India's economic performance remained lacklustre during the first quarter of fiscal year 2012/13 (April–June), as weak investor sentiment and high interest rates weighed down manufacturing and investment.
IHS Global Insight Perspective | |
Significance | India's GDP in real terms expanded 5.5% annually in the April–June quarter—the first quarter of fiscal year (FY) 2012/13—on a factor-cost basis, languishing near three-year lows of 5.3% recorded in January–March. Although the outturn beat analysts'—and IHS Global Insight's—expectations of sub-5.3% growth, growth prospects remain worrisome. |
Implications | Manufacturing remained feeble, as expected, and agriculture strengthened slightly, while services remained largely flat, remaining relatively healthy. Domestic demand continues to bear the brunt of the slowdown, especially investment, which barely remained positive this quarter. Domestic economic and policy weakness have dragged down investor sentiment. |
Outlook | Despite the poor growth data, we expect the Reserve Bank of India (RBI), preoccupied with high inflation, to wait until October to resume its rate-cutting cycle. A weak 2012 monsoon threatens agricultural output, rural spending, and food inflation. We expect only a shallow recovery in manufacturing and investment, and only a mild upturn by year-end. Growth will remain well below trend rates in the near term, at 6.0% in FY2012/13. |
Manufacturing a Drag on Growth, Services Moderately Healthy
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Economic growth in India remained tepid in the April–June quarter, the first quarter of fiscal year (FY) 2012/13, as manufacturing slowed to a crawl, and agriculture and services retained only modest traction. Real GDP on a factor-cost basis expanded 5.5% year-on-year (y/y), according to the Central Statistical Organization (CSO). The first-quarter's outturn was slightly higher than the January–March quarter's 5.3%, but much weaker than the 8.0% clocked during the same period a year earlier. Economic momentum remains weak, as growth languished close to three-year lows.
Nevertheless, the first-quarter outturn was higher than median forecasts of a Reuters poll this week, and was higher than IHS Global Insight's own projections of 5.0% expansion. Manufacturing barely eked out growth of 0.2% y/y, and industrial production remained stagnant during April–June, with growth contracting 0.1% compared with the healthy 7.0% rise in the year-earlier period. Mining and quarrying rose a mere 0.1% y/y in the first quarter, reversing last quarter's gains of 4.3%. Overall, services expanded by a moderately healthy 7.4% y/y, with positive expansion across all sub-sectors. Construction performed well, rising 10.9% y/y with expansion in building and infrastructure activity. Trade, hotels, and transport rose 4.0 % y/y, community and social services rose 7.9% y/y, and financial, real estate, and business services increased 10.8% y/y.
Agricultural sector growth was slightly better than the fourth quarter's 1.7% y/y, rising 2.9% in the first quarter. The higher base from the previous year's solid rebound still kept farm output fairly muted. The 2012 monsoon, however, has been erratic and uneven—as per the India Meteorological Department (IMD) forecast—dampening farm sector prospects during the current fiscal year and the overall economic recovery.
Poor Investment Trend Persists
On the demand side, according to the new CSO data, real GDP at market prices rose only 3.9% y/y during the fiscal first quarter, lower than the 5.6% y/y posted during the previous quarter. Real private consumption, the mainstay of India's boom, lost momentum from the fourth quarter's 6.1% rise, expanding only 4.0% y/y in the first quarter. Public spending rose 9.0% y/y, the highest in two years, as the government deployed limited fiscal stimulus, even as it attempted to pull back expenditures in an environment of weaker growth and revenue collection. Fixed investment performed abysmally, rising only 0.7% y/y, compared with last quarter's 3.6% rise, flirting with contraction territory again; capital expenditures failed to recover significantly even as borrowing costs stopped rising. Unsurprisingly, exports lost ground in the first quarter, rising only 10.1% y/y compared with last quarter's 18.1% increase, and imports rose 8.0% y/y, which will gradually help narrow the large trade and current-account deficits. Recent large government revisions to demand-side figures have led to large swings in national-income accounts data practically every quarter, but the demand-side data reinforce the lukewarm overall economic picture.
Inflation Retreating Gradually
Headline wholesale price index (WPI)—the primary inflation gauge—increased 6.9% y/y in July, falling below the 7%-mark for the first time since November 2009, but remains uncomfortably high. Food prices, which had declined earlier in the year, now are spiking upward again. Vegetable prices have surged more than 28% y/y, and other food prices have consistently shown double-digit increases. Core inflation (widely proxied by manufactured products inflation) has so far remained somewhat anchored, and stood at 5.7% y/y in July.
Indian shares pared most of their losses today (August 31), with the benchmark SENSEX down 0.1% at 17,371, up from levels earlier in the day. Government bond prices extended losses on the GDP data, since the RBI can now be persuaded to continue to hold off on lowering interest rates for now. The most commonly traded 10-year bonds fell to INR99.35 from INR99.67 before the data release. Meanwhile, the rupee stayed flat on the news, trading at INR55.69/USD1.00 during the day.
Outlook and Implications
RBI Will Wait to Ease Until October
Even as the RBI contemplates the current unenviable scenario of weak growth and elevated inflation, it is expected to remain on hold at its next monetary meeting in September. Following its front-loaded 50-basis-point repo-rate cut in April, the RBI has been on an extended pause, and has consistently maintained that it now is up to the government to tackle fiscal matters before the RBI loosens policy again. Given that today's GDP print was not worse than last quarter's, it takes some of the immediate pressure off the RBI to ease. It can wait to monitor inflation and industrial production trends for two more months before it opts to lower rates. RBI officials have steadfastly maintained that current inflation rates are well above their comfort zone, and this week RBI governor Duvvuri Subbarao posited that the central bank's goal was to tame WPI inflation to under 5%—even while acknowledging that inflation would average 7% this year. The rupee also seems to have stabilised, albeit at weaker levels, and the RBI will continue to intermittently intervene in foreign-exchange markets and liberalise capital-account transactions to boost inflows of hard currency to support the rupee. Hence the RBI is in no hurry to cut rates again, and it will probably wait until October to resume its easing cycle. We expect an additional 50 basis points of repo rate cuts by end-2012.
Reform Stalled Despite New Pro-Reform Finance Minister
Even though growth is notably below trend, passing the pressing reform agenda remains tricky. Certainly, there is no lack of qualified reformers holding senior government economic posts. Of course, respected economist prime minister Manmohan Singh himself carries impeccable reform credentials, but has been severely marginalised by party politics and political opposition. New finance minister P. Chidambaram, Harvard-educated and a lawyer, enjoys a solid rapport with Singh, having been Singh's adviser during the first wave of economic liberalisation in 1991, before subsequently going on to hold the post of finance minister twice. Reportedly, before being named finance minister again, Chidambaram told Singh that he was not interested in the post unless he was empowered to take tough decisions. Former RBI governor C. Rangarajan is the widely respected chairman of the prime minister's economic advisory council, and has tirelessly advocated fiscal discipline and subsidy reform, recognising the importance of "unpopular" reform now. Newly appointed chief economic advisor to the finance ministry Raghuram Rajan, a finance professor at University of Chicago's business school and former chief economist of the International Monetary Fund, is a free-market thinker and expected to tackle some of India's economic challenges.
Nevertheless, reforms now universally deemed necessary and critical to reviving the sinking business climate, such as subsidy reform, and foreign direct investment (FDI) in multi-brand retail, domestic aviation, and insurance, are not likely to see rapid implementation. On a priority basis, the government needs to revisit controversial tax proposals on anti-tax avoidance rules and retrospective taxation surrounding FDI that have deterred foreign investors. The current stalemate in parliament—the opposition Bharatiya Janata Party (BJP) has brought proceedings to a standstill, clamouring for Singh's resignation—and unrelenting political gridlock from coalition allies and the BJP is thwarting even bold reformer Chidambaram. Tasked with getting the economy back on track, the government hopes reform will be jumpstarted again in mid-September when parliament reconvenes, but this looks optimistic at best. Indeed, a hostile political environment that impedes passage of crucial legislation and cabinet initiatives makes the prospects for immediate reform dim.
Stagflation—persistent inflation in tandem with weak growth—remains a worrying prospect. India's current economic ills are staggering. High inflation, wide trade and current-account deficits, bloated subsidies, and a gaping fiscal deficit have all taken a toll on investment and consumption. A weak 2012 monsoon threatens agricultural output, rural spending and food inflation. Sagging investor sentiment due to corruption scandals and policy inertia has caused capital inflows to dry up. A world-record power outage in July left over 600 million people without electricity, highlighting infrastructure deficiencies and tarnishing India's image. Current trends are casting doubt over India's vaunted longer-term economic growth prospects. The impact of lagging investor sentiment and supply bottlenecks on fixed investment will be significant. We expect only a shallow recovery in manufacturing and investment, and only a mild upturn by year-end. IHS Global Insight expects GDP growth to remain well below trend rates in the near term, at 6.0% in FY2012/13 and less than 7.0% in FY2013/14.
We remain cautiously optimistic that the current political stalemate and stalled reform are transitory, and will be resolved by the next general election in 2014, at the latest. Indeed, India's main current drawback is also one of its strengths. Although it is a thriving democracy, its political system has led to a staggering bureaucracy, lack of strong leadership at the state level, and a very decentralised government that has hindered structural reform. Nevertheless, solid institutions and a stable political system will help India eventually weather the current domestic headwinds.