Necessity is the mother of Invention!

In continuation of our previous notes dates 30th November 2012 titled, “Indian macros–At an inflection point “part two and October 2011 titled, “Indian macros–At an inflection point” part one, where we talked about how the performance of the Indian economy has suffered in recent years. How rate of growth of the Indian economy has been on a downtrend over the last two years which was reflected in the fact of slowing industrial production, capital formation, and exports. As growth slowed, Investors were focused on India’s large current account deficit and financing needs. This led to a very sharp depreciation in the rupee (INR) as a result of which the RBI had to intervene to defend the INR, and increased the marginal cost of borrowing by 350bps. The resultant tightening in liquidity effectively choked the economic recovery. Domestically, structural reforms did not proceed at the pace expected by markets, as bottlenecks continued to hamper investment projects. Inflation remained elevated, in part due to FX depreciation and, increases in administered prices.

Despite all these issues Indian equities have seen a sharp rebound aided largely by policy, positioning and positive global factors. The markets have taken the announcement of moderate tapering of the Fed’s QE3 program in their stride as India’s external sector risks have materially subsided. In the medium-term, a revival of growth in advanced economies is beneficial for export demand from emerging economies like India. Strong export growth, aided by the sharp rupee depreciation, are key factors for improvement of the domestic outlook as it has reduced India’s external vulnerability and is positive for GDP growth. Coupled with this, India’s resilience on the external sector has also stemmed from a compression of imports, driven by restrictions on gold imports. Driven by these aspects the current account deficit has come down sharply at 0.9 per cent of GDP in Q2 FY2014 as against a wider deficit of 4.9 per cent of GDP in Q1 FY2014.

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