CII Communique - February, 2010

cover story
economy
The Economy is Looking Up…
The recovery process has clearly gathered
momentum with industrial growth picking up
to double digit rates. The Index of Industrial
Production (IIP) grew at 10.3% and 11.7% during
October and November 2009 and is likely to keep
growing at double digits for the rest of the year. Of
course, this can be partly attributed to a strong base
effect due to the extremely subdued growth rates at
this time last year. At this rate, industrial growth will
certainly exceed 8.0% in the current year while GDP
growth is likely to exceed 7.0%. The RBI has recently
increased its baseline projection of GDP growth from
6.5% to 7.5%, in view of the strong trends that are
currently visible.
14
12
10
8
6
4
2
0
-2
Apr-08
Source: CSO
Jun-08
IIP growth (% yoy)
Aug-08
Oct-08
Dec-08
But Challenges Remain…
Even as the current data looks encouraging, the
challenge will be to sustain the recovery next year
when the positive base effect will no longer remain.
Data released recently shows that gross capital
formation (GCF) declined by 4.0% during 2008-09.
In fact, GCF declined as a percentage of GDP from
37.7% in 2007-08 to 34.9% in 2008-09. For the recovery
to gain momentum, it will be critical for investors to
regain confidence in the economy and start investing
again. While growth has started picking up, it may
take a while before investors start expanding capacity
to drive up their investments.
The other drivers of demand include the final
consumption expenditure of the private sector and
Feb-09
Apr-09
Jun-09
Aug-09
Oct-09
the government (PFCE and GFCE). The growth in
PFCE moderated in 2008-09 while GFCE accelerated
in order to keep the economy growing. This process
will need to be reversed so that private sector spending
is encouraged and the government can cut back its
spending.
Growth in demand drivers of GDP
20
15
10
5
0
-5 2005-06 2006-07 2007-08 2008-09
-10
PFCE
GFCE
Investments
declined in
2008-09
GCF
GDP at market prices
Source: CSO
PFCE: Private Final Consumption Expenditure
GFCE: Government Final Consumption Expenditure
GCF: Gross Capital Formation
Supportive Fiscal and Monetary Policy
Given the recovery in the economy, there is now
much debate about whether it is time to exit from the
expansionary stance of both fiscal and monetary policy.
The RBI recently announced its third quarterly review of
Monetary Policy in which it hiked the cash reserve ratio
(CRR) by 75 basis points. Since banks are still flush
with funds, this is unlikely to have any immediate impact
on banks’ lending rates. The Union Budget will take a
call on whether some of the fiscal measures taken in
the aftermath of the recession last year will be taken
away. Most importantly, the government had reduced
indirect tax rates and also increased spending on social
security schemes for rural areas.
According to CII, fiscal policy must remain supportive
of the recovery for some more time. In particular, the
reduction in indirect tax rates must be maintained until
the new Goods and Services Tax (GST) is introduced
later this year. With direct tax collections showing
signs of revenue buoyancy and proceeds from PSU
disinvestment picking up, it would still be possible to
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