If a currency is a barometer of an economy’s health, then the Indian economy has fallen very ill. Back in April the rupee was trading at a relatively strong 44 to the dollar. India was coming off a year of solid growth, the monsoons had been good, and the stock market was holding up. Today things look far worse: The rupee has weakened 16 percent against the greenback since August. Analysts are predicting gross domestic product will grow less than 7 percent next year. And foreign investors have fled the Bombay Stock Exchange, helping drive it down 18 percent so far in 2011. If the rupee stays this weak, the cost of importing oil will jump, damping growth further.
What’s wrong? One problem is the nation’s long, unsuccessful fight against inflation. Thirteen times over the past two years, Duvvuri Subbarao, the governor of the Reserve Bank of India, has raised interest rates, adding 375 basis points to borrowing costs. Yet in October, India’s benchmark inflation rate was 9.73 percent year over year.
“They have gotten themselves into a real fix,” says Tim Condon, chief Asia economist at ING Financial Markets (ING). “They have tightened so much it has had an adverse effect on growth—and limited effect on inflation.” The government should have started attacking inflation sooner than it did, say analysts, and now faces a much harder task eradicating it.
Making matters worse, on Dec. 7 the coalition led by Prime Minister Manmohan Singh suspended a plan to open India’s $396 billion retail sector to foreigners. On Nov. 24, Singh’s Cabinet had approved a proposal to allow foreigners to own 51 percent of retailers. That might have helped contain inflation by permitting chains such as Wal-Mart Stores (WMT) to offer discount goods to consumers.
Then the opposition Bharatiya Janata Party as well as some of Singh’s coalition partners started to stonewall the proposal at the behest of local retailers. “Foreign direct investment will be a dinosaur in our country, eating up small businesses in their path,” Narender Madan, president of Delhi’s chapter of the Confederation of All India Traders, told demonstrators on Dec. 1. Singh’s government soon dropped the plan.
Opposition politicians are saying the government’s failure to contain prices is wounding the 800 million Indians who live on less than $2 a day. Padma Pal, a mother of five in her 40s (she’s not sure of her exact age), lives in a South Delhi slum and works sporadically on construction sites. In September, she says, her 14-year-old son went off with a gang of drug dealers, and she hasn’t tried to get him back because she can’t afford to have him at home. “I can no longer buy enough food with what little money I have,” she says. With inflation eating into her income, “I’ve gotten poorer.”
Singh has been outspoken about the challenges of inflation. Yet a poor system of roads, ports, and power plants adds to costs and makes it even harder for inflation fighters, says Joseph Tan, an economist in Singapore with Credit Suisse Group (CS). The government tries to ease the pain of rising energy prices by subsidizing the cost of diesel, kerosene, and gasoline. The subsidies deepen the budget deficit, which Tan expects to hit 5.5 percent of gross domestic product in the fiscal year ending next March: It was 4.7 percent last fiscal year. Like China, India has to worry about the European debt crisis depressing demand for its exports. For now, the rupee has every reason to stay weak.