Double whammy of high inflation, slow growth


By Heather Timmons and Lydia Polgreen

India’s central government, already convulsed by a series of corruption scandals, is under increasing pressure to nip rising inflation and shore up growth.

On Tuesday, the Indian government said inflation had increased 9.1 per cent in May, more than expected and the latest cloud in a gathering storm of troubling economic data. Indian companies are spending less, gross domestic product growth has slowed, foreign investment is down and bad loans are piling up at some banks.

While India’s long-term prospects remain strong, the country’s central government needs to act quickly to ensure these short-term problems do not intensify, a growing number of economists, investors and analysts said.

India faces “an unpleasant trinity of moderating growth, high inflation and monetary tightening,” said Rajeev Malik, senior economist for CLSA in Singapore. “It is very important that the government gets its act together and begins to do something.”

The Central government, led by prime minister Manmohan Singh, has been rocked by allegations of corruption and investigations into sweetheart deals worth billions of dollars. The scandals have paralysed decision-making and stalled development projects.

Long-term prospects for India, the second-fastest-growing major economy, after China, continue to look bright. The country’s youthful population, expanding middle class and increased demand for everything including highways and refrigerators mean it will become the world’s third-largest economy, after China and the United States, by 2030, Standard Chartered predicted this month.

Still, a recent flurry of negative economic indicators has set the stage for a rocky year. While inflation is a worry in most emerging markets, lapses and policy missteps by the government have exacerbated the problem, critics say.

In the first three months of this year, India’s gross domestic product growth slipped to 7.8 per cent from 8.3 per cent in the previous quarter, falling short of estimates by analysts and the government. Investment growth slowed in the second half of the year that ended March 31 to 4.1 per cent, down from 14.7 per cent at the beginning of the year. Foreign investment in the first three months of 2011 fell 32 per cent from the year before to $3.4 billion.

Bad loans are creeping up at India’s government-run banks, particularly at the largest, State Bank of India. In the quarter that ended March 31, the bank doubled the amount of provisions for nonperforming assets from the previous quarter, according to Enam Securities, in Mumbai.

On Tuesday, the Organisation for Economic Cooperation and Development, a group of leading free-market democracies, released a largely upbeat report on India’s economic prospects but warned that without deeper overhauls the country would struggle to sustain its growth targets.

“Moving to a new level of growth will require renewing the momentum of reforms,” said Angel Gurria, secretary general of the OECD. He called for lower barriers to international trade and investment, as well as overhauls of the financial sector and the labour market.

Each of those issues is enveloped in a political thicket, and the current government has shown little willingness to attempt changes. The OECD report highlighted India’s low spending on health, at just 1 per cent of the country’s GDP, and the country’s high spending on energy subsidies, at 9 per cent of GDP.

Montek Singh Ahluwalia, deputy chairman of the Planning Commission, acknowledged that the economy was growing more slowly than the target of 9 per cent to 9.5 per cent set by officials. He said that getting changes on the agenda had been difficult. And reaching growth targets, he said, was “not going to happen automatically – there are things that need to be done.”

Inflation, meanwhile, threatens to become an even bigger problem if agricultural productivity does not improve, said C Rangarajan, head of the prime minister’s Economic Advisory Council.

On Thursday, the Reserve Bank of India raised interest rates for the tenth time since March 2010. The decision may further limit growth but have little effect on inflation, because of structural problems in India’s food distribution, subsidies and infrastructure, analysts said.

Revising interest rates is generally considered a blunt instrument in straightforward and organised economies. In India, where the economy is fractured and complicated by everything from fuel subsidies to infrastructure bottlenecks, the central bank’s clout is even more dulled.

Rising food prices

Even as food prices skyrocket, the government has failed to fix a distribution system that means about 40 per cent of India’s agricultural products rot before being eaten, analysts note.

“You still need to develop your farm to fork model,” said Rohini Malkani, an economist with Citigroup in Mumbai including improvements in warehousing and transportation. Even though these problems have been discussed by the government, progress has been very limited, she said.

The government’s inaction on infrastructure and food distribution is helping drive up inflation, but the same government is exacerbating this problem through farmer-friendly policies like raising minimum prices for food and grains. “The last two years have been a lost opportunity” for the United Progressive Alliance government, Citigroup analysts said this month in a report.

The party’s victory in 2009 fuelled high expectations of a strong change-oriented agenda, which would address issues as varied as banking regulation, land acquisition and pension problems. “Two years down the road, the UPA has disappointed on most counts,” Citigroup said.

Kaushik Basu, the government’s chief economic adviser, said on Monday that inflation was a problem all developing countries were facing. “If you look at emerging economies around the world, India’s performance looks pretty run-of-the-mill,” Basu said.

He said recent scepticism about India’s growth prospects had been overblown. “Just like you have irrational exuberance occasionally you have irrational pessimism as well,” he said. “My own view is that for the full year, growth will be a little less than what we were forecasting. But all the long run indicators like investment and savings are going in the right direction.”

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