Dr. C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister released the document ‘Review of the Economy 2011-12’ at a Press Conference in New Delhi today. Following is the summary of the document:

Review of the Economy 2011-12

• The rate of growth in 2011-12 is estimated at 7.1%, which is marginally higher than the projection of 6.9% as per the Advance Estimates (AE). The council projects a slightly higher growth for agriculture and construction than the Advance Estimates.
• Gross fixed capital formation (GFCF) as a proportion of GDP had reached a peak of 32.9 per cent in 2007/08, the year preceding the global crisis. It dropped to 32.3 per cent in 2008/09 and then to 31.6 per cent in 2009/10. Initial estimates are that in 2010/11 this ratio slipped further to 30.4 per cent. The AE for 2011/12 suggest that there may have been further slippage to 29.3 per cent. That is a decline of almost 4 percentage points over the last four years.
• International conditions continued to worsen through 2011. The negative developments in the Eurozone outweighed the small improvements in evidence in the US economy. It is possible that the US economy will grow by more than the 1.8 per cent projected by the International Monetary Fund (IMF) in September 2011 and reiterated in January 2012.
• Large scale liquidity injection by the European Central Bank (ECB) since December 2011 has lowered yields on the government bonds of those countries under the magnifying glass. Though there is yet no resolution in sight and affected countries have large volumes of debt due for roll over, there is some improvement in the situation, insofar as the potential for shocks are concerned. Germany seems to be willing to provide extended support, partly as a result of which the European Central Bank (ECB) has provided large amount of finance through their banking system (€ 489 billion), which may go up further (to € 1 trillion). The Eurozone members appear to have signed up for a coordinated move towards a fiscal union – which is necessarily a precondition for a monetary union with a membership of heterogenous economic strength to survive.

Sectoral Developments

• Farm sector output growth in 2011/12 has been strong, coming on top of the strong growth in the previous year. The average GDP growth rate that has been reported for the farm sector in the first half of 2011/12 is 3.7 per cent. The Council expects that in combination with the strong trend growth in horticulture and in the animal husbandry sectors, the overall farm sector GDP growth for 2011/12 will average 3 per cent.
• The mining & quarrying sector has shown particular weakness this year. This was a combination of weak coal output growth – which was negative in four months of the year – a sharp decline in natural gas production in the KG-D6 fields and negative growth in crude oil output in the third quarter of the year. There has been improvement in coal output from November 2011 onwards. However, natural gas output growth is likely to remain in the negative for the rest of this fiscal. Crude oil production showed a decline of 4 per cent in Q3 of 2011/12, but is expected to recover in the last quarter. Moreover, restrictions imposed by the Courts on iron ore production in some parts of the country have also resulted in lower output. In consequence, the mining & quarrying sector is likely to report negative growth for the year as a whole – for the first time in three decades. The AE has placed this at (–) 2.2 per cent, an inference that appears to be accurate.
• While the electricity sector has performed well, manufacturing and construction have disappointed – the former particularly so from the second quarter onwards with October marking the bottom of the trough. IIP output growth showed a massive decline of 5.7 per cent in October, a sizeable recovery in November (6.6 per cent), with however a low reported growth in December of 1.8 per cent. Contributing principally to the latter was a large decline reported for capital goods, a component that has shown large volatility. If the capital goods component were to be excluded, the rest of the IIP would be seen to have shown a growth of over 5 per cent year-on-year. On average, the GDP arising in the manufacturing sector for Q3 is likely to be close to 1 per cent. The Purchase Managers Index (PMI) for January 2012 suggests a sizeable expansion and the output growth in the last quarter may on average be around 4 per cent. For the year as a whole the growth rate in manufacturing sector will be 3.9 per cent. In the construction sector there should be some improvement in the second half, a view that is reinforced by the strong rise (13 and 17 per cent) in cement output in November and December 2011. Hence, the growth rate in the construction sector for the year as a whole will be 6.2 per cent.
• Growth of GDP in the services sector was 9.6 per cent in the first half of 2011/12. The Council expects that service sector growth will continue to be strong in the second half and will close the year with growth of 9.4 per cent, slightly less than that in the first half.

External Payments

• The pressure on the Balance of Payments (BoP) – both in regard to a larger than expected Current Account Deficit (CAD) and lower than expected net capital inflows – resulted in a very sizeable depreciation in the external value of the Indian rupee. In the fiscal year to date, the nominal terms of trade weighted 6-currency index fell by 14 per cent, while in terms of the inflation adjusted effective exchange rate (REER) the decline was 11 per cent. The decline of the rupee vis-à-vis the US dollar was 19 per cent in the course of April–December 2011. However, there has been some recovery in the course of January and February 2012, with the rupee recovering about 7.5 per cent. The last few months have been about the most volatile period for the external value of the currency.
• The CAD has weakened much more than was expected, averaging 3.6 per cent of GDP in the first half of 2011/12. The position in the third quarter was much tighter than in the first two, as a result of a combination of a significant enlargement of the CAD and further weakness in capital inflows. The situation will improve in the on-going last quarter. However, for the year as a whole, the BoP position will be tight and CAD will be 3.6 per cent of the GDP.
• In a medium term sense, the weakening of the currency – in nominal and even more so in real terms – not only reflects the current situation of demand and supply of foreign exchange, but outlines a scheme for the stabilization and improvement of the external payments situation. A weaker currency can by improving the prospect of exports – of both goods and services – and also by making the price of Indian assets more attractive to foreign investors, help to contract the CAD.
• However, there are three problems that we must guard against. First, a sharp depreciation can impact the liability side of corporates to an extent that it weakens their ability to invest. That can dampen the recovery in the pace of economic growth. Second, capital inflows are a steady activity over time and if the impression gains ground that depreciation is likely to be a recurring theme, investors will tend to factor in this aspect in their valuation and to that extent it will have a negative impact on the perceived value of Indian assets. Finally, the CAD in India has an idiosyncratic element. The import of gold, which is viewed by many, if not most, Indian buyers as an investment object, forms a large component in overall imports and variation in this element accounts for a very sizeable component in the change in CAD. The dynamics that influence the import demand for gold seems to be most closely related to those which influence asset holding, rather than those which influence merchandise imports.

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Courtesy: pib.nic.in