India slowdown, high inflation likely to persist

A bank employee counts bundles of Indian currency at a cash counterin Agartala, capital of Tripura, July 7, 2009.

India's growth story, which has excited many in recentyears, is passing through anot-very-happy chapter thatmight last well into 2012. WhileIndia should keep growing atrates many nations would envy,Asia's third-largest economyfaces a period of reduced growthand stubbornly high inflation.

This is causing confidence inthe growth story to wane whileworries rise. Indian stocks, hitby inflation and high interestrates, are Asia's worst performersthis year-- down nearly 14percent -- resulting in a declinein portfolio flows. Weaker taxrevenue can widen a yawningfiscal deficit.

Also, there's a possibility thatIndia could lose out to China andsmaller Asian economies in thebattle to attract big foreign investment.China has cooled as it, too, battlesinflation, but still might grow 10percent this year.

Several years ago, annual Indian growthwas about 9.5 percent. Then it fell to 6.8percent during the global financial crisisbut recovered to 8.5 percent in the last fiscalyear, which ended March 31.

For the current fiscal year, private economistsare slashing growth forecasts tobelow 8 percent and notching up inflationprojections. In May, annual inflation was9.06 percent -- compared with 5.5 percentin China.

Unavoidable result
Lower growth is an unavoidable resultof the Reserve Bank of India's fightagainst inflation, which has featured 10 increasesin interest rates since March 2010.Growth is likely to be less than 8 percentand will not pick up rapidly "especiallywith policy having to choose betweenprice stability and growth," he said.

"We are only at the early stages of seeingthe impact of the monetary tightening,the negative effects of which are likely topersist well into 2012/13," it said.In its latest move, the central bank onJune 16 raised to 7.5 percent the rate atwhich it lends to banks. Even after 10 increases,India's real interest rates remainnegative, meaning the inflation pace remainsabove rates. That can drive consumptionat a time the government is notsucceeding in boosting supply, so inflationcan be further fuelled, resulting in furthertightening and economic pain.

"Inflation is entrenched in India, andnow mostly reflects demand side pressures,"said Frederic Neumann, managingdirector and co-head of Asian economicsresearch at HSBC.

A slowing economy cuts tax revenue,widening the fiscal deficit. High oil priceshave cut demand, swelled import bills andraised costs at corporates. Meantime, theglobal picture looks discouraging, cloudingthe outlook for exports -- which havebeen a bright spot.

India escaped the worst of the 2008global downturn due to robust internal demandand high government spending. Alarge middle class flush with cash spent oneverything from gold to cars, and factorycapacity got pushed to limits. But thenfirms dithered on adding capacity, thanksto weak global recovery and domestic policyuncertainty amid a slew of corruptionscandals.

Price pressures were emerging too. NewDelhi's easy fiscal policy to cope with theglobal slowdown was not rolled backquickly enough and the central bank waswidely seen as behind the curve. Droughtin 2009 made caused food prices to spike.But no one expected the level of India'sslowdown in the January-March quarter.For the first time in five quarters, annualgrowth was below 8 percent.

Slowing the boat
Industrial output has risen in single digitsthe past six months. Car sales, a barometerof consumer demand, have slowedwith May's total rising the least in twoyears. Manufacturing data show that firms'input costs have been rising faster thanoutput costs since December.

"It looks like the manufacturingsector is going to seevery subdued single digitgrowth. Continued interestrate hikes are going to hampersustained high growth in consumerdurables," saidVarathan of Capital Economics."Robust growth in exportis the only positive factor formanufacturing sector. But thatwill help only selective industries."

Exports posted recordgrowth in the year ended inMarch. India exported $245.9billion of goods during theyear, far above the government'starget of $200 billion.

A slowdown is evident inservices, which account forabout 58 percent of theeconomy.

The sector has slipped twice in the lastthree months, with May's expansion beingthe slowest in 20 months.

The sector is grappling with highercosts. Aon Hewitt estimates Indian companieswill have to pay 13 percent more toemployees in 2011.

"Slowing manufacturing activity, risinginput costs, tight liquidity, interest ratepressure and a government looking totighten its fiscal belt don't make a veryrosy outlook for the services sector," saidSiddhartha Sanyal, an economist with BarclaysCapital in Mumbai. He expects GDPgrowth of 7.7 percent in 2011/12.

No spending boost
The farm sector is expected to defy theslowdown on the forecast of a normalmonsoon. It grew 6.6 percent in 2010/11,compared with 0.4 percent a year earlier.

A good harvest should help shore uprural demand, which should save the economyfrom any severe slowdown. But towhat extent higher rural income can offseta slowdown in consumer spending is unclear.The government is looking to keep a lidon spending to meet its fiscal deficit targetof 4.6 percent for this fiscal year.

Policy inertia in the wake of graft scandalsis not helping the economy. The governmentis repeatedly deferring decisionson raising prices of diesel, kerosene andcooking gas, even as high global pricesthreaten its fiscal gap target.Lack of policy as well as regulatory hurdleshave held up investment in infrastructureand retail sectors.

[ BY RAJESH KUMAR SINGH ]