India's economic growth is faltering as a result of weak governance, policy paralysis and opposition to reforms by the present government. These have dragged down the investor confidence.
The economy deteriorated sharply to 5.3 percent in the three months to March, down from 9.2 percent in the same period last year. The political backdrop is that the ruling Congress party is far from committed to market-oriented reforms and its coalition allies actively oppose even incremental measures.
With elections due by May 2014, this policy paralysis is likely to get worse during the coming two years and there is also a growing risk of populist decisions such as further increases in spending on welfare programs. Looking further forward, there is no guarantee that reform prospects will improve after 2014, Andrew Kenningham, an economist at Capital Economics, said.
The current account deficit climbed to 4.5 percent of gross domestic product (GDP) or $21.7 billion in the January-March quarter, up from $6.3 billion in the same quarter in the previous financial year. Trade deficit has also advanced to $51.6 billion in the January-March quarter, up from $48.7 billion in the preceding quarter.
Another worrying factor is the depreciation of the value of the rupee. The current account deficit is particularly a key factor underlying the currency weakness. In June, the rupee fell to over 57 against the dollar.
In early June, the Reserve Bank of India (RBI) unexpectedly left its repo rate at 8.0 percent. In recent weeks, the central bank ensured that there was no recurrence of the liquidity squeeze, which took place in late 2011 and in March 2012, by injecting funds to the banking system through open market operations.
Although the central bank left the cash reserve ratio unchanged at 4.75 percent, it raised the limit for export credit refinance. The RBI expects this to inject liquidity equivalent to that from a 50 basis point cut in the reserve ratio.
The RBI argues that lower interest rates would do little to boost growth. Indeed, it concludes that further reduction of the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressures. India's inflation rose to 7.55 percent in May from 7.23 percent in April.
Compared to the past, the bank is now putting more emphasis on tackling the consumer price inflation. However, considering the present economic situation, it has to be seen how long the concerns about the flagging growth will outweigh worries about inflation.