India Going for gold As India’s current-account deficit reaches record levels, concerns are growing over the country’s ability to finance this through foreign investment inflows In his annual budget speech on February 28th India’s minister of finance, Palaniappan Chidambaram, blamed a “passion for gold” for India’s burgeoning current-account deficit, which is thought to have reached nearly 5% of Gross Domestic Product (GDP) in fiscal year 2012/13 (April-March) In terms of arithmetic, he may well have a point: India’s gold imports in 2011/12 reached US$57bn, while the current-account deficit that year was US$78bn Since then, the government has raised import taxes on gold twice, most recently in January 2013, in a bid to curb imports Despite the weakness of the Indian rupee and a 6% rise in the global price of gold, imports of the precious metal are thought to have fallen only slightly, to around US$55bn in 2012/13 India remains the world’s largest consumer, and importer, of the yellow metal Gold accounts for more than 11% of India’s total import bill, surpassed only by that other precious commodity: petroleum—liquid gold In large part, gold is bought domestically as a hedge against inflation The finance minister acknowledged this in his budget speech, proposing the introduction of inflationindexed government bonds to discourage the purchase of gold Such a measure may go some way towards easing the import bill, but does not address the fundamental concerns plaguing the Indian economy: a wide fiscal deficit and inflation Thus far, financing this fiscal deficit has not been difficult for the government Banks are required to invest at least 23% of their deposits in government securities, providing the administration with a captive market domestically for its debt However, this system, while allowing the government to easily finance its deficit, removes a sense of urgency from the monumental task of growing India’s abysmally low tax-take (India has one of the lowest tax-to-GDP ratios in the world, at just 11%) and reining in spending With private-sector financing and investment being crowded out, growth has slumped In October-December 2012 real GDP growth fell to 5% year on year—the slowest pace of expansion in a decade However, inflation remains stubbornly high, and the Reserve Bank of India (RBI, the central bank) has had limited room to ease policy in order to boost growth Meanwhile, despite the government’s efforts since September 2012 to rein in the fuel subsidy bill, they remain generous, and imports of fuel have continued unabated Faced with the combination of slowing growth, sticky inflation and a wide fiscal deficit, the Indian consumer can hardly be faulted for turning to gold to safeguard his assets, and the current-account deficit continues to widen Thus far, India has not had any difficulty in securing the level of foreign inflows needed to finance the deficit The last time India faced a balance-ofpayments crisis (in 1991), its hard-currency reserves had fallen to US$600m and it could barely finance three weeks worth of imports At present, however, the currency is freefloating and foreign-exchange reserves stand at close to US$300bn, making that sort of crisis unlikely Nevertheless, this lust for gold puts pressure on India’s external balance, as it needs to finance these imports, while parking growing amounts of household wealth in unproductive assets Reversing this trend will require structural reforms and fiscal consolidation, rather than simply curbing the supply of gold Faced with the combination of slowing growth, sticky inflation and a wide fiscal deficit, the Indian consumer can hardly be faulted for turning to gold to safeguard his assets, and the current-account deficit continues to widen Sponsored by: I n d ia Looking for silver linings Macroeconomic overview 2 Population 1.22 bn GDP US$ 1,978 bn Real GDP growth 5% Exchange rate LCU:US$ (av) 53.4 Budget balance -5.4% Consumer price inflation 9.3% Stockmarket index 19,426.71 Current-account balance -4.8% India’s economic performance in the year ending March 31st has been lacklustre, prompting much handwringing from business leaders and government officials High inflation— consumer price inflation (CPI) averaged 10.4% year on year in January-February 2013—tight credit conditions, a poor monsoon and political and regulatory instability have all been blamed for the slump According to the Central Statistical Organisation (CSO), real GDP growth (on a factorcost basis) slowed to around 5% in fiscal year 2012/13 (AprilMarch), marking the slowest pace of growth in a decade Although this pace of growth compares favourably with other countries, it is insufficient to meet India’s ambitions: at around US$1,500, India’s per capita GDP is less than onequarter of China’s (around US$6,100) and just over one-half that of neighbouring Sri Lanka (US$2,900) Both domestic and international factors hampered India’s growth in 2012/13 A poor monsoon led to a slowing of agricultural output growth, to 1.8%, from 3.7% in 2011/12 Limited progress has been made on improving irrigation, with over 60% of agricultural land being rain-fed However, attempts are being made to improve the agriculture supply chain, particularly by inviting investment from foreign retailers These reforms have been politically contentious, and although the government allowed investment by foreign multi-brand retail firms, such as Walmart and Carrefour in late 2012, it has left the eventual approval to individual state governments Should state governments proceed with allowing foreign investment, it could have a significant impact on growth in the medium term The agriculture sector accounts for less than 17% of GDP, but employs over one-half of the labour force If investment in agriculture leads to higher levels of productivity, it will boost rural incomes, thereby providing a fillip to domestic demand In turn, this will boost the prospects for India’s industrial sector, as a growing rural middle-class increases its spending on goods such as cars and consumer goods However, as long as agriculture is largely rain-fed, the sector will remain vulnerable to poor or unevenly distributed monsoon rains Government plans to increase the area of irrigated land will be expensive, and if projections of decreasing water availability prove correct, the sector may struggle in the long term The agricultural sector is forecast to grow by around 3% a year between 2013/14 and 2017/18 This rate of growth implies that the decline in the proportion of GDP accounted for by agriculture will continue: the share is forecast to slip to 14% by 2017/18 Many parts of India’s industrial sector recovered strongly following the 2008-09 global financial and economic crisis, with growth averaging over 9% in the period between 2009/10 and 2010/11 In the next two years however, industrial output slumped, growing by only 3.1% on average The mining sector, in particular, has been affected by regulatory delays in obtaining permits and land clearances, as well as allegations of graft in 2012, which resulted in further delays in project approvals Ensuring that land, power and infrastructure are available for industries is key to raising India’s growth rate in the medium term The sector will also be an important means of providing employment for some of the 10m people who enter the labour force each year Thanks to tight cost controls, and also to increases in scale and competitiveness, many parts of the manufacturing sector, including capital goods, automotive and pharmaceuticals, will perform well in the forecast period Annual growth in the industrial sector will average 6% during the next five years, and industry’s share of GDP will decline slightly to 25.1%, from 26.7% at present Gross domestic product (annual percentage change) 12.0 10.0 8.0 6.0 4.0 2.0 0.0 2007 2008 2009 2010 2011 2012 Source: Economist Intelligence Unit 2013 Budget balance (% of GDP) 0.00 -1.00 2007 2008 2009 2010 2011 2012 -2.00 -3.00 -4.00 -5.00 -6.00 -7.00 Source: Economist Intelligence Unit 2013 © The Economist Intelligence Unit Limited 2013 Between 2013/14 and 2017/18, an improvement in business and investor sentiment, as well as monetary policy loosening, will enable real GDP growth to rebound to 7.2% per year on average The services sector—the bulwark of the economy, which accounts for over one-half of total GDP—also slowed, growing by 6.7% this year, down from an average of 9.5% in the 2003/04 to 2011/12 period Nevertheless, the sector will remain the main engine of economic growth in India in the medium term The slowdown in 2012/13 is largely attributable to a decline in private income and consumption The financial services sector, which accounts for nearly one-third of all services, slowed to 8.6%, from 11.7% in 2011/12 With the Reserve Bank of India (RBI, the central bank) adopting a more accommodative monetary policy stance since the start of 2013, and the government attempting to liberalise the banking and pensions sector, The Economist Intelligence Unit expects this subsector to rebound between 2013/14 and 2017/18 Overall servicesector growth will be driven by already strong areas of activity, such as telecommunications, as well as by services in numerous high-potential but currently under-served areas, including healthcare, retailing, hospitality and education In particular, IT and IT-enabled services (ITES) will remain major sources of export revenue The positive effects of past economic reforms, together with demand for ITES, will continue to contribute to a structural shift towards strong growth for India’s economy Services will be the fastest-growing sector of the economy in the forecast period, expanding by 8.6% per year on average, and its share of GDP will consequently rise to 60.5% by 2017/18, from 56% at present After several false starts, since September 2012 the government has undertaken a series of reforms to tackle the burgeoning fiscal deficit and to create new jobs These include the raising of administered fuel prices and the easing of restrictions on foreign investment in leading sectors, including retail and aviation But with the next general election a little over a year away, progress on structural economic reform before then will be limited Regardless of which of the two main parties heads the next government, the rise of state-level and regional parties will mean that the winning party is likely to govern in a coalition (which has been the norm in India for the past two decades) Therefore, the pace of reform in 2014-17 will also be tempered by coalition politics and opposition from vested interests Between 2013/14 and 2017/18, an improvement in business and investor sentiment, as well as monetary policy loosening, will enable real GDP growth to rebound to 7.2% per year on average India’s strong fundamentals—high savings and investment rates, rapid workforce growth and a quickly expanding middle class—will continue to boost economic growth However, a shortage of skilled labour, infrastructure bottlenecks and the difficulties involved in moving from low-productivity agriculture to highproductivity manufacturing will constrain GDP expansion, which will remain well below potential Current-account balance (% of GDP) 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 2007 2008 2009 2010 2011 2012 2011 2012 Source: Economist Intelligence Unit 2013 Public debt (% of GDP) 58.0 56.0 54.0 52.0 50.0 48.0 46.0 2007 2008 2009 2010 Source: Economist Intelligence Unit 2013 © The Economist Intelligence Unit Limited 2013 The information in this report is accurate as of April 2013 About the Economist Intelligence Unit The Economist Intelligence Unit (EIU) is the world's leading resource for economic and business research, forecasting and analysis It provides accurate and impartial intelligence for companies, government agencies, financial institutions and academic organisations around the globe, 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(GDP) is the market value of all officially recognized final goods and services produced within a country in a given period of time This report is sponsored by Aberdeen Asset Management but authored solely by the Economist Intelligence Unit and reflects EIU proprietary analysis of a country’s economic environment and prospects for the future, as well as macroeconomic data and EIU rankings This article does not imply any partnership, agency or joint venture relationship with Aberdeen Asset Management While every effort has been taken to verify the accuracy of this information, neither the EIU nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in the report Some of the information in this document may contain projections or other forward-looking statements regarding future events or future financial performance of countries, markets or companies These statements are 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The positive effects of past economic reforms, together with demand for ITES, will continue to contribute to a structural shift towards strong growth for India s economy Services will be the fastest-growing... party is likely to govern in a coalition (which has been the norm in India for the past two decades) Therefore, the pace of reform in 2014-17 will also be tempered by coalition politics and opposition