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Five Challenges for India in 2013

By Sumedh Deorukhkar and Alicia Garcia Herrero

[This article was produced BBVA Research and is republished here with their permission.]

After a disappointing 2012, India heads for an uncertain 2013. Here are five key challenges we would recommend the Indian economic authorities to focus on.

 The first key challenge will be to start bringing India’s current account deficit to sustainable levels. The deficit has widened to a record 4.2 percent of GDP in 2011-12, far above what the Reserve Bank of India considers to be a sustainable level, namely 2.5 percent of GDP. The key reason for the large current account deficit lies in the trade deficit having ballooned due to India’s relatively poor competitiveness and high dependence on oil and gold imports, which alone account for virtually half of total imports. Boosting merchandise exports through greater diversification across destinations and products are essential to bridge the trade deficit but this cannot be achieved without boosting labor productivity and enhancing transportation infrastructure, especially ports.  With regards to gold, dematerialization, and introduction of inflation linked bonds would help reduce its physical imports of gold. Meanwhile, for oil, achieving greater energy efficiency, aligning domestic oil prices to international ones are a key.

The second challenge is qualitative and quantitative fiscal consolidation: Together with the current account deficit, the stubbornly high fiscal deficit (5.8 percent of GDP in 2011-12) makes the Indian economy more vulnerable to shocks than most emerging markets. India’s twin deficits have adversely affected macro stability by pushing up inflation, undermining growth and leaving limited room for monetary accommodation. India’s fiscal policy has been too loose for too long. The government must focus on quality spending by channeling resources towards infrastructure and human capital investments while reducing unproductive spending, particularly on food, fertilizer and fuel subsidies. Furthermore, the government must implement revenue enhancing reforms by making the tax system more efficient and improving compliance.

The third challenge, very much related to the previous one, is lowering high and sticky inflation. India’s persistently high inflation is fallout of myriad factors that are both cyclical and structural in nature. These include supply side bottlenecks, very high reliance on imported energy and lax fiscal policy. While a loose fiscal policy has boosted aggregate demand, particularly across rural areas, an enabling environment to enhance supply response is missing, thus aggravating inflation pressures. Containing inflation near the RBI’s comfort zone of 4 to 5 percent is crucial to facilitate sustainable growth.

The fourth challenge lies in rebalancing the growth mix in favor of investment: India’s GDP growth is mainly consumption driven in good part due to consumption subsidies.

Eliminating such subsidies will, thus, actually have three positive outcomes: reducing the fiscal deficit as well as excessive consumption which should also help reignite a virtuous savings investment cycle. In fact, since the global financial crisis of 2008-09, India’s savings rate has declined (to near 29 percent from a peak of 37 percent in 2009) amid high inflation and fiscal slippages. Given that India’s investment upturn during the golden years between 2004-2008 was largely financed by domestic savings, a revival in India’s domestic savings is critical for aiding a sustainable upturn in investment. In this regard, the Indian government needs to improve further on reforms execution and policy clarity so as to underpin foreign investor confidence.

The fifth and last challenge is to the boost manufacturing sector: Being a primarily services driven economy, the share of manufacturing has been stagnant at a mere 16 percent of total GDP. India’s Asian peers, such as China, South Korea and Taiwan, have immensely benefited from a strong manufacturing sector, which enables greater employment creation, attracts higher and stable foreign direct investment and bolsters infrastructure development. However, bottlenecks in land acquisition, archaic labor laws, poor physical infrastructure, less favorable tax rules and tight regulations deter manufacturing sector growth in India. Reassuringly, the Indian government has approved a national manufacturing policy aimed to increase the manufacturing’s share in GDP from the current 16 to 22 percent in a decade and in turn create millions of jobs and add capacity to sustain the pace of economic growth. That said, effective implementation of such policy drive will clearly prove difficult given past records.

All in all, although India’s challenges for 2013 look massive, they could still be manageable given India’s huge growth engines stemming from a young and massive population in a deep urbanization process. The Indian authorities must grasp the opportunity of reform in the good times rather than waiting any longer.



Mr. Deorukhkar is the senior economist and Ms. Garcia- Herrero is the  chief economist  at The BBVA Emerging Markets Team

[Photo courtesy of Shutterstock]


Anonymous's picture
What rubbish !

This is probably the most bigoted article on Indian economy that i had read in recent time..... this looks like the product of some under-read, short sighted, American educated indian who thinks that getting an american degree has made him more wise then every other indian on earth and hence he now has the right to show them how to 'develop'... lets you might accuse me of criticizing without rationale - 1- "The government must focus on quality spending by channeling resources towards infrastructure and human capital investments while reducing unproductive spending, particularly on food, fertilizer and fuel subsidies." Ahem ! subsidies are unproductive spending..?? 68.7% of Indians live on less than US$ 2 per day (WB).. and you expect a normal person can buy food, fertilizer , fuel and everything all on market price within 2$?? You have NO idea of the effect subsidies have on the hungry fact u have no idea about the hungry masses at all...Subsidies are a tool for the unemployed, the economically disadvantaged, the rural poor, the downtrodden, the socially backward, the innocent lot who unfortunately in reality dont even get a trickle of the benefits which should presumably trickle down to them out of the So-called 'rapidly rising Indian economy' 2- "While a loose fiscal policy has boosted aggregate demand, particularly across rural areas, an enabling environment to enhance supply response is missing, thus aggravating inflation pressures." Loose-fiscal-policy-has-boosted-aggregate-demand?? Seriously? that's like saying Beggars CAN be choosers ! Those benefited by our fiscal policy - those who are advantaged by schemes and subsidies are still way poor to assert free market choice. The only demand that has boosted is that of the upper middle class and that too without any influence of the national fiscal policy but because of the fad-like consumerism fueled by Foreign Investment.. 3-"India’s GDP growth is mainly consumption driven in good part due to consumption subsidies." This is SO blatantly and outrageously illogical at face value. Nevertheless I ll assume that this consumption you are talking about refers to the produce that the govt. purchases at market price to subsidize later. Now firstly those who undertake consumption subsidies are too poor to affect the market substantially with their what matters here are numbers.. And even if it is, Then its the poor farmers who are getting benefited by this secure demand base So if the producer and the consumer both are benefitting, and if the govt. is playing the part it should play here, why the fuck should any foreign based policy group writer have a problem with that? 4- "The fifth and last challenge is to the boost manufacturing sector" WOW, we SO didnt knew about that one !! Hell-lo !!! YOU, yes you, the ruddy world banks and the IMFs were the one who forced us to skip manufacturing and jump straight from agriculture to services way back in the early 90' practically forced us to adopt your scheming 'Structural Readjustment Programs' threatening us with removing international aid when our economy was still crawling.. all because of that American goods can find new markets ! so that you can flush in all your surplus to Asia and force it down the peoples throat while holding them from not manufacturing their own products for their own markets! Building up manufacturing helps a growing economy at a particular time in a very natural course of events.. you cant just cut it out of the timeline and paste it into the future..back then when we could have held on for some time and focused on building a base we would have been totally unemployment and poverty free today ! And today when its already hard to build something in this country, they want to force down crony capitalistic monsters- the criminal oil companies , the mining giants with blood on their hands and the godforsaken Walmarts on us in the name of 'creating infrastructure' and 'Foreign-Direct-Investments'. Actually it was way back in the early 90's ..That was when we got colonized all over again..that was when Nehru's great idea of the Democratic-SOCIALIST-Republic died..that was when we sold our country... and now you wanna sell it all over again with your poorly informed, propaganda-impacted, western-interest-driven ideas.. One doesnt needs to be a communist to see why the teeming Indian masses still need subsidies, schemes and socialist policies.. Please spare a rational thought...or two.

Anonymous's picture

On subsidies, there is little doubt on the intention and that they have indeed helped create an essential social safety net for India. However, poor targeting of subsidies and an ineffective enabling physical and social infrastructure has increasingly contributed to fiscal stress with limited progress on poverty alleviation. India's food subsidies, which have tripled since 2006, are mainly driven by increasing procurement and carrying costs, which are the main domestic drivers of higher cost of food grains. Subsidised food and fuel such as kerosene & LPG are intended for the below-poverty line and have a ration card to prove their economic status. However, NSSO data reveals that about 50% of poor rural households did not have a BPL card and in some states such as Bihar, it was as high as 80%. This results in red tapism as large share of PDS items are illegaly sold, diverted to non-household use or hoarded. A recent report by TERI estimates that the adulteration of diesel may have cost state governments up to USD 224 mn in foregone excise duties from diesel sales in 2005-06. Market distortions are common as well, as exemplified by the growing number of private vehicles that run on diesel rather than petrol. Even with LPG cylinders,the uptake is largely skewed towards urban affluent households. Only 12% of rural households have access to LPG compared to 65% in urban households (NSSO data). Even fertilizer subsidies are concentrated geographically on a relatively small number of crops and producers. Against this backdrop, one finds that the current subsidies structure for India is infact long term regressive and not sustainable from a fiscal as well as growth perspective. The answer lies in gradually moving towards a more effective direct cash tranfers system, which is much better targeted, eliminates abnormal profits gained by the middlemen, reduces dependence on supply side bottlenecks and creates fiscal space for investment in infrastructure.
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