India Economy - September 2012

Source: OPEC 10/4/2012, Location: Asia

Despite pressure for a further cut in interest rates following its April action that after nearly three years lowered the benchmark interest rate by 50 basis points, reducing borrowing cost to 8.0%, the Reserve Bank of India (RBI) decided to keep the benchmark interest rate on hold for the time being, primarily due to elevated inflation. While business leaders might argue that lackluster growth warrants a further easing in monetary conditions, inflationary pressures are still uncomfortably high. This, along with the fact that the government has shown little progress in reining in its huge fiscal deficit, appears to have encouraged the central bank to keep policy interest rates unchanged The latest inflation report shows that wholesale price rises, though still high, unexpectedly fell to 7.3% y-o-y in June on the back of a sharp drop in global commodity prices.

The consumer price index (CPI) on the other hand stood at 10% in June compared to 10.4% in the previous month. CPI inflation is estimated to moderate to 8.7% on average for 2012, and to 7.6% for 2013. There is a possibility of a rebound in the inflation rate to double digits, considering the disappointing start to this year’s monsoon, which is likely to lead to a resurgence in food prices in the months ahead. While the progress of the monsoon has improved in recent weeks, it is still expected to remain deficient, exerting an adverse effect on agricultural output and rural demand in coming quarters.

Real GDP growth expectations for this year have continued to slide this month, with the central bank reducing its GDP growth projection from 7.3% to 6.5%. We have reduced our forecast of India’s GDP growth in 2012 to 6.3% considering the economy’s performance in first half of the year. Although annualized GDP growth picked up in the second quarter compared to the first quarter, sequential movement continues to fall. According to JP Morgan the sequential momentum of GDP growth has continued to moderate for a third successive quarter. While the momentum of industrial production growth continues to weaken, different sub-sectors of the Indian economy are pulling in different directions. The sequential momentum of manufacturing fell for a third quarter, with y-o-y growth at a slight 0.2%.

Mining activity also lapsed in the second quarter, contracting on a sequential basis. However, some sectors such as electricity, gas and water showed better-thanexpected performance. Sub sectors in services also grew in different directions. Services growth has been holding up GDP growth over the last year even as industrial momentum slowed markedly. Y-o-y, growth of services activities moderated to 6.9% from 7.9% in the second quarter of the year, while q-o-q, the momentum of the services sector fell off sharply to 6.4% in 2Q12 from 8.6% in the previous quarter. India’s widening trade gap together with its fiscal deficit has put downward pressure on the rupee. The rupee is forecast to remain weak in the short-to-medium term considering the lack of any sign of improving external demand for the economy’s exports.

The current account deficit is expected to widen from the equivalent of 3.2% of GDP in 2011 to 4.4% in 2012. In the first seven months of 2012 merchandise exports shrank by 4.1% on an annual basis, while imports grew by 1.9%. Inward capital flow is also expected to decrease, lowering the demand for the rupee. In the medium-to-longer term however, one can expect a stronger rupee, taking into account the relatively bright prospect for the economy. Services exports will retain their vital role in the country’s external trade as information technology and business process outsourcing continue to lure Western firms to India.

In the budget for the year 2012-13 which was revised in March, the government outlined a modest programme of fiscal consolidation, with the budget deficit targeted to narrow to the equivalent of 5.1% of GDP in 2012-13, from an estimated 5.9% in 2011-12. The budget includes an increase in service and excise taxes as well as import duties, as part of a bid to raise additional tax revenue. On the expenditure side, the budget targets a reduction in subsidy spending to the equivalent of 1.9% of GDP in 2012-13 from an estimated 2.4% in 2011-12. However, the original target for subsidy spending in 2011-12 was 1.6% of GDP. An expected increase in subsidy expenditure due to this year’s poor monsoon means that the government’s target looks optimistic and unlikely to be met. Therefore, the budget deficit is expected to stay high and narrow only slightly to the equivalent of 5.6% of GDP.

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