These are gloomy times for the Indian economy. With rupee touching new lows and fiscal deficit knowing no bounds, it is difficult to be optimistic. Perhaps the only question that looks relevant now is how bad the fall can be. And as global and domestic economic pointers suggest, the worst probably is yet to come.
Part of the blame goes to the working model of the developing economies. The expansionary monetary policy in the US led to overwhelming capital outflows to emerging economies leading to credit bubbles. Thus, a mere hint given by the US to roll back quantitative easing has caused reverse movement in international capital. The steep decline in the rupee versus the dollar is one of the outcomes of this model.
However, in case of India, it would be unfair to put the entire blame on developed economies. Much of the crisis that our economy is witnessing has its roots within the country. As an article in Economic Times suggests, as a result of the steep fall in the rupee, there has been huge erosion in the purchasing power of the people. The increase in the price of basic commodities is dampening demand which is further slowing down the manufacturing activities and service industry. But what makes things worse and vicious is the fact the country is grappling with inflationary pressures and a huge fiscal deficit at the same time. Huge oil and gold imports and subsidy schemes have finally taken a toll on the economy. And even now, instead of clearing the mess, the Government has approved the Food Security Bill , a classic example of bad economics.
Despite having an independent monetary policy, fiscal and monetary stimuli are unlikely to salvage as such moves will lead to inflation or fuel fiscal deficit further. While normally, a depreciating currency boosts exports, this time the slowdown in global demand is not strong enough for the economic growth to be led by exports. The investment climate does not look bright either. The policy logjam and execution and bureaucratic delays have stifled the investments and kept even foreign companies at bay. Hence, with Government expenses rising and slowdown in demand, the only way to limit fiscal deficit is to cut down the planned investments. A slowdown in investments from the public and private sector will just feed the vicious circle that India seems to be stuck in. To conclude, what we are witnessing now might just be a tip of the iceberg. As things stand, we will not be surprised to see the rupee slide down further.