The economy is on a roll – as we expected, the growth numbers for 2010-2011 Q1 came in high at 8.8%, the highest in more than two years. But this will also be the highest growth we see this year. While manufacturing has turned in the highest growth amongst all sectors at 12.4%, the deceleration is clearly in force and production is set to grow at much lower rates, close to 6-7% by the last quarter of this year. This does not however spell dark gloom for manufacturing, as industries have been spurred by the visible growth in domestic demand, especially in rural and small town India. Yet, hit by the high input prices, interest costs and wage rises this year, companies have to take a closer look at managing expansion expenses. If firms do pull this off, and we believe they will, a return to 9% growth levels can be expected in industry by the end of the next financial year.

The bright spot is that capex plans can take support from the fact that rate hikes are set to level off over the course of this year. While markets have factored in a 50 basis point rise in the coming quarter, RBIspeak already indicates that the good monsoon and subdued global commodity price rises point to lower pressures on inflation- a higher than expected rate hike therefore is not on the cards. Inflation according to all indices - WPI, CPI or manufactured products - has come off the peaks seen early this year. While the WPI will move down gradually towards 6% levels by March-end, CPI will continue to be high in the 8-9% range. However, the only way to get significantly lower consumer prices in the long term would be through drastic reform in the food stock procurement and distribution system, and there is no sign that such changes are even in the pipeline.

The service sector has been the one that has consistently pushed the economy upwards. There is much more action coming through in this sector, especially in the two booming sectors - aviation and telecom, the former moving into new cities and the latter expanding into the rural areas.

Even though growth prospects are generally upbeat, on the export front, there are still no clear indications from the West whether markets are set to revive this year. While the government has put through an additional dose of stimulus for some export-sectors, this strategy that has propped up these sectors for more than 2 years now does not augur well for their long term sustainability. An additional impact of the uncertainty and the slowing down of growth in China will be on raising the volatility in global crude and commodity prices, this needs to be factored into cost and price plans this year.

Net net, the picture is bright for now - growth is on the up trend and we expect it to touch 8.2% this year and 8.7% in 2011-12. India is set to be the fastest growing economy in the world by 2015, but before we pop the champagne, the fact remains that we are still operating way below our potential and a double-digit growth will require substantial change, not just in markets, but also in governance.

See accompanying graphs here