The RBI agrees.

All of 2012 we have been banging on about how the economy is teetering on the edge of a cliff and could fall off. Seems that the Reserve Bank of India agreed at last. In its Financial Stability Report the RBI says," The overall macro-economic risks in the Indian financial system seem to have increased since the publication of the previous FSR in June 2012." TOI, 29 December. Economic slowdown, high inflation, ballooning fiscal  and Current Account deficits, slowdown in domestic savings and investment demand and moderation in consumption are all threats to macroeconomic stability. So, according to the RBI every economic indicator points downwards. The main threat is inflation which is cutting household spending which, in turn, reduces sales and investment demand. Rising costs of basic materials, such as food, leads to less savings so banks have less money to lend and forces interest rates to stay high. The remedy should be straight forward - bring down inflation and everything will fall into place. That is where the trouble is. Inflation is being caused by high wasteful spending by the government and will probably get worse in the next budget to win the elections in 2014. High spending results in ballooning fiscal deficit which leads to very high levels of taxes on all goods and services increasing inflation and costs of exports which, in turn, reduces exports and increases Current Account Deficit. A significant portion of foreign exchange exposure of companies remain unhedged. " This is especially disquieting given that the exchange rate volatility has been higher in India in comparison to other emerging market currencies as well as those of advanced countries," says the report. Which is the RBI way of saying that the rupee has fallen against every currency and there is scope for more falls. Companies which have borrowed in foreign currency will have to pay more in rupees which will increase the risk of defaults. Falling currency has meant a rise in the value of oil imports and frantic buying of gold by the people as they looked to hedge against inflation. If prices rise and spending falls it results in the rise of bad loans. Non Performing assets of banks, as bad loans are known, have risen from 2.9% of assets at the end of March to 3.6% at the end of September and could rise to 4%. The RBI predicts a fall in tax and non-tax revenue increasing the risk of over spending by the government leading to a rise in fiscal deficit. However, even as the RBI was publishing such a gloomy report our most revered Finance Minister was exuding confidence about the economy while speaking at the National Development Council. He was saying that the fundamentals remain strong, there is a high savings rate, a growing services sector and a growing middle class so everything is first rate. Someone is clearly living in cloud cuckoo land. Question is, who?