Friday, March 02, 2012

India Shows Signs of a Slowing Economy

India’s economic growth rate slipped to an annualized 6.1% in the fourth quarter of 2011, the lowest growth rate in nearly three years. This growth rate marks the seventh consecutive quarterly slowdown in India and a steep drop from the 6.9% growth rate in the third quarter of 2011. In 2007, India’s economy grew 9.5%, but growth slowed to 8.4% in the last two years and is expected to fall to somewhere between 6.5% and 7% in the fiscal year ending in March.

One reason for the slower economic growth is very high interests rates in India (the official interest rate is at 8.5%), which gives businesses and consumers an incentive to save their money rather than spend it, lowering demand for goods in the economy and limiting economic growth. High interest rates have lowered corporate investment from an average of 18% of GDP in the previous five years to 14% of GDP in 2011. Furthermore, high borrowing costs have stifled the growth of the manufacturing industry, which only grew at an annualized rate of 0.4% in the fourth quarter of 2011—a three-year low.

While other Asian countries have cut their interest rates to promote economic growth in the wake of the global economic slowdown, India has not because it is struggling to rein in inflationary pressure. This inflationary pressure is due, in part, to an increasing government fiscal deficit that has pumped extra cash into the economy. Lower tax revenues due to the slowing economy, along with expensive oil subsidies and a rural worker employment-guarantee program have contributed most to the increased deficit. The money for oil subsidies and the employment-guarantee program increases demand in the economy by ensuring consumers have more money available to spend, but with the supply of goods staying stable, prices rise due to simple supply and demand principles. India’s 2011-2012 fiscal deficit has swelled to an estimated 6% of GDP, which is higher than its 4.6% target, and up from an average of 3% of GDP in the previous four years. Since the inflation rate is so high, the Reserve Bank of India has been unwilling to cut official interest rates. Lower interest rates would encourage businesses and individuals to spend rather than save (borrowing would be cheaper and saving would not provide as high a rate of return), which would further increase demand and push inflation even higher, destabilizing prices and creating a risky atmosphere for foreign investors who worry that prolonged inflation will decrease the value of their assets.

The Reserve Bank meets on March 15th and there are indications that it will cut interest rates to promote economic growth. However, this decision is far from certain. India faces a unique mix of high inflation and slowing growth, and these pressures could increase because of rising oil prices. Higher oil prices cause inflation because producers face higher costs to provide the same amount of goods (e.g., heating, gasoline, and manufacturing products) and pass the cost on to consumers in the form of higher prices.

India is in a difficult position. The Indian government has so far been unwilling to control its spending which has contributed to inflationary pressures, but with high inflation the Reserve Bank has been unwilling to cut interest rates which would increase inflation, but promote economic growth as well. Unless India can manage this problem, it may have to grow accustomed to disappointing economic growth rates in the future.

1 comment:

preeti said...

Nice post. In the recent survey's shows that Indian economy growth slips a bit in the year 2011-12 to 6.9%. 6.9% growth is the lowest economy growth after the year 2008.

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