The Indian Economy in a Downward Spiral

The previous articles discussed how the Indian economy was able to weather the fallout from the global economic crisis in the initial phases in the years 2008-’10. This was mainly because the government buffeted the economy from the strong headwinds of the crisis by providing stimulus packages to industry and boosting exports. Further, the government did not hesitate to pursue a loose monetary policy as was the case in the West albeit for different reasons.

The steps taken by the government had the intended effect which when coupled with the flows of hot money from the West in search of attractive returns meant that the Indian economy grew at a good rate of 7-8% when the rest of the world was slowing down. However, in recent months the sheen appears to have come off the India story and with the recent downgrade of Moody’s and Standard and Poor’s of the creditworthiness of the Indian economy; it appears as though the economy is on a downward spiral.

The reasons for this situation lie in the spiraling fiscal deficit which for the first three months of this financial year is already over the budgeted limit of 4.5% of GDP and is currently at around 6% of GDP.

Since the gap in the fiscal deficit is funded by domestic borrowing and by printing money, both options make investment crowded out of the public and private sector as well as raising inflation in the process. Since the Inflation has been stubbornly high, the RBI has pursued a tight monetary policy and has stopped propping up the government and the rupee as well. This is aimed at preventing stagflation and deflation though the rate of growth has come down drastically. Coupled with the policy paralysis or the stasis as the government’s economic advisors have put it, the resultant situation has been a case of inertia and slowdown at a time when energetic responses are needed to the crisis.

The other aspect is that the ratio of bad loans or the NPA’s (Non Performing Assets) in the banking sector is growing which has led to the fall in the Bank Index in recent weeks. This means that the Indian banking sector which was not allowed too much liberty by trading in derivatives and hence survived the global bloodbath of the derivative implosion is now seriously threatened by domestic factors.

The point here is that the Indian economy has weathered the global storm but it looks like it is going to falter for domestic reasons. The weather gods also seem to be playing their part as a truant monsoon has added to the worries of weak agricultural growth on the back of a precipitous fall in the manufacturing activity.

All these signs point to the fact that the Indian economy is on a downward spiral and unless urgent steps are taken to revive the economy, we might be headed for a severe recession in the months to come. It is hoped that the ruling party and the opposition work together instead of blaming each other and resolve the gridlock.

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