Can India’s level of economic growth continue?

Wednesday, October 13, 2010 | Posted by: Grant Thornton
Categories: India, India Watch Issue 10 | Tags: business, India, finance, investment, economy, growth, India Watch, infrastructure, GDP, South Asia, Alex Wright, inflation

Over the last quarter, India’s economy has continued to grow at a significant rate. Nevertheless, doubts still remain as to the extent to which India’s level of growth can be maintained. The prohibitive combination of considerable inflation rates and years of underinvestment in the country’s infrastructure continues to prove an obstacle to growth.

India’s economy grew by 8.8% year on year in the three months to June - 0.2% higher than the growth in the first quarter of India’s financial year (January – March 2010). As highlighted in India Watch 9, this level of growth seems unforeseen given the global economic backdrop; however, as long as India’s domestic demand – the country’s main source of economic growth – continues to increase, the future of India’s GDP growth look set to continue.

However, as mentioned above, there are concerns that the level of growth achievable will be severely restricted by the country’s infrastructure, which requires vast spending increases in order to reach the necessary standard to support economic growth. The country’s relatively weak fiscal position has and will continue to limit its ability to fund capital projects and, clearly, external investment is going to be vital for any meaningful infrastructural development to really take-off. This is an issue which has been much-commented upon, however, the issue still remains. Increased spending on India’s infrastructure is vital and, furthermore, the level of bureaucratic red tape surrounding infrastructural development urgently needs to be addressed by local governments.

As we move into the final quarter of the calendar year, inflation also continues to hamper India’s growth strategy. The most recent inflation figures saw India’s wholesale price index – the main measure of inflation – at 8.5% year on year in September. As reported by the Economist Intelligence Unit, this figure is down slightly from the double-digits seen in previous months but it nevertheless remains high. The primary reasons for this are related to supply and demand issues, such as food prices, which have increased dramatically over the year due to last year’s poor monsoons; fortunately, this year’s monsoons have been good and the resulting normalisation of food prices should help create downward pressure on the current inflation rate.

However, a more significant risk to inflation comes from rising wages in India. Inflation-driven wage increases are naturally being fed in to the price of manufacturing and, should wages continue to rise, the knock-on effect could have a detrimental impact on manufacturing costs and sector wage demands across the country, creating an even more unmanageable spiral of inflation.

The Reserve Bank of India (RBI) – India’s central bank – has again been trying to curb the significant level of inflation by raising interest rates. On 16 September, the fifth raise of the year was announced, with the reverse repurchase rate being increased by 50 basis points to 5%. The benchmark repurchase rate was also increased this quarter, to 6%, an increase of 25 basis points.

A question which remains from last quarter’s economic update is “Is the RBI doing enough to curb India’s inflation?” Whilst there are benefits to the slow implementation of increased interest rates, in India’s case, more drastic measures are still needed. Fortunately for the RBI, as already discussed, a return this year to more normal monsoon patterns should help curtail inflation rates, however, because of the effects of the RBI’s slow implementation of suitable inflationary management measures and the increasing number of factors that are now feeding into the inflation problem, the consequence may linger well into India’s economic future.

Whilst India continues to be one of the fastest growing economies in the world, with a plethora of economic opportunities to be found nationwide, there are still a number of issues which the current and future governments will need to address -  issues ranging from the countries huge power deficit to its rigid labour laws.

By no means am I suggesting that India should follow the pattern of the western world, as we all know where that could lead, but that it should take confidence in its own thriving economy and international relations and build upon them. The following was written in India’s ‘The Financial Express’ over two years ago and the points ring as true today as they did then:

‘[India’s] unreformed public sector is a huge barrier to two things a growing population needs. The first is a faster rate of sustainable growth: the government’s debts and its infrastructure failings set a lower-than-necessary speed-limit for the economy. The second is to spread the fruits of a growing economy to India’s poor.’

It is over two years since these points were raised, and not for the first time, raising a realistic fear that these words will still be relevant in twenty years’ time. India must actively seek and support external investment into the country and more hard hitting economic policies must not be shied away from.

Alex Wright

Executive

Capital Markets, South Asia Group

For Grant Thornton UK LLP

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