservoir positions in almost every part of the country, particularly southern and central India, showed a significantly better position at the end of January 2011 compared to either last year, or for that matter the average of the last 10 years. It is possible that the Rabi rice harvest may eventually turn out to be larger than that projected in the Second Advance Estimate.
It is likely that with favourable weather conditions continuing, the council feel India will have the largest ever wheat harvest, at 81.5 million tonnes.
Kharif pulses output is a record 6.5 million tonnes and total output for the year is likely to touch a record level of 16.5 million tonnes, which is an outcome of the combination of farmers positive response to high prices and a well thought out programme of the Central and State Governments to support higher pulse output, especially kharif pulse output, through increasing the availability of certified seeds, DAP fertilizer and other initiatives.
Kharif oilseed output has been revised sharply upward to 182.2 lakh tonnes, the second largest on record.
Overall, for the year, oilseeds position is unlikely to exceed 280 lakh tonnes. Given the fact that we are large importers of crude edible oil and also that a linkage has developed over the years between international edible oil prices and that of crude petroleum, we need to strengthen our output levels of oilseeds and thus domestic edible oil production. Cotton and sugarcane harvests have also been revised upward marginally.
Overall, from the farm viewpoint, output conditions are likely to result in good economic growth in 2010-11, and have been gauged in the CSO's Advance Estimate to be 5.4%.
The council advocates service sector growth to show a slight pickup in the second half of the year, thus averaging 9.6% growth for the year as a whole. Growth of GDP in the services sector was 10.1% in 2009-10 and 9.5% in the first half of 2010-11.
While bank deposit growth has shown slower expansion in the current year, other business services, particularly the IT sector, has reported a strong rebound.
Transportation and other businesses have registered strong double-digit growth in the first two quarters of 2010-11. The available information on general trade, retail, transport and hospitality sectors support the assessment made in the Advance Estimate of GDP for 2010-11.
On the other hand, the council expects further moderation in manufacturing output growth. In light of the IIP data for November and December 2010, the Council expects that manufacturing output growth is likely to be depressed through the last quarter of 2010-11.
In consequence, the Council estimates that this overall manufacturing output growth may be in the range of 7.5%. The Advance Estimate of GDP has estimated that GDP arising in the manufactured sector will expand by 8.8% and this may thus turn out to be lower, introducing a downward bias to the estimate of overall GDP growth of 8.6%. However, this may be offset by higher output in the mining sector and better performance of the services sector.
The Advance Estimate places GDP arising in the mining sector at 6.2% and that in the electricity, gas & water supply sector at 5.1%. It is likely that the output/GDP growth in the mining sector may turn out to be higher, while that arising in the electricity, gas and water supply sector may not vary much from that estimated.
The Council continues to be of the view that it is possible to achieve growth of 9% in 2011-12, while slightly refashioning the GDP components. The farm sector is now expected to grow by 3%, the industrial sector by 9.2% and the services sector by 10.3%.
Per capita GDP at factor cost is projected to increase by 7.5% in 2011-12, as against 7.1% in 2010-11. These adjustments reflect ongoing changes observed in the industrial and services sector, both in respect of the domestic economy and global prospects.
The investment and savings rate for the years up to 2009-10 and available data for the first half of 2010-11 clearly suggests that, in terms of aggregate resources, the Indian economy is capable of growing at around 9%.
The principal challenge is to ease the various sectoral bottlenecks that continue to exist, whether it be in electricity and other infrastructure availability or slow-growing farm productivity and inadequate logistics for farm produce.
The Council expects that the overall investment rate in 2010-11 will be above the 36.5% reported for 2009-10, at about 37% propelled by real annual increase of about 12% in private corporate capital formation and about 10% for the economy as a whole.
The domestic savings rate is expected to improve from 33.7% in 2009-10 to 34.0% in 2010-11. The CSO data clearly showed that companies have again begun to place orders on equipment suppliers and investment in capital asset, especially equipment, is proceeding well.
This is also borne out by the sharp rebound in Gross Domestic Capital Formation in the private corporate sector, which grew (at constant prices) by 29.1% in 2009-10, after suffering a severe decline of 28.9% in 2008-09.
Going further, the investment rate will rise to 37.5%, while the domestic savings rate would rise to 34.7%, partly on account of further improvement in Government finances. The ratio of gross fixed investment to GDP is also likely to show a slight elevation from the 30.8% reported in 2009-10 and the 29.6% reported in the Advance Estimates for 2010-11.
The latter is likely to be an underestimate and given changes in other parameters it is likely that on revision this ratio for 2010-11 will turn out to be close to value registered in 2009-10, namely 30.8%.
In 2011-12 it is expected that this ratio will improve to 32%, while the real increase by the private sector in fixed capital will rise by 15%.
Private Final Consumption Expenditure has shown steady growth of between 7% and 9% per year, except for 2009-10, with average growth of 8% and remained steady (7.4%) even in the Crisis year of 2008-09.
The Advance Estimates suggest that in 2010-11 private consumption expenditure in real terms grew by 8.2%. The Council expects that in 2011-12 the rate of growth is likely to slightly higher.
In consequence of the withdrawal of stimulus, the growth in Government consumption expenditure fell to a mere 2.6% in 2010-11 from over 16% in 2009-10. In 2011-12, the real growth in government consumption expenditure is expected to remain subdued at around 5%.
Capital flows expectations revised downwards; CAD/GDP at 2.8% for FY2012E
On the Balance of Payments front, the Current Account Deficit (CAD) has been uncharacteristically high, especially in the second quarter of 2010-11. In the July 2010 Economic Outlook, the Council had expected that on account of the poor recovery in export markets and strong domestic demand for imports, the Current Account Deficit would be much higher than what used to be considered the comfort-zone (namely 1.5 to 2.0% of GDP).
The Council had expected that the Current Account Deficit would be 2.7% of GDP for 2010-11. In the first half of the year the Current Account Deficit was much higher at 3.7% of GDP and as high as 4.1% in the second quarter.
The sharp improvements in merchandise exports in the months of November-December 2010 as well as that assessed in January 2011 of about 32% have begun to cast a more favourable light on the current account.
Not only has growth of merchandise exports recovered well, import growth has also begun to moderate. Undoubtedly the higher world prices for crude oil may have an impact on the import side, but this will, be offset to an extent by the increased availability of domestic crude from the Rajasthan oil fields.
The merchandise trade deficit in the second half of 2010-11 is now expected to be slightly lower at just below 7% of GDP, compared to 8.85% in the first half. Thus, the Council feels that the Current Account Deficit will show considerable moderation in the quarter ended December 2010, as well as in the quarter ended March 2011.
Accordingly in the second half of 2011, the Council places the Current Account Deficit at 2.4% of GDP, thus making for an overall Current Account Deficit of about 3.0% of GDP in 2010-11.
It is also equally important that investment conditions are conducive for the continued flow of foreign capital especially equity capital, in order to sustain even a 2.0 to 2.5% level of Current Account Deficit.
The Council estimates that the capital account surplus will be .9 billion in the second half of 2010-11 which will be one quarter less than the .7 billion recorded in the first half of the fiscal.
Overall, that would leave a very modest balance of payment surplus of about billion in the second half of 2010-11, which is 30% less than the modest billion reported in the first half.
Thus, total accretion to foreign exchange reserves will be about billion for the full year 2010-11, smaller than that recorded in 2009-10 (.4 billion).
On the basis of the experience of the current year, the Council projects that the merchandise trade deficit will be of the same order in 2011-12 as that estimated for the current year (7.7% of GDP).
The position on net invisibles is also expected to remain at the same level (4.8% of GDP). Improvement in service sector exports is likely to be offset to an expansion in the outflow of investment income.
The Current Account Deficit for 2011-12 is accordingly projected at about billion or 2.8% of GDP. On the capital side, flows of a similar magnitude amounting to billion (3.8% of GDP) is projected for 2011-12, which will leave a modest sum of billion to be added in the foreign exchange reserves.
The council stated that the magnitude of the Current Account Deficits reflects the growth dynamics of the domestic economy. Undoubtedly, if export conditions improve, a moderation of Current Account Deficit will result.
However, it is quite likely that the magnitude of the deficit will continue to be large and to that extent domestic conditions need to be favourable in order to attract foreign capital inflows, especially non-debt inflows.
Investment conditions at home to a great extent determine its attraction to Foreign Direct Investment, as well as to investors in the equity of Indian companies.
In order to be able to finance these large Current Account Deficits in a manner that does not stress the external payment account, and therefore the otherwise favourable macro-economic growth conditions in the Indian economy, the focus must be on facilitating such capital inflows.
Inflation forecasts up by 50 bps to 7% in end-FY2011E
The Council expects the headline inflation rate to be around 7% with the risk of being marginally higher in March 2011, compared with July 2010 expectations that the WPI headline inflation rate will remain high at 78% till December 2010 and would subsequently drop to around 6.5% by March 2011.
To the extent that there is some greater than expected easing of the downward stickiness in vegetable prices, the headline inflation rate may be marginally lower.
Vegetables, which normally show a pronounced seasonal decline in prices as winter sets in and the supply expands sharply, began to show a contrary trend.
Instead of falling, the normally seasonal decline through November, December 2010 and first half of January 2011 was reversed. Several key vegetable items experienced very sharp increases in price.
As a category, vegetable prices rose by 48% between the beginning of November 2010 and the third week of January 2011.
This was in sharp contrast to the decline of 21% that characterized the change in vegetable prices over the same period in the previous year (2009-10). Three items in particular drove this increase.
The first was onion (94% increase), the second was tomato (144%) and the third brinjal (57%). However, in recent days, the data has shown some degree of decline in the price of the above-mentioned vegetable items.
Provisional WPI for the week ending 29 January 2011 show that the price index for vegetables fell by 17% compared to that in the previous week. The council stated, "Further correction is expected to happen in the subsequent weeks.
However, like in many other things, prices tend to be downward sticky and in our assessment a complete normalisation in the prices of vegetables may not reasonably be hoped for in the time horizon of next one to two months."
The report noted that the rice harvest and procurement, and the expected wheat harvest and procurement, are likely to be comfortable. Pulses output has increased dramatically this year and hopefully some further improvement will be manifest in the next year too.
On the basis of this and assuming that the monsoon is moderately normal, stability in food grain prices may be maintained even in a world where these price changes are quite adverse.
On the non-food primary products side, some easing could be seen in further inflationary movement in raw cotton, although with international edible oil prices rising rapidly there may be some rise in the price of domestic oil seeds and edible oil. International crude oil prices are likely to go up further.
While some rationalization may help to make the enormous shortfalls in revenue for LPG and kerosene more manageable (as has been recommended by several high-powered Committees in the past) there is clearly an overdue need to make some adjustments in the price of diesel, even if this were to be done in a phased fashion. Thus, on the energy price front the only reasonable expectation is further upward price adjustments.
The report notes that energy prices on account of possible reforms would be on the upside along with global prices of basic commodities as "worldwide monetary and fiscal accommodations continue to create conditions where inflationary pressures have considerable headroom".
We continue to expect inflation to be sticky in FY2012E. The PMEAC highlights that macro-economic policies, both on the fiscal and the monetary side and also to some extent trade policies should "re-anchor" inflation expectations to the 4-5% comfort zone.
In conforming to the targets set by the 13th Finance Commission, the Centre's fiscal deficit was planned to be reduced to 5.2% in 2010-11 from 6.3% in the previous year.
Similarly, the revenue deficit of the Centre was budgeted at 4% of GDP which, although was higher than the target set by the Finance Commission (3.2%), was lower than the revised estimate of the previous year by 1.3 percentage points.
In the case of the States, despite larger allowance for borrowing space given to them (4% of GSDP) as a part of the fiscal stimulus package, their aggregate fiscal deficit for 2010-11 is budgeted at 3% of GDP and revenue deficit is estimated at 0.5%.
With the recent upward revision of GDP estimates, the estimated revenue, fiscal and primary deficits as a ratio of GDP are marginally lower.
Thus, the budget estimate of Central government's fiscal deficit relative to GDP is estimated at 5.2% and the consolidated fiscal deficit of Central and State governments is estimated at 8%.
Similarly, the revenue deficit-GDP ratio of the centre for 2010-11 is budgeted at 5.2%. Thus, both fiscal and revenue deficits in 2010-11 were lower than the previous year's revised estimates by 1.6 percentage points.
While the current year's fiscal adjustment may not be a problem, the government faces formidable challenge of conforming to the Finance Commission's targets in the medium term.
According to the targets set by the Finance Commission, the Central government should compress its fiscal deficit to 3% of GDP and increase capital expenditures to 4.5% of GDP by 2014-15.
About one per cent of GDP of capital expenditure is supposed to be financed from disinvestment proceeds and this means that in addition to the borrowings of 3% of GDP, the Centre has to generate a revenue surplus of 0.5% by 2014-15.
Thus, the Centre has to reduce the fiscal deficit to GDP ratio by 2.5 percentage points and revenue deficit to GDP ratio by over four percentage points over the budget estimates.
In addition, there are pressures to increase expenditures on food security, right to education, universalising healthcare and increased wages in MGNREGA and these may require additional spending of about three per cent of GDP.
On the whole, in the medium term, the central government may have to raise additional revenues or reallocate expenditures of about 5 percentage points to GDP and this is going to be a formidable challenge.
A significant proportion of this fiscal adjustment will have to come from additional tax revenues. The two major tax reforms planned to generate additional revenues are the implementation of the direct taxes code (DTC) and the introduction of goods and services tax (GST).
The DTC reform may increase the revenue productivity of direct taxes in the medium term, there may not be significant expansion of the tax base and revenue gains in the short run.
Indeed, increase in revenue productivity will have to come from continued attempts to reform tax administration, review the double taxation agreements and other measures to prevent the flight of incomes to tax havens. Implementation of GST is another reform which can bring about significant improvement in revenue productivity.
GST reform is imperative to achieve the fiscal consolidation goals in the medium term. It is important to implement the reform without much loss of time. This reform is necessary not only to enhance the revenue productivity of the tax system but also to minimize compliance cost and distortions in resource allocation.
The reform undertaken when the economy is on the recovery path results in buoyant revenues and therefore, will be successful. Introduction of GST will be a win-win strategy for both the Centre and States and there is every reason to embrace it.
Global Economic Scenario
The ups and downs in the global financial conditions which have emanated from the sovereign debt crisis in the euro zone have also impacted the currency markets, with the effects not being restricted to just the Euro Dollar pair. The turbulence being witnessed in the global currency markets have led to a strengthening of the US Dollar vis-à-vis India and China.
The recent volatility in the currency markets have acted as pointers of the risk appetite prevalent in the markets. Euro appreciation coupled with Dollar depreciation has been seen as an indicator of a decline in risk aversion, thus underpinning asset prices helped by improved confidence, while the strengthening of the Dollar and weakening of the Euro has been indicative of a rise in risk perception.
The IMF in its latest Update to the world Economic Outlook has not only reiterated the robust growth in emerging and developing economies, but has also mentioned that growth in the US and Japan have shown an uptick. It has also pointed out the possibility of contagion effects of the resurgence of the Euro zone woes and has underscored the need for policy makers to take appropriate steps.
The IMF has mentioned about the sharp increase in inflation rate in many developing countries, it expresses relief due to the subdued inflationary conditions in advanced economies. The IMF is of the view that the "overheating pressures" can be tackled if emerging economies allow a real appreciation in external values of their currencies. The high domestic inflation rates may lead to the erosion of the financial and economic strength that China and India have come to acquire in the past few years. In some other countries high inflation has been the primary cause of civil disturbances with some leading to a change in government.
The monetary and other policy steps taken by the Chinese and Indian governments to tackle inflation have been interpreted as risk enhancive, as such measures would slow down the economies, and have thus led to a weakness in assets prices. But the inherent dynamics point at sustained growth and improvement in general economic conditions in emerging Asia and expectations of an improvement in the advanced economies will be further supportive of growth. Only factor to watch out for is commodity prices which may be pressured due to an improvement in demand from developed countries.
The Council is of the view that the pace of formation of incremental domestic demand is autonomously quite strong and policy must be focused on resolving the elements that persistently result in serious supply bottlenecks across the economy from power to farm output to logistics.
There is a need to lift the range of food grain output to a significantly higher level. Three areas need particular attention. The first is certified seeds of appropriate quality and quantity. The second is the management of water which includes both rainwater harvesting and impounding in surface reservoirs or through recharging ground water and better means of utilizing the groundwater through sprinkler and drip irrigation, as opposed to flood irrigation.
The third challenge is managing soil fertility, where we have seen a decline in the organic content and natural fertility of soil, widespread prevalence of micronutrient deficiency and problems of salinity in certain areas. These are substantial challenges and we must be able to develop a time-bound programme of dealing with these challenges appropriately.
On the external front, efforts must be maintained to bring down the CAD to a more manageable level of between 2.02.5% of GDP. This is desirable to impart much needed stability on the external payments front and to reduce the risk the domestic economy runs from volatility in international financial markets.
However, in order to do this it is necessary, on the one hand, to make our exports more competitive and on the other, to moderate the dependence of the Indian economy on imported fuels to the extent that is possible. While capital inflows have been adequate in the current year to finance the elevated CAD and it is expected this will be so true in the next year also, adequate attention must be paid to take the necessary steps so that the Indian economy is seen to be an attractive destination for foreign investors.
The decline in FDI in the current year is a matter of concern and it is important for policy makers to examine what concerns there may be amongst foreign investors, which has resulted in this outcome and take considered and appropriate steps. The need is also to continue to encourage the flow of other kinds of equity investments and understand and meaningfully act on the concerns that this class of foreign investors may also have.
Another aspect to be paid attention is the physical infrastructure. The pace of infrastructure creation has to be stepped up. The electricity sector is at the same time the single largest sub-sector in this field and is a good illustration. The Eleventh Five Year Plan had envisaged the creation of 78.4 GW of new capacity during the Plan period. At the end of January 2011, total addition to capacity in this Plan period was 32.5 GW.
It now seems unlikely that the aggregate of capacity creation in the Plan period would approach the revised target 62.3 GW assessed in the Mid Term Appraisal barely a year ago, and may more likely be around 55 GW or even lower. The slippage has been of a large order (though admittedly less than in the Tenth Plan) and seemingly continues even as between March 2010 and today.