Global rating agency S&P has reaffirmed India’s sovereign ratings, noting that growth will gradually recover over two-three years. It has also said India is experiencing a cyclical, rather than a structural, economic slowdown. S&P’s optimism notwithstanding, the latest data on industrial production and inflation signals that the wait for revival will be longer than expected. Industrial output, as measured by the index of industrial production (IIP), declined by 0.3 per cent, year-on-year, in December. IIP growth during April-December was a meagre 0.5 per cent. While mining improved by 5.4 per cent in December, manufacturing output declined by 1.2 per cent, and electricity generation also contracted. Meanwhile, the retail inflation rate went up to a 68-month high of 7.59 per cent in January. An increase in headline inflation despite some moderation in food prices indicates that inflation has become more broad-based. Clearly, inflation and the industrial production data do not present a pleasant picture of the economy. The Reserve Bank of India in its latest policy review had stated that there was policy space for future action. However, if inflation becomes more broad-based, it will be difficult for the central bank to cut policy rates further in the near term.
There have been some positive developments, of course. For instance, the Purchasing Managers’ Index for both manufacturing and services has registered a sharp jump in January. The third-quarter results show that the balance sheets of some public-sector banks have improved, raising hopes that the flow of credit to the productive sectors would increase. But these positive indicators should not be mistaken for a broad-based recovery. Investment by foreign portfolio investors, a rising stock market, and higher foreign exchange reserves, highlighted by the finance minister recently, do not always present the correct picture of the economy. For instance, research shows that the flow of foreign portfolio investment, to a large extent, depends on the availability of liquidity in the global financial system. Since there is ample liquidity in the system, thanks to the accommodative monetary policy in advanced economies, inflows are likely to remain strong. Intervention in the currency market to avoid appreciation in the rupee is resulting in higher foreign exchange reserves.
Also, the benchmark stock market indices do not reflect the state of the economy. A quick analysis of corporate results shows that the rise in profits is concentrated in sectors such as banks and oil refineries. Net sales at the aggregate level have gone up by just about 2 per cent in the third quarter. This again suggests that the economy remains in a weak spot. It is possible that a lower base will push growth in different areas, but those numbers should be read carefully.
Further, global uncertainty on account of Coronavirus could affect output in the near term. The Indian pharmaceutical industry, for example, imports many of its active ingredients from China. Although the impact on global output is not yet clear, the drop in crude oil prices suggests that it could be significant. The government should use the opportunity provided by the oil price drop to strengthen its finances. It has done well by not trying to push up economic growth through higher government expenditure, which could have increased macroeconomic risks. Instead of a turn towards protectionism, which does not augur well for a sustainable recovery, the government should continue to push reforms to improve the ease of doing business and enhance growth potential.