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What has suddenly changed for the Indian economy?

07 May, 2015

India had everything going for it over the last one year. Political stability with a new non-coalition dependent central government in decades and crude oil price more than halving and thereby placing India’s current account deficit in a comfortable position. Not surprisingly, the stock market indices shot up by more than one-third, making India one of the best performing markets globally.

With inflation finally being reined in partly due to lower fuel prices, the central bank also cut interest rates twice in a span of as many months.

A change in methodology to calculate GDP also pushed India as the fastest growing large economy in the world and foreign investors lapped the story.

But just five weeks into the new fiscal and many of these positive vibes seem to be dissipating. The stock market has tanked over 10 per cent in the last two months and rupee is at the lowest level in almost two years.

So what has changed?

Lack of bolder on-ground reforms is one reason for the change in sentiment. Narendra Modi-led BJP government came to power last year, highlighting the corruption and mismanagement of the economy by the Congress in its 10-year rule. The incumbent prime minister promised better governance and a set of much needed reforms to set the economy on a higher growth trajectory. While the government has been successful in ensuring some measures to improve the ease of doing business and setting up India as the preferred FDI destination, many believe less has happened on the ground.

While the government has been able to pass some crucial legislation pertaining to the minerals and mines act, FDI in defence and insurance sectors, it has failed to muster support for several others such as the land bill legislation which still remains in an ordinance stage. The other crucial tax reform related to GST has passed in Lok Sabha where the government already has a majority but faces tough test in bringing political consensus to see it through the Rajya Sabha. The government does not have the required number of seats in the upper house of the Parliament to implement GST as it aims to by April 2016.

Political pundits now question whether the government can even think about tougher reforms such as those related to labour laws.

The government’s stand-off on the minimum alternate tax (MAT) issue has also eroded confidence of the investors. MAT is a tax for those not covered under corporate income tax. While Finance Minister Arun Jaitley had promised not to go after foreign investors with retrospective tax demands, the MAT demand letters has led foreign portfolio investors knock on the doors of the court.

Crude, rupee, interest rates and rains

One of the key drivers of improving economic prospects in the country was lower crude oil prices. However, a bounce back in the oil prices with Brent crude oil futures climbing to $68.55 per barrel on Tuesday has fuelled fears that the rising prices would spell trouble for the Indian economy.

Brent crude futures have increased 40 per cent since the start of the year but are still below the $100 mark that they were hovering around a year ago. This spells trouble for two reasons. One is the impact on import bills and thereby current account deficit and the other is the impact on domestic fuel prices leading to a rise in inflation.

Indian oil companies increased the price of diesel and petrol a week ago to adjust for the rising prices; they may have to realign prices again with the further spurt adding to inflation woes.

“Assuming that the prices are going to increase substantially, then definitely it will have an impact on prices and given the fact that we have mark to market substantial part of our oil products, it will lead to higher inflation which will put higher pressure as far as RBI is concerned. As long as we are within the $60-70 band it shouldn’t be major issue,” said Madan Sabnavis, chief economist at credit rating agency CARE.

RBI is now targeting 4 per cent consumer inflation with a margin of +/- 2 per cent. Although consume inflation in March—the last month for which the government has compiled national statistics—was comfortably at 5.17 per cent, the recent rise in oil prices may push it up.

The possibility of a poor monsoon (although two agencies have come with contrasting forecast of the monsoon) this year could also lead to food prices going up. Coupled with higher fuel prices, it has raised the spectre of return to the old days where the two formed a deadly cocktail leading to stubborn inflation.

All this spells bad news for those looking at lower interest rates to boost investments and thereby growth in the economy.

“Higher oil prices will also have an impact on the fiscal side as the subsidy element would tend to increase,” Sabnavis added.

Higher crude prices can also wreak havoc for the country’s current account and for the Indian currency. The Indian rupee, which had strengthened against its peers, hit the lowest level in almost two years on Thursday and this means bad news for foreign investors as they get to repatriate less in dollar terms for their capital appreciation in local currency.

Then there is a fundamental issue in the stock market—that of corporate earnings not matching up to the investment euphoria.

On the positive side, some analysts expect a few of these issues to be part of a passing phase and the stock market slide as a healthy correction.

(Edited by Joby Puthuparampil Johnson)


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What has suddenly changed for the Indian economy?

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