The Indian economy faced many headwinds in fiscal 2011-12 leading to GDP growth coming off from 8.6% in fiscal 2010-11 to levels of around 7%. The economy in fiscal 2011-12 faced headwinds in the form of inflation, high interest rates, tight liquidity conditions and global economic uncertainty. The headwinds have been well documented in previous issues of economic analysis. The question is are the headwinds weakening and can the economy look up in fiscal 2012-13?
The headwinds do appear to be weakening as seen by the trends in the first two months of calendar year 2012. Inflation as measured by the WPI (Wholesale Price Index), which had been trending at over 9% levels for a major part of fiscal 2011-12 is looking to trend at below 7% levels for the fiscal 2012-13. Inflation for the months of January and February 2012 has printed at below 7% levels and given the slowdown in GDP growth seen in 2011-12, inflation outlook is not highly negative. The fact that the base is high, as prices have been trending up over the last two years, inflation to go back to high levels of over 9% will require a shock in the form of oil prices shooting up.
Oil prices have gone up by over 15% calendar year 2012 to data, largely on the back of geo political tensions over Iran. The outlook for the global economy especially the Eurozone and China is not robust enough to drive up oil prices substantially. The Eurozone is on the brink of a recession as it contracted in the fourth quarter of 2011 while China’s GDP forecast for 2012 at 7.5% is the lowest since 1999.
RBI has cut CRR (Cash Reserve Ratio) by 125bps over the last two months to release around Rs 80,000 crores into the system. The CRR cut will keep liquidity stable in fiscal 2012-13 leading to more lendable resources for the banking system. Other drivers of liquidity include RBI bond purchase of Rs 125,000 crores in fiscal 2011-12 and FII inflows of USD 8 billion in the first three months of calendar year 2012. The liquidity impact of RBI bond purchases and FII inflows will be felt starting April 2012.
Falling GDP growth and falling inflation will prompt the RBI to cut its key policy rate the Repo rate. RBI cutting policy rates will lower interest rates in the economy leading to improving investment and consumption sentiments.
Global economy can pick up leading to a positive effect on the domestic economy
The job numbers coming out of the US is positive with 277,000 jobs added in February 2012 taking the last six months job additions to 1.2 million, the best streak seen since 2006. Manufacturing and retail sales numbers have been positive for the US in February with both showing growth for the month. The easy monetary policy stance adopted by the US Federal Reserve will continue well into 2014 leading to low rates and good liquidity in the US economy. US economy may well show higher than forecast growth in 2012 if economic factors continue to be positive.
The Eurozone economy is unlikely to look up in 2012 given austerity measures adopted by major economies of Italy, Spain and France. However the liquidity infusion of over Euro 1 trillion by the European Central Bank (ECB) through the LTRO (Long Term Refinancing Operation) will keep European banks liquid and that could filter down into the Eurozone economy as banks gain confidence on lending.
China’s inflation for February 2012 came in at 3.2%, the lowest over the last 20 months. China’s highest trade deficit over almost a decade in February coupled with its low GDP growth forecast of 7.5% will prompt the central bank to loosen bank reserve ratios and lower interest rates. Higher liquidity for Chinese banks is positive for the economy as bank lending could trend up.