A balancing act ahead of India
Indian economy grew at a rate of 8.8% in Q2. This was the fastest quarterly growth seen since 2007. Investors are going crazy over the growth prospects of India. Developing countries seem to have become investors hotspot and the tremendous growth gap between developed and developing countries has charmed every type of investor from retail to institutional investors. Release of Indian GDP data was a further confirmation to this fact. Asia’s third largest economy is accelerating at very fast pace and every picture of its growth looks rosy.
But this economic report by finance minister Mr. Pranab Mukherjee has few problems which never came up while he delivered the speech. Looking deeper into the report suggests few negatives of Indian economy which may not be evident in first look. Investors were encouraged by bullish statements from Finance Minister Pranab Mukherjee, who indicated that growth could exceed government projections of 8.5% to 8.75% for the fiscal year as a whole. But the industrial output in June rose about 7% from a year earlier, the slowest growth in more than a year and the first time that measure of expansion came in at less than 10% in nine months. The domestic demand picture is also a bit troubling. Private consumption slumped to 0.3% y-o-y in Q2 from 2.6% in Q1, fixed investment has dropped to 3.7% from 17.7%, government consumption growth was negative and both export and import growth contracted.
The biggest threat to India’s continued expansion, however, centers around monetary policy decisions to be made in coming months. With inflation bordering on double-digit territory, the Reserve Bank of India has already raised the repurchase rate by 100 basis points so far this year and the reverse repurchase rate by 125 bps. Expectations are now for the RBI to increase both rates by 50 to 75 basis points by the end of the current fiscal year (March 2011). While clearly necessary to prevent inflation from spiralling out of control, some economists worry that the tightening campaign will weigh on local demand, a major driver of manufacturing activity.
Supply side of economy may weaken if the demand side is not able to grow. Indian government can not afford to let inflation go out of control as this will lead to all the growth going meaningless. But the problem with monetary tightening is that it could decrease domestic demand which has been the prime driver of the Indian growth.