2011 set to be a key year for India’s economy

Friday, January 21, 2011 | Posted by: Grant Summers
Categories: | Tags: India, finance, investment, economy, Grant Thornton, global, growth, India Watch, UK, risk, Grant Thornton India, international, aim, GDP, economic, Capital Markets, Alex Wright, FTSE, sectors, India Economy

As we say farewell to 2010,  we can take this opportunity to reflect upon the economic environment in India over the past year and also the opportunity to focus on some of the key areas of economic importance for the year ahead.

The first half of 2010 saw significant year on year growth, with GDP ranging between 8.5% and 8.8%. The year, however, was not without its problems, as highlighted by the Economist Intelligence Unit (EIU), economic activity in both the manufacturing and service sectors in India slowed in the 3rd quarter of the year while infrastructural development and investment continued to cause concern, along with India’s ‘old friend’ inflation.

After hitting the 16% level at the start of 2010, the annual rate of consumer inflation dropped to 9.8% in the last quarter of the year. This was due mainly to increased monetary policy and slower food price inflation seen earlier on in the year. The EIU estimates that consumer price inflation will continue to decelerate in 2011, to an average of 6.8% (11.9% in 2010). This estimation, however, assumes that there are no sharp rises in commodity prices or a failure of the monsoon. Unfortunately, with oil prices currently rising, this forecast might have to be revised rather sooner than envisaged.

Furthermore, the Indian Government, having ended the state control of petrol and diesel prices in June, might have to reinstate these controls should oil prices continue to rise – a real blow to what could have been a significant benefit to public finances.

While the EIU estimates a decline in inflation in 2011, we consider that with increasing wage pressures - especially in respect to the urban middle classes - rising commodity prices and a slower growth momentum, inflation levels are actually at risk of seeing an increase this year.

On the political front, the Indian National Congress-led United Progressive Alliance (UPA) coalition government continued their second term in office, however, the UPA has found passing important legislation incredibly difficult as the ruling party does not hold a working majority in the Lok Sabha (the lower house of the Parliament of India) and it is in a minority in the Rajya Sabha (the upper house of the Parliament of India). With key legislative policies not being passed, India’s short-term economic recovery efforts are being hampered.

In addition to this, with a number of state elections planned, the lack of focus on new legislative policies could further impact India’s reform strategy. While the current government is expected to see out the remainder of its term in office (ending 2014), the recent corruption scandals has gone to weaken the country’s economic position even further, especially in respect to the country’s attractiveness to Western investors – a country which can’t agree on important reform policies and suffers from gross corruption is most likely going to deter foreign investors and we don’t need to remind anyone of India’s increasing need for Foreign Direct Investment (FDI).

With regard to FDI over the year, 2010 saw a significant decline in total value. From January to October 2010, FDI amounted to around $17.4 billion, a 27% decline from the corresponding period in 2009. While the political factors mentioned above might have contributed to this decline, the responsibility was not theirs alone. According to report from the World Bank, ‘World Investment and Political Risk’, FDI across the globe saw a decline. The report went on to say that “Multinational enterprises were hit hard by the global economic recession and financial crisis of 2008. Slower global growth in 2008 and 2009 squeezed their profitability, while global economic uncertainty, weak global demand and the credit crunch affected their willingness and ability to expand overseas”. Even though 2009, saw relatively high levels of FDI, the ongoing global economic instability which continued throughout 2010 resulted in these ‘multinational enterprises’ holding back investment. However, even in light of this, India was ranked second only to China in the amount of FDI it received in 2010 and forecasts hint at FDI into India increasing significantly from 2010 levels.

Nevertheless, in conclusion, 2010 did not quite live up to expectations. A number of issues including those mentioned above, along with a sizable fiscal deficit continued to hamper India’s growth strategy. Furthermore, as thing stand today, there are no indications of upcoming policies or economic changes which will rid the country of these issues. A report from ‘seekingalpha.com’ even went as far as stating that “India enters 2011 facing many of the same risks from early 2008”.

In many ways this is an accurate assessment of where the economy stands. India’s Sensex Index is close to 20,000, a level not too far away from pre-credit crunch levels and, with no significant change to the fundamentals of the companies within the Sensex Index, can these valuations remain? The country’s own finances also continue to cause concern with the fiscal deficit of the central government at a high of around 6.8% of GDP. The likely effect of all these persistent troubles is a reduction in FDI, a fall in the value of the rupee and a slow decline in the country’s GDP. In the short term, 2011 is set to be a key year for which route India’s economy is set to go down. Will it make a sustainable recovery or will it continue to struggle against a number of internal pressures?

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Executive, Capital Markets

Grant Thornton UK LLP

Other articles in this issue of India Watch include:

Grant Thornton India Watch shows significant growth in 2010

Indian cross boarder M&A closes the year on a high

The UK Bribery Act. Is your organisation adequately prepared?

Proposed amendments to UK’s takeover regime and its potential impact on acquisitive Indian companies