Indian economy needs some capacity unlocking

The Indian equities market operated within a broad range in May 2011. The key benchmark indices, SENSEX and Nifty posted a month-on-month performance of -3.31% and -3.29% respectively. The sentiment in the market dampened on account of various factors: namely, the rising credit risk perception in the PIIGS nations (especially Greece); the deterioration in the asset quality of the PSU banks; and the net withdrawal of $1.48 billion by the FIIs from the equity market. However, it may be the un-intentioned slowdown in the domestic economy that is being considered as a more troubling development. The inflation in the fuel segment has necessitated a partial pass-through to the general consumers, adding further spurt to the already elevated price levels in the economy. In turn, this has called for a far more stringent interest rate regime by the RBI, who have consequently raised the cost of capital (and thus of the investment) in the economy. The resultant contraction in the aggregate demand is expected to moderate the economic growth for FY12. The GDP growth for Q4-FY11 has already tempered down to 7.8%. The IIP growth also seems to be signalling towards a slowdown, with the average IIP growth for FY11 estimated at 7.2% over the last year. Resultantly, the revised growth projection for FY12 is in the vicinity of 8-8.5% from the earlier expectation of 9-9.5% for the same period. It is therefore believed that the RBI may adopt a more flexible policy option were the inflation numbers to moderate post-monsoon. Therefore, it is essential here that a coordinated policy action be effected to cushion the economic growth while addressing high-inflation. A potential policy of strengthen the rupee in the near-term can be of vital consequence in this regard. This may reduce the landed cost of petroleum imports and thus help cushion growth. Additionally, a targeted delivery of the fuel subsidy to the goods transportation industry is needed. This may constrain the fuel price pass-through from spilling-over into the general economy. The debt market continues to be wary; with the market liquidity tightening further over the month. The 10-year gilt was hovering at a 26-month-high before moderating down to some extent, in the process driving up the commensurate 10-year corporate bond at 9.70% levels. With inflation continuing to remain stubbornly persistent, we can expect the gilt yields to remain at current levels, inducing the corporate sector to increasingly resort to overseas debt to meet their capital requirements. Going forward, it remains to be seen how regulatory policies surrounding issues like land acquisition, environment, fuel availability, and transparent governance, are formulated. Indian economy has displayed a tendency of overheating as it approaches the 9% GDP growth mark. This is indicative of supply constraints within the economy that are unable to withstand the high demand pressures. Therefore, if India is to attain an inclusive and sustainable double-digit growth trajectory, the capacity unlocking within the economy would be necessary. To achieve this, the liberalisation of policy on some of the above stated issues would be critical.

Source: http://www.moneyguruindia.com/article.php?cid=1330&id=11&sid=27