Indian Economy: Hard or Soft Landing in 2011?

Pakistan's economy had a hard landing in 2008. It was triggered by a balance of payments crisis brought about through precipitous decline in foreign capital inflows combined with policy inaction in response to major external shocks in terms of food and fuel prices during political transition. Is the Indian economy similarly vulnerable in 2011? Is it headed for significant slowdown in the next twelve months? And if it is, can the Indian leadership manage a soft landing through major policy actions now?

To answer these questions, let us examine the following facts:

1. India's current account deficit widened sharply to $13.7 billion in the June-quarter, which was around 3.7 per cent of GDP. The deficit was $4.5 billion in the same period year ago.



2. India's FDI has declined by a third from $34.6 billion in 2009 to $23.7 billion in 2010. Its current account deficit is being increasingly funded by short-term capital inflows (FII up 66% from $17.4 billion in 2009 to $29 billion in 2010) rather than more durable foreign direct investment (FDI), posing a risk to external balance and funding of gap, according to a recent warning by Goldman Sachs. "Nearly 80 per cent of the capital inflows are non- FDI related. Given the excess spare capacity globally, FDI may remain weak going forward," the Goldman note said.





3. Inflation in India is running at a double digit pace as is credit expansion. India's primary articles price index was up 15.35 percent in the latest week compared with an annual rise of 13.25 percent a week earlier, data on Thursday showed. Year-over-year credit growth was 23 per cent till December 3, while deposit growth was only 15 per cent, as compared to RBI's projection of 20 per cent and 18 per cent, respectively, for 2010-11.



4. India's Food and fuel prices are continuing to rise by double digits. The food price index rose more than 12 percent, with the price of onions -- the country's most widely-eaten vegetable -- of especial concern, while the fuel price index climbed 10.74 percent. This compared with 9.46 percent and 10.67 percent respectively in the previous week.

5. The oil prices are likely to spike as the American and European economies recover in 2011, prompting Indian commerce secretary Rahul Kullar to acknowledge that “I am not sanguine. One blip on crude prices and my import bill suddenly zooms. On pro-rata basis we are looking at $ 120 billion with a caveat that if oil prices go up, it could be $ 130-135 billion”. Crude oil prices are currently running at $ 87-88 per barrel.



While China's situation is better because it enjoys significant current account surpluses and has strong capital flow controls, it is also seeing its economy overheat along with India's economy. Joseph Stiglitz, a Nobel Laureate Columbia University economist, has argued that India is more vulnerable to an asset bubble than China, saying that “strong economies that don’t yet have capital control become the focal point” for the liquidity injected by the US Federal Reserve. Stiglitz thinks that India, more than China or Brazil, should watch out for the tidal wave of money made available from the Fed’s quantitative easing. Mike Shedlock, an American investment advisor, believes that "India and China are going to overheat and crash, or their economic growth is going to slow dramatically, quite possibly both".

Indian President Pratibha Patil said last week that she is confident the economy will grow at about 9 percent in the current fiscal year ending March 2011 and would be on a sustained growth path of about 9 to 10 percent in FY12, according to Reuters. It is quite surprising that the Indian government continues to talk about increasing levels of economic growth in 2010-2011 and beyond amidst growing inflation and rising imbalances in the Indian economy. What they should be thinking about now is how to manage a soft landing by reducing liquidity and cutting India's twin deficits, rather than stepping on the accelerator and risk a big economic crash with long term negative consequences.

Related Links:

Haq's Musings

China's Trade and Investment in South Asia

India's Twin Deficits

Pakistan's Economy 2008-2010

Inflation Hits India

Goldman Sachs India Warning on Twin Deficits

India's Nov 2010 Imports, Exports

Pakistan Economic Growth to Hit a Five Year Low

Pakistan's central bank expects economic growth will come in between 5.5 percent and 6 percent in fiscal 2008, which ends June 30, down from 7 percent the previous year. This forecast comes on the heels of dire talk of economic "meltdown" by the new leadership that is facing serious political instability amid serious differences in the PPP-PML(N) coalition government. The ongoing unease with new leadership is continuing to accelerate loss of confidence in Pakistan's economy by businesses, investors and consumers.

In a quarterly report released Saturday, the State Bank of Pakistan said the economy was showing "increasing signs of stress" as a result of both homegrown and international factors. A disappointing wheat harvest will likely impact the key agriculture sector, while chronic power shortages - both households and businesses face regular load shedding - have slowed industries including steel and textiles, it said.

With the dramatic rise in international commodity prices, the food and fuel subsidies have contributed to the government's rising budget deficit, which the central bank said would reach 6.5 percent to 7 percent. The deficit was just 4.3 percent in fiscal 2007. With imports rising faster than exports, the central bank said Pakistan's current account deficit will rise between 7.3 percent and 7.8 percent - a record high.

State Bank has raised interest rates from 10% to 12.5%, the rupee is in free fall, the dollar reserves are disappearing and both S&P and Moody’s have cut Pakistan’s credit ratings.

KSE 100 index lost 2992 pts during May 2008 starting at 15122 & ending at 12130. The index lost 879 pts during the week ended May 30th , 2008, at a nine month low.

Credit-default swaps on Pakistan's government debt increased 10 basis points to 530 in Hong Kong, according to Morgan Stanley's prices. That means it costs $530,000 a year to protect $10 million of Pakistan's debt from default for five years.

The impact on the working poor is already apparent from the longer lines of people waiting for free food from charities, according to a BBC report. "Laborers started appearing in the beggars' queues some three years ago, and have now become a dominant element," says Mohammad Azeem, who supervises the distribution of food to beggars at Sabri Hotel in Karachi. According to Mr Azeem, the queues have grown longer during the last couple of months that saw the Pakistani rupee shed nearly 10% of its value, undercutting its purchasing power.

In the crisis situation that exists, strong economic and political leadership is needed to rescue the economy from imminent collapse. Unless the PPP and the PML(N) leadership deal with the situation on war footing, Pakistan could slide back to the near bankruptcy situation that existed in 1999 prior to the Musharraf-led coup against Nawaz Sharif's government.