Countries that grow fast and have low government deficits, inflation and interest rates attract capital flows.
Here five things to know about India's macro-challenges:
Inflation: The Reserve Bank of India has often highlighted the threat of inflation. While the wholesale price inflation eased to 7.18% for December 2012, it is still high, according to RBI governor D Subbarao. This makes any rapid cut in borrowing rates difficult for RBI. This is because sharp cuts in interest rates could fuel more inflation as money becomes cheap. Although inflation is expected to ease in 2013-14, a higher-than-expected government spending due to general elections in 2014 or a sharp rise in commodity and oil prices could limit the downside, credit rating agency CRISIL said in a note.
Current account deficit: India is a net importer of goods and services. Hence, it runs a current account deficit. The latest government data showed that the current account deficit stood at 5.4% of GDP. Exports are slowing and imports continue to stay firm. India relies on foreign capital flows to meet the increase in the US dollar demand. Media reports suggest that the government is expected to conduct road shows to attract more foreign capital. It has also decided to defer the implementation of the controversial General Anti Avoidance rules or GAAR.
Fiscal deficit: The Indian government spends more than it earns in terms of tax revenue and other means. The fiscal deficit equals the money the government has to borrow from RBI to meet the expenditure. To reduce the fiscal deficit, the government has to cut expenditure and raise resources. The government has not succeeded in doing both in a meaningful way, according to a recent report by Kotak Securities. The Indian government is likely to spend close to Rs 3,00,000crore on providing jobs, cheap fuel, food and fertiliser by 2013-14, the report adds. The increased borrowing from the government leads to more demand for money and high interest rates.
Balance of payment: India's transactions with the rest of the world are reflected in the balance of payment. India is a net importer of goods and services. To pay for these excess imports, India has to use external financing. However, in the current economic environment, challenges emerge for this financing. India's overall external debt stands at $ 346bn for 2011-12. This has more than doubled over the past 5 years. "Rising external debt would make India's balance of payment position more vulnerable to global volatility in investor sentiment and related capital flows," said Kotak Securities in a report. The brokerage argues for taking steps to increase exports to manage the balance of payment situation.
Investment growth: An economy needs investment from businesses and governments to stimulate growth. The growth in investment is measured by a factor called gross fixed capital formation. This is rate at which new assets are created. This is hovering around 2% for the past four quarters. RBI data suggests that this is the lowest rate since 2008-09. For an economy to revive, this number needs to look up. During the high growth phase of over 8 per cent between 2004 and 2008, gross fixed capital formation was around 15 per cent, according to the data. This means that companies are holding back investments for new projects.
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