While addressing a crowd of industrialists and mediapersons in the national capital last week, Finance Minister Pranab Mukherjee was upbeat about the country’s economy. Taking even the most optimistic observers by surprise, the minister said that the economic output would expand 7.5-8 percent in 2009-10, a far higher expectation than the initial forecast of 6.7 percent. He didn’t stop even there. The growth rate, according to Mukherjee, will return to 9 percent in two to three years!
The finance minister’s optimism soon reflected in the equities markets. The benchmark index of the Bombay Stock Exchange, Sensex, soared 539 points the same day and a further 129 points on the next day i.e. Thursday to close at a 19-month high of 17,360.61 points. The Nifty of the National Stock Exchange also rose to close at 5,178.40 points, its highest since May 5, 2008.
This turnaround story was surprising given the predicted impact of the global financial crisis. At the beginning of 2009, market analysts across the world had warned of a sharp erosion of capital in equity markets that could leave the real economy in perils.
Contrary to these claims, Sensex surged nearly 113 percent from its year’s low of 8,069 points, outperforming most of its peers.
The recent indications show that the real economy is also recovering from the effects of the global slowdown. Indian economy grew 7.9 percent in the second quarter this fiscal, the fastest pace in six quarters, as against 7.7 percent in the like period last year. The GDP growth in the April-June quarter was 6.1 percent.
The growth in the second quarter was mainly powered by a surge in the industrial production. The factory output expanded 9.2 percent year-on-year, signalling a strong recovery in one of the worst-hit segments of the slowdown.
Foreign direct investment (FDI) flow into the country also jumped 60 percent in the first eight months this fiscal, while exports, the worst-hit sector by the slowdown, registered 18.2 percent positive growth for the first time after 13 months in November.
The Other Side of Recovery
Good signs galore. But are they enough to claim that the recovery is sustainable? According to the government’s critics, it is a “stimulus-powered” recovery. Since the collapse of US investment giant Lehman Brothers in September 2008, the government has announced three stimulus packages to help the industry to weather the downturn. Besides, the Reserve Bank of India (RBI) slashed key rates to pump liquidity into the financial system and strengthen the credit flow to industries.
Moreover, the government’s decision to implement the Pay Commission recommendations has boosted domestic demand, which got a further fillip during the Lok Sabha elections.
The key question is, what will happen to the economy if the government withdraws the stimuli? The ruling class will have to take some brave decisions in the new year which may have far reaching implications on the economy. The biggest challenge before the government is to put a cap on the runaway food prices without jeopardising the growth sentiments.
Though the finance minister and Planning Commission Deputy Chairman Montek Singh Ahluwalia have reiterated many times that high food inflation is a result of supply constraints, it’s still not clear whether the RBI would hike rates when it reviews the monetary policy next month.
If the central bank decides to give up its cheap money policy, it will certainly have an impact on the industrial sector as banks may turn reluctant to lend more. If the central bank retains the low rates, the government will have to look for alternatives to contain inflation.
Another major concern is the performance of the global economy. Unless the global economy stabilises, exports from the emerging countries would not pick up. Although the exports registered positive growth for November, it’s mainly due to the low-base effect of the year-ago period.
Exports declined 22.3 percent to $104.2 billion during April-November this year from $134.2 billion in the corresponding period last fiscal.
Planning Commission deputy chief had last week said exports were unlikely to return to the pre-crisis levels unless there’s a robust recovery in the advanced developed countries. Even the most optimistic forecasters say it will take at least five years for the industrialised economies to return to the pre-crisis growth rates.
So what can India do? According to Ahluwalia and many other like-minded optimists, the fundamentals of the Indian economy are strong and the government should take measures to stimulate domestic demand to make up for the losses caused by the exports decline. Will that be possible without breaching the fiscal rectitude? Well, one has to wait and see.
India entered 2009 with little hope and many apprehensions. At the beginning of the year, equity markets were down, industrial and agricultural output was plummeting and the money supply was facing constraints. In sharp contrast, when we are set to welcome 2010, the macro economy is better placed. But it still remains to be seen whether the recovery is sustainable or not.