India's Economic Challenges

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India’ GDP grew by 6% over same period last year in 1st Qtr 2012; they are expecting a growth of 7.6% next year. But they are faced with 3 main economic challenges : inflation, fiscal deficit and current account deficit
Inflation
There’s 10% inflation (Consumer Price Index)in India  mainly because of food inflation and energy inflation. Otherwise the inflation (core inflation as they call it, which is non food non oil) would have just been 5%.  2009 onwards this rate has been hovering around 9%.
Food inflation has been primarily because of the following factors:
a)      Increase in supply of food has not been commensurate with the growing demand on account of bigger population and more buying power
b)      Hoarding of onions , sugar and pulses
c)       Cut in subsidies by govt to reduce fiscal deficit
Energy inflation has been because of :
a)      Cut in subsidies by govt to reduce fiscal deficit
b)      Weaker Ruppee leading to oil import becoming more expensive

Fiscal Deficit
Currently fiscal deficit (difference between government’s incomes, which is primarily through taxes, and it’s expenses) is around 5.9%. India government will raise taxes, cut subsidies of fuel and food to bring this deficit down to 5.1% next year and to under 4% in 3 years’ time.
Main reasons for this are:
a)      Constantly increasing defence expenditure
b)      Increasing subsidies in the past on fertilizer, energy etc.
c)       Poor performance of govt due to red tapism and corruption
d)      Too much of interest to pay due to excessive govt borrowing

Current Account deficit
Current Account is the sum of
(i)                  Balance of Trade- exports minus imports
(ii)                Factor Income - Earnings on assets abroad (including inward remittances) minus returns given (including outward remittances) to foreigners for their assets in the country
(iii)               Cash transfers
India has a current account deficit of 4% of GDP or $20 Bn meaning there is a huge net outflow of forex from the country which has contributing to the rupee free falling. Since July last year, the Indian rupee has fallen by more than 27% against the US dollar, one of the biggest declines among Asian currencies.
This is because MNCs in India due to the global economic crunch in general, & in particular the Eurozone crisis, are selling their assets in India and repatriating the money to their home countries. As such there is considerable outflow of FDI from the country. Also the investment climate for big foreign investors has been tense. Examples:
a)      New York Life (insurance company) exited with 530 Mn $
b)      Etisalat and Bahrain Telecom have had their licences cancelled
c)       Vodaphone is in a big tussle with Indian govt as the latter wanted to tax it in a retrospective manner for $ 2 Bn
Secondly, due to crisis in EU, the demand for Indian exports has slowed down, so there isn’t enough $ inflow into the country. India is targeting exports of $ 500 Bn by 2014. Its trade deficit (exports minus imports) has been $ 185 bn. Since India imports 75% of its oil requirement, a $1/barrel increase in oil prices results in $ 1 Bn increase in the trade deficit !
These factors mean that there is immense pressure on the Ruppee which against the $ has dropped from 49 Rs in Feb to 56 Rs now and is expected to go upto Rs 60 per$

In summary, these issues have created a vicious cycle of sorts whereby the outflow of money forex from India is leading to a decline in the value of rupee which is raising its huge oil import bill thereby increasing trade deficit and further weakening the rupee. On the other hand, to reduce the fiscal deficit, India’s government is removing subsidies on oil and food which, along with higher import price of oil (due to weak INR) is contributing to inflation.

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