Deceleration is one of the biggest challenges for India. Weak external demand, domestic challenges, and limited policy options for the central bank add to the complex macroeconomic environment.
A wave of reforms is kindling optimism in India, but its economy is experiencing its slowest growth rate in nearly a decade. While macroeconomic indicators appear to be stabilizing, business confidence has declined on the heels of global economic uncertainty. Furthermore, uncertainty pertaining to the government’s ability to implement its reform plan is leaving businesses cautious about their investments. The International Monetary Fund (IMF) cut its projection for India’s economic growth to below 5 percent for the year, down from 6.1 percent. While the IMF’s forecast is much too pessimistic, India’s GDP growth will likely drop to between 5.5 and 6 percent in 2012.
The effects of a weak monsoon are beginning to manifest. The summer crop’s estimated yield suggests a decline of nearly 10 percent. Output of corn, rice, and oilseeds as well as cash crops such as cotton is expected to fall. The drop in output could lead to higher inflation, which remains well above the central bank’s comfort level. In addition, a decline in the production of coarse cereals, which are mainly used as cattle feed, could result in higher prices for milk and meat products. Headline inflation inched up to 7.8 percent in September, owing to an increase in prices of wheat, cereals, and diesel. However, as vegetable prices continue to soften, food inflation dropped from 9.1 in August to 7.9 percent. Inflation is likely to remain high in the next couple of months as the pass-through of oil prices takes full effect.
Plummeting business confidence and decelerating growth beckoned the Reserve Bank of India (RBI) to revisit its monetary stance. Market participants anticipated an interest rate cut, which could decrease borrowing costs and spur economic activity. However, in its policy review meeting in October, the RBI chose to keep its policy rate unchanged, but it reduced the cash reserve ratio by 25 basis points. The RBI’s monetary stance will add liquidity and enhance credit availability, but it may not directly impact borrowing rates. Furthermore, by maintaining its policy rate amid elevated inflation, the RBI will likely anchor inflation expectations.
The effects of a weak monsoon are beginning to manifest. Output of corn, rice, and oilseeds as well as cash crops such as cotton is expected to fall.
Meanwhile, many private and public sector banks have lowered borrowing rates on home and auto loans in an attempt to boost demand ahead of the festive season. A rise in consumer demand could spur manufacturing activity as well. Meanwhile, India’s industrial growth came in at 2.7 percent in August, following months of stagnation and contraction. While it may be too early to suggest a reversal in the trend, an uptick in industrial production is certainly a positive signal. Furthermore, the consumer goods and manufacturing indexes rose in August. The Purchase Managers Index remained unchanged from the previous month at 52.8, indicating sustained improvement in the manufacturing industry.
In an attempt to spur growth, the government announced reforms in retail, insurance, pensions, aviation, and broadcasting. Furthermore, the government also decided to reduce the subsidy on diesel and cooking gas in an attempt to reduce its budget deficit. While the corporate sector welcomed the government’s decisions, trade unions and several political parties have staunchly opposed the government’s action. Furthermore, opening up the ailing aviation sector to foreign investors has found few takers so far. It may be too early to assess the impact of these reforms, and multinational retailers and foreign investors will likely tread cautiously amid this uncertainty. Additionally, the government inducted seventeen new ministers into the cabinet. In several ministries, the old guard made way for younger ministers. Whether the government’s action will reap political dividends in the regional and national election remains to be seen.