The effects of strong monetary and fiscal stimulus are gradually lifting the economy out of below-trend growth. Forward-looking confidence indicators look promising and unemployment is low. Inflation has declined and stabilised, albeit somewhat above the midpoint of the target range.

Growth fell to an estimated 7½ per cent in 2012 – the lowest rate for over a decade. This reflects weak export market growth and the effect on domestic demand of government measures to cool inflationary pressures. This objective has now been achieved, including for property prices, and the authorities have started to ease the stance of macroeconomic policy. Going forward, the economy will still face external headwinds, but housing and infrastructure outlays are likely to revert to their longer-term trend. With domestic demand gathering renewed momentum, the current account surplus is set to shrink to 2¼ per cent of GDP by 2014, compared with the peak of 10% in 2007.

The economy has experienced a broad-based slowdown and growth is expected to remain weak for some time. The current account deficit has narrowed as imports have softened on account of cooling domestic demand and a weaker rupee. Inflation has temporarily been pushed up by hikes in regulated petroleum prices but is expected to decline as spare capacity mounts. This will create room for easing monetary policy, which has been hindered by persistently high inflation and a widening fiscal deficit.

Domestic spending has remained solid, but demand from key trading partners has been slowing sharply. Output is nevertheless expected to grow at close to trend rates over the projection period, held up by domestic demand. An intended hike in the price of electricity next year will drive inflation up temporarily. However, tight labour markets and large minimum wage rises will exert more fundamental pressures.

Following a soft patch in the second half of 2012, growth is projected to pick up again to around 4% in 2013 and 2014, underpinned by increasing oil prices and easing headwinds from the euro area crisis. Gradual disinflation will continue after a temporary rebound of inflation due to the delayed increase of administrative prices and food price increases. The budget will be in surplus, but the non-oil deficit will remain substantial. The large current account surplus will diminish slowly.

The anticipated acceleration in growth has been delayed by the global slowdown and a wave of strikes. Growth is expected to be 2.6% in 2012, below potential, but is projected to pick up to 3.3% in 2013 and 4% in 2014. Core inflation will be contained by the large degree of slack in the economy, although recent food price increases are expected to fuel a temporary rise in headline inflation. Weak export volumes and the worsening terms of trade have widened the current account deficit this year and will take it to around 6% of GDP in 2013-14.