India Economy - November 2011

Source: OPEC 12/2/2011, Location: Asia

On 25 October, the Reserve Bank of India (RBI) increased the economy’s benchmark interest rate by 25 basis points. This interest rate increase came on top of the previous interest rate rise of September, which hiked the repo rate to 8.5%. The central bank’s statement, however, indicates that no other increase in interest rates is likely in the coming months. The RBI has reiterated its March 2012 projection of inflation at 7% and has stated that if inflation conformed to expectations, other hikes in interest rates may not be warranted. It seems that the authorities’ stance in India has now moved from anti-inflationary to managing the growth-inflation trade-off. In a few months, managing inflation appeared to be the priority of the RBI; but in its recent statement justifying its recent interest rate increases because inflation had stayed above its comfort zone, the RBI indicated that stimulating investment and economic growth remains its priority as well.

As an economy with a large public sector deficit (around 5% of its GDP) and growing trade deficit ($54 billion), an increase in public sector spending to stimulate growth will inevitably exert a crowding-out effect. An increase in government expenditure above its ascending longer-term trend is associated with a downtrend in short-term private investment towards its descending investment trend. In moving to a slower GDP growth forecast for this fiscal year, the RBI pointed out that slowing down investment, slower clearance and execution of projects, and rising interest rates were key factors contributing to the slowdown of economic growth. Another significant element of the RBI’s recent policy change was deregulation of savings bank deposit rates. This is a clear sign of monetary policy reform that would increase efficiency of the transmission mechanism of Indian monetary policy, linking policy rates more closely to market rates.

India’s economy faces high inflation and high interest rate with growing uncertainties concerning the government’s ability to lead the economy to sustainable growth. As a result, consumer confidence has been fading and there has been a moderation in the demand for durables. One obvious manifestation of this is declining demand for cars – growth of automobile sales is believed to have fallen to a mere 2% to 4%, from a high of 35% y-o-y in 2010, according to the Indian Society of Automobile Manufacturers.

High interest rates and fuel price increase are blamed for this significant change in demand for cars in a relatively short period of time. However, sales of trucks and buses, often seen as a proxy for investment, rose by 18.1% in September on top of an increase of around 18% in the April-September period. Interruptions have been reported in the car industry—such as in Maruti Suzuki, India largest car manufacturer— with a significant impact on the sector’s output. The company estimates that labourmanagement disputes have cost $330 million so far. The disputes are important because the outcome can affect general working conditions and pay in the overall automotive industry.

Industrial output growth has moderated in 2011 and rose by a slower than expected 4.1% on an annual basis in August. The manufacturing sector, with a 76% share in industrial output, grew only by 4.5% in August. Although power generation rose by 9.5%, mining production fell by 3.4% in August, year-on-year. Growth of consumer durables fell from 16.3% in August 2010 to 4.3% in same month of 2011. There are signs that the slowdown has become more broad-based and has affected the services sector. According to recent reports, the HSBC Markit India services PMI slipped from 53.4 in August to 49.8 in September, the sector’s first contraction since 2009.

Wholesale prices effectively were unchanged and stood at 9.7% in September, slipping slightly from 9.8% in August. Key drivers of the overall price index (food, energy and primary goods) did not moderate in a significant way, although inflation of manufacturing goods eased from 7.8% in August to 7.7% in September. Inflation in the fuel and power category accelerated to 14.1% in September, affected by the government’s fuel price rise of 15 September. Given the effects of the fuel price increase on consumer price levels, the Ministry of Commerce and Industries tends to revise upwards-wholesale price data in the coming months. Subsequent inflation figures might, therefore, appear to have remained in two-digit territory in 3Q11.

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