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MAY 10, 2012 India — Ample Opportunities, But Obstacles Must Be Overcome By Sharada Prahladrao and Rajabahadur V. Arcot Keywords GDP, Global, Economy, India, National Manufacturing Policy, State Overview India's economy is not completely insulated from the global turbulence: the country's trade deficit and rising external debt, high inflation, and the fluctuating value of the rupee create dents in industrial growth. According to This Insight tracks the current trends in India's economic growth — the gaps, the challenges, and the State's initiatives. the recent trade figures during the period 2011-2012 (India's fiscal year is from April to March), deficit soared to $185 billion as a 32.1 percent jump in imports outpaced a 21 percent growth in exports. Petroleum imports touched close to 47 percent year-over-year growth to over $155 billion; imports of capital goods such as industrial machinery increased 27.7 percent to $35.4 billion; imports of coal rose 80.3 percent to $17.6 billion; and fertilizer imports rose 59 percent to $11 billion. Domestic demand remains buoyant, but the manufacturing sector is plagued due to inadequate availability of coal and other energy resources. India is the world's fourth-largest oil consumer; but production averages close to 762,000 barrels per day, which is the same as it was over two decades ago. During the same period, consumption has more than tripled, so the country depends on imports to the tune of 70 percent. Coal India Limited (CIL), the largest producer of coal in India, has fixed a production target of 468.74 MT for the current fiscal. However, the power crisis in the 12th Five-Year Plan (2012-2017) is likely to increase due to overall shortfall of production (about 260 MT) by the end of the Plan period. This will impact the manufacturing sector acutely and coal imports will increase. Due to prevailing global negative sentiments, the country may witness slowdown in the GDP growth rate, but probably only for a few quarters as has happened in the fiscal year 2008-09. The International Monetary Fund VISION, EXPERIENCE, ANSWERS FOR INDUSTRY ARC Insights, Page 2 (IMF) has reduced the GDP growth forecast to 6.9 percent in 2012 from 7 percent projected in January — a marginal decrease. What is important to note is that according to the recent Regus Business Confidence Index (which is based on revenue, profit trends, and projected growth) in terms of stability and confidence, India ranks second with 143 points. However, India's fundamentals are strong; the sails just need to be set in the direction of the blowing wind. And for this to happen, the objectives of the State, the Reserve Bank of India (RBI) and industry leaders must be wellsynchronized. Domestic Challenges The IMF said that "governance concerns have weakened investment sentiments." The State is taking initiatives to enhance investor confidence, but many challenges need to be addressed, such as removal of infrastructure bottlenecks and trade barriers. In the 2012-13 budget, financial reforms and measures were announced to encourage public-private partnerships; but In the 2012-13 budget, financial reforms and measures were announced to encourage public-private partnerships; but the implementation of reforms related to infrastructure is likely to move at a slower pace. the implementation of reforms related to infrastructure is likely to move at a slower pace. Other factors crippling India's economy are high inflation due to supply-side constraints, trade deficit resulting from imports exceeding exports, fiscal deficit climbing to 5.9 percent of the country's GDP (end March 2012) due to heavy subsidies on food, fuel, and fertilizers. However, high inflation due to supply chain-side constraints and trade deficit indicate excess demand. This is in sharp contrast to other countries in which demand has declined, making it evident that India faces a different set of challenges. However, to bring the trade balance under control over the long term, it will be necessary for the manufacturing sector to grow to be able to meet the country's demand. Currently, India's largest import bill is from the oil & gas sector; making it imperative for the country to scale up production capacities. If that does not happen, global companies with excess production capacities will fill that void. Current Scenario India's manufacturing sector receives encouragement from the State to produce goods indigenously. The recent National Manufacturing Policy represents a laudable effort in this direction. With ever-increasing domestic ©2012 • ARC • 3 Allied Drive • Dedham, MA 02026 USA • 781-471-1000 • ARCweb.com ARC Insights, Page 3 consumer demand, expertise, and the required talent pool, India is wellpositioned to emerge as a strong manufacturing base. Global companies, spotting the immense potential that the India market offers, have set up manufacturing hubs here. Paradoxically, Indian manufacturers depend on imports in many industrial sectors. For example, China's power equipment suppliers won 34 percent of new equipment orders for additional capacity in India's power plants; this segment could have easily been captured by companies in India, such as BHEL and L&T. To protect local interests, the Union Power Ministry has endorsed a plan to almost triple the import duties and policies are being reset to address the liquidity crisis. This should be a clarion call for industrial companies to maximize all available resources, reduce imports, and revive investor confidence. Inflation in India, which is driven largely by rising food and global commodity prices, is the highest among major economies in Asia. Inflation in India, which is driven largely by rising food and global commodity prices, is the highest among major economies in Asia. Food inflation is attributable to rising incomes and changing dietary habits and lifestyles. The landmark National Food Security Bill received Cabinet approval at the end of 2011 and will be implemented this year. This will provide monthly supplies of subsidized wheat, rice, and millet to millions. The goal seems altruistic, but clearly will strain the State's finances. This Bill has enormous political significance for the coalition party, which was re-elected due to its “pro-poor” stance. But tracing India's sociopolitical history shows that food subsidy programs in India encounter widespread corruption and rarely reach the intended populace. External Commercial Borrowing India's foreign exchange reserve, stood at $293.14 billion in mid April 2012. This can be released in the market to purchase dollars and consequently raise the rupee value. However, if the RBI intervenes, it also requires support from other quarters or its impact will be negated. Apart from direct intervention in the currency market, the RBI is relaxing its external commercial borrowing (ECB) policy to encourage inflow of foreign currency. For greenfield projects, plus projects in the infrastructure and telecom sectors, 50 percent funding via ECBs are permitted. The State has increased the limit on RBI to $30 billion and allowed borrowing in China's currency — remnimbi. ©2012 • ARC • 3 Allied Drive • Dedham, MA 02026 USA • 781-471-1000 • ARCweb.com ARC Insights, Page 4 Foreign retailers have India on their radar — the Global Retail Development Index ranks India fourth globally. At present, the industry is worth Foreign retailers have India on their radar — the Global Retail Development Index ranks India fourth globally. over $410 billion and expected to cross $800 billion by 2015. Recently, the State decided to allow 100 percent foreign direct investment in single-brand retail outlets. Industry observers see this as a precursor to allow the entry of multi-brand international chains. Recommendations Global economic rumblings bruise India's economy, but do not cause major trauma. The State and the RBI can only initiate industry-friendly policies; it is up to the industrial companies to increase their investments to expand production capacities to benefit from robust domestic demand. ARC believes that the State should introduce initiatives and reforms that bolster confidence in the economy. With the appropriate policies and inflation under control, industrial growth will remain on track. Global companies are entering the India market and providing stiff competition to domestic companies. Demand-driven growth is evident and the market potential is huge — but to realize this there has to be coordination between the State, industry and other stakeholders. ARC Advisory Group recommends the following actions: • Industrial companies in India should reduce dependence on imports and scale up production capacities • The State must implement appropriate initiatives and measures in an efficient manner ARC's tenth India forum in Hyderabad from July 5-7, 2012, “Transforming Industry and Infrastructure through New Processes and Technologies,” will discuss the challenges faced in India's manufacturing sector and the measures being taken to combat them. For further information or to provide feedback on this Insight, please contact your account manager or the authors: [email protected] or [email protected]. ARC Insights are published and copyrighted by ARC Advisory Group. The information is proprietary to ARC and no part may be reproduced without prior permission from ARC. ©2012 • ARC • 3 Allied Drive • Dedham, MA 02026 USA • 781-471-1000 • ARCweb.com