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India's Economic Problems: Difficult Road Ahead?

Yet history suggests economic development is like a game of snakes & ladders. There is no
straight path to the top, and there are fewer ladders than snakes which mean that its much
easier to fall than to climb."
-Ruchir Sharma, Chief Financial Analyst at Morgan Stanley Investment Management Inc,
in 2012.
"While global factors such as tensions over Syria and the prospect of U.S. Federal Reserve
tapering its policy of quantitative easing have caused general weakness in emerging market
currencies, the rupee has been especially hit because of our large current account deficit and
some other domestic factors."
-Manmohan Singh, India's Prime Minister, August 30 2013.
"In India, the combination of large fiscal and CAD, high and persistent inflation, sizable
unhedged corporate foreign borrowing and reliance on portfolio inflows are longstanding
vulnerabilities that have now been elevated as global liquidity conditions tighten, and this
clearly has affected market confidence."
-Gerry Rice, Spokesman International Monetary Fund (IMF), August 30 2012.
On August 28, 2013, the value of the Indian rupee vis--vis
the US dollar plummeted to a record low of INR68.80. The
stock market took a plunge and BSE SENSEX on August 28,
2013, touched an intra-day low of 17,720, down a whopping
13.6 % from January 2013's high of 20,500. Experts pointed
out that the Indian economic condition in 2013 was the worst
since 1991.
The Indian economy had posted good growth during 2003-2007 with growth rates averaging 9%.
In 2008, growth moderated due to the global financial crisis. Starting 2012, India was showing
signs of deceleration. According to a report by The Central Statistics Office (CSO), in the first
quarter (April-June) of the fiscal year 2013-14, India's economy grew at its slowest in the
previous four years and recorded a growth rate of 4.4%. Inflation was running high at above 7%
since December 2009; Current Account Deficit (CAD) was expanding to record levels; several
projects were reportedly stalled due to policy bottlenecks. The investment climate was not seen
as
encouraging by
corporates.
Parallels were drawn with the situation India faced in 1991. But observes felt that Manmohan

Singh (Singh), Prime Minister of India (2004-2014), who as the Finance Minister in 1991, had
initiated bold reforms that helped a turnaround of the economy, was not able to placate the
criticism that the government was lacking concrete action. Though Singh said there was no need
for panic, analysts were skeptical, since the government continued to roll out populist policies
giving out huge subsidies, like the Food Security Bill (FSB) in September 2013. With elections
for the parliament due in 2014, the atmosphere was highly charged with opposition parties'
waiting for every opportunity to criticize the government. In the absence of an absolute majority
in the parliament, the ruling UPA government was in a tight position.
Problems on Many Fronts

As a result of Indias slowest economic expansion since 2009, BNP Paribas, Frances biggest
listed bank, sharply cut India's GDP forecast to 3.7% for fiscal 2014, from an earlier estimate of
5.2%. Economists pointed out a number of economic challenges facing the Indian economy, the
major ones being rupee depreciation; widening current account deficit; falling investment levels;
inflation, and fiscal deficit.

Rupee Depreciation
In the fiscal year 2012-2013, the rupee depreciated by roughly 10% against the dollar. According
to the Ministry of Finance, the rupee depreciation was "due to decline in exports on account of
euro-zone crisis and widening of trade deficit, as imports remained resilient due to high oil prices
and gold imports." A trade deficit of 10.2% of GDP in 2011-2012 created volatility in the supplydemand balance in Indias domestic foreign exchange market, which placed a downward
pressure
on
the
rupee.
The average exchange rate of the rupee per US dollar ranged between INR51.81 in April 2012
and INR56.03 in December 2012. On June 27, 2012, the rupee touched an all time low of
INR57.22 per US dollar, which was at 10.9% depreciation over INR51.16 on March 30, 2012.
On October 05 2012, the rupee appreciated to INR51.62 per US dollar. However, thereafter, the
rupee began declining and the monthly average exchange rate of the rupee ranged between
INR53.02 and INR54.78 per US dollar between October and December 2012. Such volatility in
the rupee increased uncertainty in India's domestic market and impacted business confidence in
2012.
The rupee's volatility continued in 2013 also. The Indian rupee, which was around INR54 against
the US dollar at the beginning of the year, fell to a record low level of INR68.80 on August 28,
2013. The slide of the rupee started in May 2013 and by August 2013 it had lost 20% of its value
against the dollar. Increasing oil prices as a result of the Syria conflict, widening CAD, and
capital outflows intensified the rupees fall in August 2013... .

Current Account Deficit

According to the Reserve Bank of India (RBI), India's current


account deficit , swelled to US$87.8 billion (4.8% of GDP)
during 2012-2013, from US$78.2 billion (4.2% of GDP) in
2011-2012. The reason behind India's swelling current
account deficit in 2012 was lower exports and higher imports
of oil, coal, and gold. Morgan Stanley, a global financial
services firm, estimated that India's current account deficit
stood at US$93.9 billion (5.1% of GDP) in 2012, just behind
that of the US in absolute terms. Such a high current account
deficit was expected to weaken India's economic growth, as it
created a situation wherein investors dumped the country's
assets...

Falling Investment
The growth rate of the Indian economy since 2003-04 showed a correlation with the investment
rate. For instance, the GDP growth was lower in the years 2008-2009 and 2011-2012, when the
growth rate of investment was low. One of the major economic problems which India faced in
2012-2013, was lack of investments happening in the country. According to Harish Damodaran,
Reporter and Editorial Analyst of The Hindu Business Line, "The economy's main problem
today is investment, not fiscal and current account deficits that will take care of themselves."...
Fiscal Deficit
India's fiscal deficit widened to 5.7% of GDP in 2011-12, according to the Economic Survey
201213 report. A high fiscal deficit was a cause of concern for the Indian economy as due to it,
inflation increased; monetary policy expansion became constrained; external sector imbalances
widened; and investment growth and employment took a hit. This resulted overall in weak
economic growth in 2011-2012...
Inflation
High inflation since 2009 had been the most challenging issue for policymakers in India. The
inflation rate in India was based on the Wholesale Price Index (WPI). Inflation, as measured by
the WPI remained above 7% since December 2009. During 2010-2011, it was as high as 11.1%
and in 2011-2012 it was around 7.2%. Since the WPI included a higher number of products, it
was given more importance than the Consumer Price Index (CPI) in India. The weight of
manufactured products was 65% in the WPI basket...
Outlook

India's economic situation in 2013, according to some, was a repeat of 1991, which was the
worst economic crisis of India. However, analysts opined that the situation was not as bad as in
1991, as India had reserves to pay seven months of imports in 2013, compared to just 15 days in
1991.
India's growing economic problems in 2013 were a matter of great concern, especially its large
current account deficit and rupee depreciation. Apart from this, the Indian Prime Minister's
economic advisory council (council) opined that containing fiscal deficit at 4.8% of GDP could
be a challenge for the Indian government...
The case discusses the major economic problems faced by India in 2012-2013 and how these
problems were caused. The major economic problems included: rupee depreciation; widening
current account deficit; falling investment levels; fiscal deficit; and inflation. In the first quarter
(April-June) of the fiscal year 2013-14, India's economy grew at its slowest in the previous four
years and recorded a growth rate of 4.4%. As a result of India's slowest economic expansion
since 2009, BNP Paribas, France's biggest listed bank, sharply cut India's GDP forecast to 3.7%
for fiscal 2014, from an earlier estimate of 5.2%. In the fiscal year 2012-2013, the rupee
depreciated by roughly 10% against the dollar. By August 2013 the slide of rupee intensified
with it loosing 20% of its value against the dollar. Increasing oil prices as a result of the Syria
conflict, widening current account deficit, and capital outflows intensified the rupee's fall in
August 2013. Apart from it, India's current account deficit, swelled to 4.8% of GDP during 20122013, from 4.2% of GDP in 2011-2012. The reason behind India's swelling current account
deficit in 2012 was lower exports and higher imports of oil, coal, and gold.
In 2012, on the investment front, several projects were reportedly stalled due to policy
bottlenecks. The investment climate in India was not seen as encouraging by corporates. The FDI
inflows to India decreased by 29% y-o-y to USD26 billion in 2012. The reason for this
significant decline was India's slowest growth in a decade and high inflation which increased the
risks for foreign investors. Along with declining investments, another major economic problem
which India faced was its increasing fiscal deficit. India's fiscal deficit widened to 5.7% of GDP
in 2011-12. Analysts were skeptical that government would be able to contain its fiscal deficit, as
it continued to rollout populist policies giving out huge subsidies, like the Food Security Bill
(FSB) in
September
2013.
High inflation since 2009 had been the most challenging issue for policymakers in India. In the
fiscal year 2012, food inflation remained an area of concern as it was contributing to an average
of one third of total inflation. The case study goes into details of as to why India was facing such
wide-spread economic problems and what steps the Indian government had initiated to combat
these problems.
On

the

basis

of

above

text,

discuss

the

following

questions:

Which
are
the
major
economic
problems
which
an
economy
faces?
Study the concept of currency (rupee) depreciation and discuss the pros and cons of currency
depreciation.
What are the reasons behind Indias falling investment levels and its correlation with economic
growth.
Discuss
why
Indias
current
account
is
widening.
List
the
reasons
behind
Indias
ballooning
fiscal
deficit.
Examine the concept of inflation and discuss how harmful it is for the Indian economy.
Study the steps taken by the Indian government to overcome its economic problems and
analyze
whether
they were appropriate.
Discuss ways in which India could combat its major macroeconomic problems.

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