It is sometimes helpful to carve up the economy into two slices — the real and the financial sectors — and the developments in the latter, quite often, tell us what to expect in the former. Let’s examine the two sectors in the context of the current state of the economy. First, the financial sector. The rupee, which has slid 15% since May, continues to plumb new depths.
Having breach 62 to a dollar, the debate now is veering around the next barrier — a scary 65. More than the number, it’s the rupee’s sharp and unhindered slide that is causing unease. If the country’s top economy and currency administrators have gone into a huddle in recent days, it is only symptomatic of the anxiety gripping India’s macroeconomic managers.
Few events capture the resilience of an economy as dramatically as trends in the equity markets. Less than a year ago, backed by a 25% rise in key indices, India’s markets were eyeing an all-time high for the Sensex in 2013 powered by an anticipated flurry of government-initiated reformist moves and a flood of investment from overseas funds. The tide has since turned for the worse. The unwinding of the stimulus package in the US, couldn’t have come at a more inopportune time for the economy.
With the US — that represents about a quarter of the world’s economy — showing early signs of turnaround, and the resultant increase in interest rates in the US after the central bank starts sucking out extra cash from the system, foreign funds will be tempted to move investments closer home. The mayhem in markets on Friday when the Sensex crashed by over 700 points mirrors this syndrome.
That brings us to the real sector. India is struggling to claw out of a decade-low growth in the economy. While the newly set up Cabinet Committee on Investment has taken the task of fast-tracking infrastructure projects in earnestness, slow project implementation remains a critical concern dogging the economy. Last year, Morgan Stanley had projected that there was a 60% probability of Sensex breaching 23,000 by December 2013. Its forecast was predicated upon a succession of reasonable actions: fiscal discipline, progressive rise in spending on infrastructure projects, movement on goods and services tax and gradual monetary easing.
Over the last one year, the government has demonstrated its determination to walk the talk on fiscal rectitude. The finance minister has unveiled plans to gradually narrow down India’s fiscal deficit to 3% of GDP by 2016-17. Key legislations, such as easing up foreign investment norms in the country’s insurance and pension sectors are stuck in a political logjam. There is precious little any government can do to keep hot money from flowing out, but it can still do a lot to straighten the kinks in the domestic policy environment. Fresh, and consistent, policy pronouncements will, at the very least, help soothe frayed nerves of investors who fear that the government is more likely to be focused on political risk management rather than reverse the slowdown in the economy.