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|Many a Slip ’twixt the Cusp & the Lip|
|Thursday, 08 December 2011 04:28|
Holding up investment plans will hurt growth.
Source: Economic Times
Finally, an end in sight to the rate hikes — growth has been pushed down, the estimates for Q2 growth have come in at less than 7% and, for the first time in more than two years, inflation in primary products has dropped to below double digits. Unfortunately, this does not bring us immediately back to the good times. Inflationary pressures persist, especially in minerals and fuel, and the Reserve Bank of India (RBI) continues to warn us that it will not hesitate to act to dampen expectations. So, the trajectory of inflation will be watched closely. While inflation in manufactured products is currently expected to touch 6% levels in the next quarter, wholesale price index (WPI) for the next year is still expected to average 7%. But that is nowhere close to the 4-5% that RBI has been comfortable with in the past. Although the RBI has factored this in, there would be little tolerance of a movement away from the 6-7% level.
So, it will take a few more months before a pause can actually translate into rate cuts, if the RBI sticks to what it said in the past. Support for a less tight monetary policy comes in, of course, from low manufacturing growth. The Purchasing Managers’ Index (PMI) for India has been hovering just above 50 over the last three months and the index of industrial production (IIP) growth has been heading downwards. We expect IIP growth to reach a low, averaging around 0.6% in Q3, and then moving up gradually to 3-4% levels by next June, a slow recovery at best.
On the other hand, there are additional complications coming in from the external front that will make it even more difficult to keep inflationary pressures down. Though the rupee has seen a steady decline in the past few months, there were hopes that the RBI would step in aggressively to stem the fall. This has not happened.
The RBI has stuck to its stated policy of only managing intra-day volatility. Given the inflationary impact of a falling rupee, the lack of support may seem baffling, but look at the underlying factors for the decline and the policy stance is understandable. The rupee has been hit by large capital outflows — partly due to the dark global environment, and partly due to policy stagnation that has undermined confidence in the domestic economy. With the RBI seeing no signs of positive movement on either of these fronts, a commitment to holding up the rupee can have dire consequences on the forex reserves in the medium term. So, the central bank will tread softly, taking small measures like controls on external commercial borrowings, some sort of capital controls and so on, but little else. Whether uninterested, unwilling or unable, or perhaps all three, we cannot expect anything more from this constellation of policymakers and central bankers.
Apart from all the rest, the fisc that has played a key role in raising inflation needs greater attention. It is clear that the fiscal deficit target for 2011-12 will not be met. Confidence in the economy can be boosted if there is an assurance to trimming the deficit. The question is whether the government can even think of looking in that direction, given that the focus on welfare expenditure is clearly taking precedence, especially with seven states going to the polls next year.
Fortunately, on the growth front, all is not as gloomy as before. Yes, construction and mining are two sectors that will take a while to recover, but agriculture has done well, auto sales were much better than expected in November and the services sector PMI was significantly higher in November with strong expansion in new business. Seasonality factors will also give a short fillip next quarter. Yet, all this is overshadowed by the loss in India’s growth potential, with investment plans on hold. The crux of the matter is that while in the short term, we can expect better growth over the last two quarters of this year; inflation and policy stagnation have already taken a toll on the long term.