India’s economy

OECD Observer

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An assessment of India’s short-term economic prospects appears for the first time in the latest OECD Economic Outlook, so adding to the coverage in this report of key non-OECD economies Brazil, China and the Russian Federation. India has been one of the most rapidly growing economies in the world over the past five years. Nonetheless, with a slightly lower population than China and significantly lower average incomes, the economy is only half the size of China’s, though double that of Brazil and Russia.

The Indian economy has benefited from a strong cyclical upswing since 2003, triggered by the return to normal rainfall and consequent rise in agricultural output and incomes. Output growth averaged 8.4% per annum in real terms in the three years to March 2006. Private consumption growth has been buoyant but exports too have been strong, with growth evident in a number of manufacturing sectors and not just sales of information technology services. With final demand robust, investment has surged, especially in the private corporate sector (whose fixed capital formation is nonetheless still low). Overall, total demand rose 12% in Fiscal Year (FY) 2004 and possibly by more than 9% in FY2005.

Despite the expansion in capacity, domestic supply has not been able to match the increase in demand, growing some 2.5 percentage points slower than demand in the past three years, with the balance being met by a surge in imports. In addition, the terms-of-trade worsened as a result of rising oil prices, and consequently the current account balance fell by almost 5 percentage points of GDP between FY2003 and FY2005, bringing a slowdown in the pace of reserve accumulation. The growth in imports may have also helped to lessen the pressure on domestic resources and inflation.

However, the full impact of world oil prices has not yet been felt, as the government has not allowed the predominately state-owned petroleum companies to raise prices in line with those on world markets. The government estimated that, by February 2006, these restrictions were lowering oil company profits by an amount equivalent to 1.1% of GDP. In addition, government revenue has also suffered from a reduction in taxes and duties on crude and refined petroleum products.

Faced with a rapid increase in domestic demand, and with money and credit growing at above its target rates, the central bank initiated a tightening of policy during 2005. At the same time, the central bank has attempted to slow the growth of credit to the real estate market to guard against the re-emergence of bad loans. These have been markedly reduced, falling from 4.4% in 2003 to just 2% of advances (when measured net of provisions) by end 2005.

Very strong revenue growth and subdued expenditure increases have brought central government finances back on track in FY2005. State governments have also managed to reduce deficits, with the result that the combined central and state government fiscal deficit is projected to drop from 8.5% to 6.8% of GDP between 2003 and 2007, bringing a drop in the combined total of central and state government debt, relative to GDP, of 4 percentage points between 2003 and 2007. A significant reform of indirect taxation has occurred at the state level, with the introduction of a value-added tax, and the central plans to generalise this tax by the end of the decade–a reform that should help to ease barriers to internal trade.

During 2006-2007, the tighter stance of both monetary and fiscal policy is projected to slow economic growth. In the corporate sector, lower availability of finance and higher interest rates seem likely to reduce investment growth while the upswing in inventories may also end. However, private consumption growth may only slacken marginally as income growth remains high. At the same time the economy will continue its integration into the world economy, helped by further tariff reductions. Overall, output growth is projected to slacken from 8.5% in 2005 to 7% in 2007. Such a decrease in growth should keep the inflation rate anchored below 5%, while the current account deficit may stabilise at around 3% of GDP.

projected to slow economic growth. In the corporate sector, lower availability of finance and higher interest rates seem likely to reduce investment growth while the upswing in inventories may also end. However, private consumption growth may only slacken marginally as income growth remains high. At the same time the economy will continue its integration into the world economy, helped by further tariff reductions. Overall, output growth is projected to slacken from 8.5% in 2005 to 7% in 2007. Such a decrease in growth should keep the inflation rate anchored below 5%, while the current account deficit may stabilise at around 3% of GDP.

From OECD (2006), Economic Outlook, No. 79, Paris, June. ISBN 9264018379

©OECD Observer No 256, July 2006




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