Global Insight Perspective | |
Significance | Despite the weaker trend and the deteriorating global environment, India's economy registered relatively robust growth of 7.9% y/y in the first quarter of FY 2008/09. |
Implications | Even with the slowdown in economic momentum, the central bank is likely to pursue further monetary tightening to subdue inflation, currently hovering at 13-year highs. |
Outlook | Given the higher costs of borrowing and projected weaker capital inflows, economic growth will decelerate moderately, to 7.5% for the whole of FY 2008/09. |
Manufacturing Weakens, Though Service Sector Provides Traction
India's economy posted growth below 8% for the first time since 2004, as rising interest rates and spiralling inflation dented domestic demand. During the first quarter (April–June) of FY 2008/09, real GDP expanded by 7.9% year-on-year (y/y), according to the Central Statistical Organization. Growth in the first quarter declined from 9.2% a year earlier and 8.8% registered in the January–March quarter. Despite the overall slowdown, services and construction provided traction during the quarter. Construction increased by 11.4% y/y, while services, including trade, hotels, transport, and financial services, expanded by 10.2%. However, manufacturing growth moderated to 5.6%, and industrial production growth during the quarter stood at only 5.2%. Meanwhile, the farm sector registered meagre growth of 3.0%. Agriculture and allied industries account for more than one-quarter of India’s GDP, and employ more than half of the country's billion-plus population. Meanwhile, on the demand side, private consumption expanded 8.0%, government spending increased 7.7%, and fixed investment grew 9.0%. Exports and imports increased by 19.5% and 21.5%, respectively.
Outlook and Implications
The economy's momentum will remain weaker in the near term. The current overall economic pace is likely to decelerate moderately in FY 2008/09 (April 2008–March 2009), falling well short of the 9.0% growth registered last year. We expect GDP to register increases of 7.5% in FY 2008/09 and 7.8% in FY 2009/10. The fast-growing service sector, which accounts for more than half of the economy, will remain a key driver in upcoming quarters. The industrial sector will probably weaken substantially, however, and rising costs of capital and weaker business confidence will hit private investment. Despite rising policy-interest rates, prime-lending rates have not risen substantially, and Indian consumers have continued to borrow and spend, though the spending spree will falter considerably. A predicted normal monsoon season will ensure stability in the agricultural sector, which will bolster the economy and help mitigate any fallout in services and industry sectors emanating from the sharp global economic slowdown.
Inflation Remains High, But Is Showing Signs of Easing
The wholesale price index (WPI) rose steadily throughout early 2008 on the back of strong economic activity, high liquidity, and higher food, oil, and other commodity prices. The WPI continues to be on a steep trend, but eased for the first time in months: the WPI rose 12.40% year-on-year (y/y) during the week of 16 August, compared with a 12.63% y/y rise during the previous week. However, inflation still remains significantly higher than the central bank's comfort zone. Inflation spiked following June's sweeping increases in government-set retail fuel prices, by an average of 10%, to address mounting losses at state oil firms, which have been forced to sell fuel at sharply discounted rates. The increase in fuel prices added to significant supply-side pressures already generated by surging food prices amid domestic and global production shortfalls. India's central Reserve Bank of India (RBI) hinted today that the states-administered fuel process might have to rise again in the near term. Any further hike in administered fuel prices would drive inflation even more.
Elections and Fiscal Expenditures Complicate Economic Policy
A series of key state elections are also scheduled over the next few months, and will be a harbinger of the outcome of a general election, due before May 2009. High inflation is a perennial election issue, since the rural poor, severely affected by spiralling inflation, comprise the majority of the electorate. Attempting to soften the adverse impact of rising commodity prices on inflation and the cost of living for the poor, the government is incurring off-budget subsidies on oil, electricity, fertilisers and food. In addition, the government has committed to major expenditure items, including a farm loan write-off and an increase in its employees’ wages. While these measures will help counter some of the inflationary impact, this expansionary fiscal policy is at odds with the monetary tightening underway.
More Monetary Tightening Likely
The RBI tightened monetary policy aggressively in June and July to counter the uptick in prices, increasing the repo rate, its overnight lending rate, by a total of 125 basis points, to 9.0%. Meanwhile, it also has raised the cash-reserve ratio to 9.0%—150 basis points higher than at the beginning of the year. However, inflation is expected to intensify further before it abates, indicating that additional monetary policy will be forthcoming. The RBI is likely to raise the cash-reserve ratio further in the near term, and could raise the repo rate again if inflation fails to subside. The RBI has emphasised that fighting inflation remains the highest priority, and that it is willing to tolerate slower growth in favour of keeping inflation in check. The RBI is scheduled to hold its next policy-making meeting at the end of October,
New Futures-Trading in the Rupee
In other developments, the National Stock Exchange commenced futures-trading in the rupee, thereby increasing its financial market offerings. The new currency futures will help Indian companies and individuals wishing to hedge their exposure to the rupee-dollar exchange rates. The new futures-trading is likely to boost trading in the spot foreign-exchange market as well. The booming Indian economy has fuelled outward-looking trends. As Indian companies increasingly acquire foreign companies to diversify their growth profile, individuals also are progressively purchasing assets abroad. Many foreign investment banks have also entered the Indian market, aided by easing restrictions on investment. The new trading permits speculative trading on the rupee for the first time. Two of India's other exchanges—the Bombay Stock Exchange and the Multi Commodity Exchange—are also seeking similar futures contracts. The RBI has limited the size of the contracts, at $1,000 each, and imposed position limits of $5 million for clients of banks and brokerages and $25 million for trading members.