Fear of economic deceleration now looms large

Three months ago when the Finance Minister Pranab Mukherjee presented his Union Budget, he was gung ho about the Indian economy moving on to a higher growth path.

His exuberance came from the fact that in terms of most macroeconomic indicators, be it the growth in GDP (gross domestic products), tax collection or industrial production, the economy was firing on all cylinders. But, now, all of a sudden Mukherjee seems to have lost his enthusiasm and fears a slowdown.

The government is already wary that the overall revenue collection targets in the current fiscal may be adversely impacted. As the rate of inflation refuses to come down, there is a lurking fear among the key policy makers that the growth rate of the Indian economy, could moderate to around 8 per cent against the earlier projection of 9 per cent.

Slower GDP growth can have wide range of impacts like lesser volume of production leading to contraction in revenue collection both in the Direct Tax and Indirect Tax fronts. The trouble is that all these are happening at a time when the Indian economy is just about recovering from global slowdown triggered by the US financial meltdown.

As the latest GDP data shows while in the first three quarters of fiscal 2010-11 the economy witnessed growth momentum posting growth rate of 9.4 per cent, the fourth and last quarter (January to March 31, 2011) recorded a lower growth rate of 7.8 per cent. Worse, the growth in industrial production in April was just 6 per cent, half of what it achieved in the same month last year. Already, in the fiscal 2010-11 the overall growth of the industry has dropped to 7.8 per cent as against 10.5 per cent in the previous year.

Weak spots

Recent decline in pace of economic growth was primarily due to poor performance of the key manufacturing sector accounting for 80 per cent of the industrial production index.

Steep hike in interest rates by the RBI, nine times in the last 14 months, has taken its toll on industrial activity as the cost of money has gone up nearly 30 per cent in the recent months.

Industry gears that to contain inflation by monetary measures, a stated objective of the central  bank, interest are likely to be raised again. As a worried FICCI Director General Rajiv Kumar forecasts “growth in the manufacturing sector is going to slowdown in the coming months because banks have raised interest rates further. This will also affect investments in the sector.”

The profitability of the manufacturing sector in the last quarter had fallen as a result of the steep rise in prices of commodities and raw materials, the apex chamber says. The other key sector of the industry that witnessed sharp decline in the growth rate relates to that of the key capital goods segment.

Experts say that decline in capital goods growth rate indicates a slowdown in investment demand. Though it is little bit early to conclude that slowdown will prevail all throughout the current fiscal, Mukherjee is worried. At a recent meeting of the senior tax officials he has expressed doubts over achieving the target of revenue collection in the current fiscal.

“It will be challenging to achieve high revenue targets we have set for ourselves…Global recovery is very slow and sluggish. Doubts are being raised over growth projection of 9 per cent for the current fiscal,” Mukherjee said.

Echoing similar views Finance Secretary Sunil Mitra has cautioned that the government could miss the revenue collection targets during 2011-12 primarily on account of high inflation and moderating economic growth. “Inflation can affect domestic demand and thereby adversely affect economic growth and consequently our revenue collection,” he feels.

Global factors

The global economic scenario is not very encouraging either. As international oil prices continue to rule very high, most oil importing countries including India are suffering from high inflation leading to contractionary fiscal policies by respective governments.

In a globalised world, economic situation in other large countries, specially developed economies like USA, countries in Europe, Japan, determines the global economic growth.

On this front the picture is quite gloomy. America’s economic recovery is far slower than was expected despite nearly $1,500 billion dollars pumped into the economy by way stimulus packages. Recent fall in new job creation numbers and higher unemployment rates are pointers to this. In fact, in a recent interaction, the US Federal Reserve Chief Ben Bernanke offered a relatively glum view of the US economy acknowledging that it growing slower than the Fed had predicted.

Europe is in trouble as weaker countries like Ireland, Spain, Portugal, Greece in the Euro zone have not seen much of economic recovery although billions have been spent in these economies as booster packages. Some of these countries are now in need of fresh bailout packages, which relatively well off countries like Germany and France are finding difficult to accommodate.

Moreover, there is no clear sign when the Japanese economy, world’s second largest, will start recovering from the devastation caused by the recent earthquake and tsunami. The most disturbing possibility is a slowdown in China.

Chinese government, in a bid to contain inflation, is taking several measures to cool down the ‘overheated’ economy. As a result, China, a major driver of global growth through its large consumption of commodities, is cutting down on its imports of commodities like coal, sponge iron, iron ore, cotton, copper, etc. “What we’re seeing now is a moderate slowdown in China,” lead World Bank economist in China Ardo Hansson recently said. “A moderation in high growth is something that could be welcome,” he told state-run China Daily.

Tight situation

As the government virtually has no elbow room to cut down expenditure, which in fact is set to grow because of mounting subsidy bill on heads of food, fertilizer and oil and increasing political pressure to allocate more money to fund populist socio-economic welfare schemes, it can hardly afford any decline in revenue collection.

This year the government is unlikely to see any unexpected revenue bonanza like the Rs 100,000 crore collected by selling telecom licenses last year. Besides, it is too early to expect that the government will be able to raise funds to the tune of
Rs 40,000 crore from PSU disinvestment as targeted in the Budget 2011-12.

Fall in revenue collection coupled with rise in expenditure will only further widen the fiscal deficit—the net difference between the expenditure and income of the government. The Budget pegs the fiscal deficit at 4.6 per cent of the GDP in the current fiscal. A widening fiscal deficit apart from pushing up inflation and frustrating the process of fiscal consolidation can thus disturb the overall fiscal equilibrium of the economy.

Thus government has to be vigilant against any slippage in the target of revenue collection, which holds key to maintain fiscal equilibrium and sustain ongoing fiscal consolidation. The only ray of hope at the moment is the possibility of a near normal monsoon and stabilisation of prices of farm products. Good monsoon will also enhance the purchasing power of the rural India, providing the much needed boost. If the global oil prices soften, that will also help us contain some of the damages.   

(With reporting by Dilip Maitra from Bangalore)