Growth in India’s economy decelerated to its weakest pace in seven years during the fourth quarter (January-March) of fiscal year 2011/12, as poor investor sentiment dragged down manufacturing
and investment. India’s GDP expanded only 5.3% in annual terms in the fourth quarter of fiscal year (FY) 2011/12 – on a factor-cost basis, markedly lower than the already weak 6.1% rate recorded in October–December. The fourth-quarter figures bring full-year GDP growth in FY 2011/12 to 6.5%, markedly lower than government projections of 6.9% growth, and lower than IHS Global Insight’s current forecasts.
Manufacturing contracted on weaker industrial growth, agriculture remained anaemic, but services continued to enjoy relative health during the quarter. The stringent monetary-tightening campaign (that ended in October) hit domestic demand, particularly investment, hard, and worryingly, a confluence of domestic economic and policy weakness and international risk aversion is causing the rupee to plummet.
Even as inflation remains elevated, the Reserve Bank of India (RBI) will continue to ease monetary policy to spur growth in the absence of effective fiscal policy, and IHS now expects an additional 50 basis points of policy repo rate cuts by end-2012.
A weaker investment outlook, driven by global financial uncertainties, domestic policy uncertainties, sticky inflation, and lesser monetary policy easing has prompted the lowering of the country’s GDP growth forecast for FY 2012/13 from 7.2% to 7.0%. Economic growth in India dipped dramatically in the January–March quarter, as manufacturing contracted and agriculture slowed to a crawl, as official data released 31 May show. According to the Central Statistical Organisation (CSO), real GDP on a factor-cost basis expanded by only 5.3% year-on-year (y/y). With a palpable slowdown in the fiscal fourth quarter, the economy continues to lose momentum and expanded at its weakest pace since the third quarter of 2004. The alarming GDP print highlights the extreme slowdown in momentum, and in fact, the fourth-quarter outturn was lower than the lowest forecast of a recent Reuters poll. Manufacturing growth declined 0.3% y/y, and industrial production remained stagnant during January–March, with growth at a feeble 0.6% compared with the 7.9% in the year-earlier period. Mining and quarrying rose by 4.3% y/y in the fourth quarter, reversing three quarters of contraction. Overall, services expanded by a healthy 7.9% y/y, with positive expansion across all sub-sectors. Construction increased by 4.8% y/y with expansion in building and infrastructure activity. Trade, hotels, and transport rose 7.0 % y/y, community and social services rose 7.0% y/y, and financial, real estate, and business services increased 10.0% y/y. Agricultural sector growth was muted, at 1.7% y/y during the fourth quarter. Although discouraging, the modest expansion is largely due to the higher base from the previous year’s solid rebound. The expected 2012 monsoon – as predicted by the National Meteorological Society – will help the farm sector maintain traction during the current fiscal year, proving to be beneficial to boosting rural demand and overall consumer spending as the economy recovers.
Weak investment trends to continue
On the demand side, according to the new CSO data, real GDP at market prices rose at 5.6% y/y during the fiscal fourth quarter, lower than the 6.7% y/y posted during the third quarter. Real private consumption, the mainstay of India’s boom, gained strength, expanding 6.1% y/y, and public spending rose 4.1% y/y as the government attempted to pull back expenditures in an environment of elevated global oil prices and weaker growth and revenue collection. Fixed investment rose 3.6% y/y, reversing last quarter’s contraction; capital expenditures recovered slightly as borrowing costs stopped rising. Exports surprisingly gained ground in the fourth quarter, by 18.0% y/y, and imports rose by 2.0% y/y, which will help narrow the large trade and current-account deficits. Recent large government revisions to demand-side figures have led to swings in national-income accounts data every quarter, but the demand-side data reinforce the lacklustre overall economic picture.
Modest retreat in inflation
Headline wholesale price index (WPI)—the primary inflation gauge—increased 7.2% y/y in April, and has not really budged since December–January. Food prices, which had declined earlier in the year, are now spiking upward again. Vegetable prices have shot up more
than 50% y/y, and other food prices have consistently shown double-digit increases. Core inflation (widely proxied by manufactured products inflation) has so far remained anchored, but the recent sharp rupee depreciation could add to inflationary pressures.
Outlook and implications
The scenario of weaker growth and elevated headline inflation poses major challenges to the Reserve Bank of India (RBI) as it considers monetary policy. It has already reduced reserve requirements by 125 basis points in 2012 to ease liquidity, and lowered policy rates by 50 basis points in April. The current priority for the RBI is undoubtedly to prevent further sharp currency depreciation and any potential impact on inflation. HIS Global Insight lowered their forecast for remaining rate cuts in 2012 from 75 basis points to 50 basis points. In July-September, the RBI will probably ease again, given that core inflation is expected to remain contained, and the food and fuel-price shocks to abate. After hitting new troughs, the rupee could begin recovering, and this will also help the RBI lower rates again. IHS expects the RBI to continue to infuse liquidity, intervene in foreign-exchange markets, and pursue open-market operations. The investment environment remains noxious, not only because of still-high borrowing costs – though these are coming down as commercial banks begin lowering lending rates – but because of policy missteps and reversals. Political opposition to reform initiatives from inside and outside the governing UPA coalition has stymied policy initiatives.
In fact, a nationwide strike called by the opposition to protest against fuel price hikes underscores difficulty in enacting policy, as transportation, businesses, government offices, and schools shut down for a day.
No doubt, weak leadership by the Manmohan Singh administration has certainly contributed to the
political gridlock, which has quickly alienated foreign investors. Slowing capital expenditures, a wide current-account deficit that highlights India’s reliance on fickle capital inflows during a time of global financial risk aversion, sticky inflation, and a runaway fiscal deficit are all casting doubt over India’s economic growth story.
On a priority basis, the government needs to circumvent fractious political coalitions and address fiscal consolidation, subsidies, liberalisation of foreign direct investment in retail, infrastructure investment, and tax policies on investment. Sounding a warning, credit rating agency Standard & Poor’s downgraded its outlook on India’s sovereign rating in April – any actual downgrade would result in India losing its investment-grade status. Stubborn inflation coupled with weak growth is prompting worries of extended stagflation. But a negative output gap – GDP growth will remain under 8% for three years through FY 2013/14 – will temper demand, and with it, core inflation. Rupee weakness will continue over the shorter term, even as a weaker rupee alleviates trade and current account imbalances. As a result, IHS expects only 50 basis points of policy repo rate cuts by end-2012, from 75 basis points previously. The impact of lagging investor sentiment on fixed investment will probably be significant as bottlenecks and approval delays compound the negative trends. Due to a shallower recovery in investment, they expect economic growth to recover even more modestly than earlier forecast, and are lowering GDP growth forecast for FY 2012/13 from 7.2% to 7.0%.
To add to India’s troubles in late July the national electricity grid unexpectedly shut down across the country with an estimated 350 million people left without electricity. This sparked debate about the chronic lack of power to fuel India’s industry growth requirements and expectations that power supplies might be back on within a week will undoubtedly affect GDP growth in this quarter and, perhaps, beyond. And all of this will filter through to the port sector as exports drop.