Indian Economy Growth during Global Recession - Essay Example

? Growth of the Indian Economy Immediate to the Global Recession Introduction The problem of economic recession that countries in the developed world are facing has drawn the attention of the communities around the world, eclipsing other concerns like global warming and the humanitarian crisis in the Continent of Africa. The financial crisis in the developed world has led to economic recession in almost all the developed countries, including its leading lights of the United Sates of America and the European countries of United Kingdom, Germany and France (1). According to predictions form the Organization for Economic Cooperation and Development, the economic recession in the developed world will have a deep impact on the developed world and last for a long time. (2). 2. Growth of the Indian Economy From a pre-independence average growth of 0.9 % in the Indian economy in the first fifty years of the twentieth century, the Indian economy started to demonstrate accelerated growth in the last decade of the twentieth century, with the economic growth touching six percent. The new millennium witnessed even higher GDP growth rate at an average of 6.9% in the seven year period 2000-2001 to 2006-2007. The acceleration in the economic growth becomes even more evident in from the growth in GDP between in the four years of 2003 to 2004 till 2006-2007., where the average growth in GDP stands at 8.6%, which grew in 2005 to 2006 higher at nine percent and even higher to 9.6% in the year 2006-2007. (3). In 2006-2007 the high growth rate was maintained at 8.7%, though dropping from the high of the previous years. In 2008-2009 the real growth in GDP is estimated to remain high ranging between 8% and 8.5%. (4). Two features stand out in this acceleration in growth of the Indian economy. The first is that there has been a significant moderation in the volatility, with particular reference to the in industries and services sector. The second is the main driving force behind the accelerated growth has been domestic consumption, which is estimated to almost two-thirds of the total demand. (3). The strong economic activity in the last decade has received support from the strong financials of gross domestic investment and domestic savings rate. The gross domestic investment, which was 24.3% of GDP in 2000-2001 rose to 33.8% in 2005-2006. The domestic savings rates also rose from 23.7% in 2000-2001 to 32.4% in 2005-2006. Domestic savings was a critical factor in the gross domestic investment contributing about ninety percent of it. (3). In the 1990s India opened out its international trade policy, initiating reforms to create a new market oriented environment. The structural adjustments and the economic reforms that resulted from these initiatives were to have a strong impact on the Indian economy, particularly with regard to the positive flow of foreign direct investments (FDI). (3). Table -1 shows the year wise FDI inflow into India. Table -1 FDI Inflow into India 1992-1993 to 2008-2009 Year FDI in US $ Million 1992-1993 193 1993-1994 654 1994-1995 1,374 1995-1996 2.141 1996-1997 2,770 1997-1998 3,682 1998-1999 3,083 1999-2000 2,439 2000-2001 2,908 2001-2002 4,222 2003-2004 3,134 2005-2006 2,634 2006-2007 3,754 2007-2008 1,270 2008-2009 1,447 (5). India has demonstrated better fiscal management in the new millennium that has caused a clear drop in the fiscal deficit of the Central Government and the State Governments. In 2000-2001 the fiscal deficit was 9.5%, which diminished to 6.4% by 2006-2007. (3). However, this rosy picture on the fiscal front has changed since the economic recession, which has forced the government to take money spending initiatives to stimulate growth in the economy, besides the political compulsions of an election year. The forecast of the Central Government on the fiscal deficit for the year 2008-2009 is 6% of GDP. This is well above the targeted fiscal of 2.5% for the year 2008-2009 and is a cause for concern on the health of the Indian economy. (6). The growth of the Indian economy has seen a significant rise in its foreign exchange reserves. The foreign exchange reserves of India are comprised of Foreign Currency Assets (FCA), Special Drawing Rights (SDR), Gold and the Reserve Tranche Position in the IMF (RTP). The foreign exchange reserves have seen a steady growth since 1991, when the foreign exchange reserves stood at $5.8 billion. At the end of the 2006-2007 financial period, in March 2007, the foreign exchange reserves had risen to $199.2 billion, and rising further to US$ 309.7 by March 2008. The downtrend in the economy of the developed world has led to an erosion of these foreign exchange reserves, as result of which the foreign exchange reserves dwindled to $286.3 billion by September 2008. (7). The erosion of the foreign exchange reserves of India continues in an environment of continuing recession, so much so that by March 2009, the foreign exchange reserves had gone down to $243.3 billion, an erosion of $66.4 billion in a period of one year. (8). Table -2 Movement in Foreign Exchange Reserves of India Date FCA SDR Gold RTP Foreign Exchange Reserves (US $ million) 31.03.06 145.108 3 5,755 756 151,622 31.09.06 158,340 1 6,202 762 165,305 31.03.07 191,924 2 6,784 469 199,179 31.09.07 239,954 2 7,367 438 247,761 31.03.08 299,320 18 10,039 436 309,723 31.00.08 277,300 4 8,565 467 286,336 (7). India is the country that enjoys the largest quantum of worker remittances, and this contributes significantly to the foreign exchange reserves of the country. Worker remittances have a strong influence on the growth of the foreign exchange reserves. (8). Table – 3 Worker Remittances (2002-2007) Year Worker Remittances in US $ million 2002 16,285 2003 21,885 2004 20,012 2005 23,909 2006 29,247 2007 38,219 (8) Foreign trade is another component that has contributed to the significant growth in the Indian economy. In 2002-2003 exports were $52.72 billion, while imports were 61.41 billion. In 2008-2009 exports had risen to $144.26 billion and imports to 243.34 billion. Table 4 Foreign Trade (2002-2003 to 2008-2009) Year Exports in US $ million Imports in US $ million 2002-2003 52,719 61,412 2003-2004 63,843 78,149 2004-2005 83,536 111,517 2005-2006 103,091 149,166 2006-2007 126,414 185,735 2007-2008 127,454 194,285 2008-2009 144,266 243,358 (8) The growth in the economy has fueled domestic demand in the country, where the numbers of the middle income are growing, as more numbers of the population move into this stratum of economic classification. By 2005 the middle income group had grown to 250 million in India, making up about 25% of the total population. The middle income group is expected to 400 million by the year 2025, were India to continue to grow at the same pace it has demonstrated in the very early stages of the twenty-first century. The strength of demand from the middle income group, with an increasing appetite for consumerism has led to 3. Strengths of the Indian Economy to Sustain Growth India entered the period of recession in the developed world on a strong note on foreign exchange reserves in that it had nearly $300 billion available to it in terms of foreign exchange reserves (8). This large amount of foreign exchange reserves puts India on a strong footing to fight the negative impact of the recession on the growth of its economy. The government has the money to take the necessary initiatives for public spending to boost industrial activity and encourage consumer spending. There has been an erosion of $66.4 billion in a period of one year. Yet, the foreign exchange reserves still remain large and sufficient to support government initiatives to ward of the negative effects of recession in the developed world. (9). Though global factors have had a role to play in the growth of the Indian economy, there is no denying the significant role played by the gross domestic savings and domestic demand. The gross domestic savings continue to be sustained at nearly 35% of GDP and should help to encourage continued growth in the Indian economy. (10). A key feature of the gross domestic savings is the continuing dominant position of household savings, which continues to remain stable against a drop in the public sector savings and fluctuations in the private sector savings. Traditionally savings is the established norm in households, even during the times of limited economic growth. The period of economic well-being that India has enjoyed has only added to the housing savings component in the gross domestic savings and is unlikely to be swayed by the recession being experienced in the developed world. (11). The Indian banks were not exposed to the toxic assets that caused the plummeting of the banking sector of the developed world. Furthermore the checks and balances within the banking system of India would make it difficult to be involved in too risky investments. Traditionally the Indian banking system has been averse to taking too much risk. This factor along with the lack of complex financial products and strong central bank interventions has prevented the Indian banking system from being buffeted by the winds of the financial turmoil in the developed world. The robust standing of the banks and their financial strength is a blessing for the continued growth of the Indian economy, for the banks are in a position to provide the finances required for sustaining the growth activities in the various segments of the Indian economy. (12). Corporate India balance sheets continue to present picture in comparison to many counterparts in the developed world. Shares of Indian corporate companies took a beating as shares in the stock exchanges around the world plunged in response to the news of recession in the developed world. The downward trend has not just been turned around, but the gains have been impressive, reflecting confidence in Corporate India and their balance sheets and an indication of the strength of the domestic demand that has succeeded in dampening the impact of reduced demand from the developed world due to the slide into recession. Multinational companies have found relief from bad results in the results that have been achieved in India. ABB India presented a net profit of $ 50 million, while the parent company reported an 88% drop in its international earnings in the fourth quarter. The software giant Oracle reported global earnings drop by 0.7% for the period October to December 2008, while its Indian operations posted a 74% profit. In a similar vein the profitability of Maruti Suzuki in India helped to cushion the losses of Japanese car maker Suzuki. (13). 4. Impact of Recession on the Economic Growth of India There are signs of slow down in the economy of India since the recession in the developed world. The real GDP for the period January 2008 to December 2008 was 7.45% as against 9.2% in the corresponding period of the previous year. (14). In the last decade the balance of payments was on the positive side. Figures from the balance of payments data for the quarter 2008-2009, show a deficit for the first time in ten years. The capital account has a deficit or net outgo of $3.68 billion against a positive inflow of $31.27 billion during the previous year. The deficit or net outgo has resulted from portfolio investment of $5.79 billion, banking capital %4.96 billion, and shot term credit of $3.14 billion. A large merchandise deficit of $ 36.31 has caused a higher current account deficit. The only silver lining is the continued strong showing of the IT sector and its exports (8). In this period of recession many countries are combating deflation, and there is apprehension that India could slip into deflation. Deflation can be taken as a situation, where the prices fall in tandem with the drop in economic output. These fears have arisen from the economic data of India. In August 2008, the inflation rate based on the wholesale price index (WPI) had risen on the back of sustained increasing trend to reach the highest inflation rate in thirteen years of 12.91%. Subsequently inflation starting dropping and it was believed that this drop was a result of the initiatives of the government and a benefit to the economy of the nation. However, by the first week of march 2009, the WPI had slid to 0.44 %, which slipped further to 0.27%, leading to concerns that inflation would slip into negative territory. At the same time significantly the Index of Industrial Production (IIP) had already turned negative at 0.4%, by October 2008, demonstrating a negative growth for the first time since 1993. Since then the IIP figures have fluctuated and by January 2009 it was at -0.5%, which is well below the 6.2% that was seen in January 2008. It is this combination of falling prices and drop in industrial output that has caused alarm bells to ring regarding the possibility of the Indian economy slipping into deflation. The government denies this possibility and is putting together a stimulus package to ease these worries. The impact of this stimulus package is still to be felt. (15). Table – 5 Trends in Industrial Output Segment of Industry Percentage Growth April-Jan 2007-2008 Percentage Growth April-Jan 2008-2009 Manufacturing 9.3 3 Electricity 6.3 2.6 Mining 4.9 2.7 (15). The decline in growth in the industrial sector is a result of several factors, starting with high price of inputs in early 2008, which could not be passed on due to the drop in demand influenced by the worldwide recessions. High prevailing interest rates and the unwillingness of banks to provide real relief in drop in interest rates despite pressure from Reserve Bank of India to do so and action from the side of the Reserve bank of India in the for of drop of REPO tares by 25 basic points. (16). Domestic demand which was one of the driving forces for the economic growth and a supposed buffer against the consequences of recession in the developed world has begun to lose its cushioning effect. Drop in employment by IT majors and mirrored across all segments of industry has and the worries on job security have reduced domestic demand and its buffering strength against recession in the developed world. (14). There is another area of likely stress to the Indian economy. There is significant contribution to the foreign exchange reserves by worker remittances. The recession in the developed world and the protectionist policies that these countries are adopting will have a negative effect on foreign worker remittances and through that on the foreign exchange reserves. (14). 5. Discussion Substantial foreign exchange earning to the tune of $300 billion dollars were in India’s favor to buffer the effects of the recession in the developed. This large foreign exchange reserves would make it possible for the government to take initiatives to encourage domestic demand and thereby sustain growth. There has been an erosion of the foreign exchange reserves by $66.4 billion, but a drop in domestic demand has opened up in some sectors of industry, whereby IIP has slipped into the negative, calling for more action on the part of the government. Coupled with this is the alarm that is raised by the low rate of inflation, which is hovering between the 0.25% and 0.50% mar, bringing on fears of deflation. To offset this, the government action will have to be strong to rally domestic demand to get industry back on the rails. These efforts are likely to take a heavy toll on the foreign exchange reserves, thereby causing heavy erosion of foreign exchange reserves. This would come at a time, when one of the contributing factors of worker remittances would face reduced flows, because of the recession in the developed world and the protectionist policies are being seen in the developed world. Therefore on one side the there will be an erosion of foreign exchange reserves and on the other there will be a reduced inflow of foreign exchange reserves. This means that the buffer of foreign exchange reserves is time dependent and an extended recession in the developed world would lead to the loss of this buffer and the Indian economy loosing steam in its growth. Domestic demand has been touted as a bulwark for developing economies like India against the recession in the developed world. In a world of globalization, domestic demand soon gets conditioned to what is taking place elsewhere in the world. Hiring by organizations has fallen and with that has come arisen the worry of job security. Against this backdrop, domestic demand is bound to slacken and weaken further in an environment of continued recession in the developed world. The longer the recession in the developed world, less effective will be the factor of domestic demand in propping up the economic growth in India. The healthy banking sector is of use only if its health is utilized to help the ailing industrial sectors in the face of recession. High rates of interest for industrial loans are maintained by banks, in spite of lowering REPO rates means that industry is left high and dry for liquidity at a time when it is essential. The healthy banking sector remains a chimera of no use to strengthen the Indian economy. It will become useful only when easy liquidity is made available to the industries. This has to be done immediately otherwise the winds of recession will topple the Indian economy, no matter how healthy the banking sector remains. Corporate balance sheets remain robust only in an environment of high profitability. The lack of external markets and the drop in domestic demand will cause a reduction in profitability, as business organizations try to maintain their market shares. A clear indication that price lines are low is evident from the low inflation of between 0.25% and 0.5% being experienced in the Indian economy. Such low inflation is bound to reflect on the corporate balance sheets with the passage of time and the robustness will no longer be there, removing this factor also with sustained recession in the developed world Works Cited 1. “World Bank: Recession in developed countries, sharp slowdown in developing countries inevitable”. 2008. Xinhua News. 22 April 2011. . 2. Jolly, David. “OECD predicts protracted recession in developed world”. 2008. International Herald Tribune. 22 April 2011. . 3. Reddy, Y. V. “Some Perspectives on the Indian Economy”. 2007. Petersen Institute for International Economics. 22 April 2011. . 4. Reddy, Y.V. “Indian economy on stable growth mode”. 2008. CommodityOnline. 22 April 2011. . 5. “INDIA: YEARWISE FDI INFLOWS”. 22 April 2011. . 6. “India’s fiscal deficit a concern: Fitch Ratings”. 2009. The Wall Street Journal. 22 April 2011. . 7. “Half Yearly Report on Foreign Exchange Reserves”. 2008. Reserve Bank of India. 22 April 2011. . 8. “Current Statistics”. Economic & Political Weekly 44.14 (2009): 76-77. 9. “BRIC economies withstand global financial crisis”. 2008. Euromonitor Archive. 22 April 2011. . 10. Reddy, Y.V. “Indian economy – prospects for growth and stability”. 2008. Address by Dr Y V Reddy, Governor of the Reserve Bank of India, at the Institute of South Asian Studies, Singapore, 20 May 2008. Bank for International Settlements Review 64/2008. 22 April 2011. . 11. “'Domestic savings rise, public savings decline”. 2006. Expressindia 22 April 2011. . 12. Maheswari, Shushmul. “Strong Foundation Saving Indian Banks from Fallout”. 2009. Free Press Release. 22 April 2011. . 13. Sinha, Vivek & Bhushan, Ratna. “India bright spot in MNC gloom story”. 2009. The Economic Times. 22 April 2011. . 14. “Indian Economy Outlook 2009-10”. 2009. Federation of Automobile Dealers Association. 22 April 2011.. . 15. Goswami, Anupam. “Dangerous Dip”. Business India. April 19, 2009. 16. Sheshan, Sekhar. “The meltdown threatens to spell disaster for industry”. Business India. April 19, 2009. Read More