Signs of cooling in Indian economy

June 14, 2011

(The views expressed in this column are the author’s own and do not represent those of Reuters)

This was not unexpected. The RBI has taken every care to cool down the economy with successive increases in interest rates. The results are now beginning to show.

But ours is not the only economy that is slowing down. Almost every large economy is under pressure for one reason or the other and the IMF was consequently compelled to slice off its own estimate of world GDP growth by 20 bps.

Unemployment in the U.S. has climbed to 9.1 pct and Dow Jones sank for six consecutive weeks, the longest losing streak since 2002. The investor, however, expects the fall to be short lived in the hope that the Fed, which is too eager to pump in money, will intervene. Even that is not going to lift up the economy.

Growth continues to be weak in Europe. Spain is sinking deeper into the debt crisis. With the impact of tsunami, the Japanese GDP may drop 0.7 pct in 2011. The Chinese economy is cooling down after inflation at 5.5 pct and new loans down 12 pct.

It is no wonder that the Indian economy is also losing pace. The original sin is food inflation which, in spite of the costlier credit, persists. At the end of May it perked up to 9 pct.

GDP growth in the first quarter of 2011 slumped to 7.8 pct in spite of good agricultural production. It was industry that let growth down.

The rate of growth of industrial production had eased since late last year to 3-4 pct. It picked up in March but dropped again to 6.3 pct in April. The hardest hit was capital goods production. Capacity expansion and construction activity were the worst victims of interest hike.

The Sensex tumbled after reaching a peak of 20500 in December. It lost 1700 points in six months. This was partly due to drop in EPS and rise in the rate of interest. The mood in the market continues to be gloomy and has stopped many companies from issuing IPOs. Consequently, investment has been delayed.

In spite of the high rate of interest, bank credit is shooting up. It increased 22 pct  y/y in the fortnight ending May 20, about 500 bps more than the rate of increase in deposits. The demand for credit is bloated because of the higher cost of operations and not higher production.

The only bright spot is exports. In April-May growth was over 45 pct though world trade is not booming. It may not be possible to sustain this rate of growth because the rest of the world is slowing down.

There are enough signs that the Indian economy is cooling down without really being heated up. The inflation that took place was not because of excessive investment unmatched by savings. The increase in interest rate hardly made any difference to inflation even after 15 months; but it made a lot of difference to growth which slowed down and may take some time to recover to 9 pct.

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