India’s industrial sector has nearly come to a halt, going by the 0.1 per cent factory output growth data for April. Exasperated economists with large conglomerates say since the government has not been able to resolve the structural supply-side issues, the central bank had to curtail demand through rate rises. Demand is weak and there are few triggers which can revive sentiment adequately to improve growth. Moody’s Analytics says, “Soft business investment is now both a cause and an effect of India’s weak economic environment. The reasons for the weak economic environment have been detailed many times before — centred on a weak national government and declining investor confidence — and this is now the new status quo in India.”
While most believe the high cost of capital is a big reason for the weakness in industrial output, Richard Iley, chief Asia economist at BNP Paribas, believes sluggish export markets, lagged impact of the previous rupee real overvaluation, policy (and demand) uncertainty and high cost of capital, exacerbated by excessively loose fiscal policy settings, have contributed to the weak index of industrial production (IIP) print.
At this point in time, it doesn’t really matter which of these factors is more debilitating. But such a slowdown in industrial production means economic growth in the first quarter of FY13 will mimic the 5.3 per cent seen in Q4 of FY12. Siddhartha Roy, chief economist at Tata Sons, is expecting a 50 basis points rate cut, without which nothing will move. Both, availability and cost of money are problems, he explains.
Weak IIP data, cheaper crude oil and a precarious global situation may push the Reserve Bank of India to cut rates by 25-50 basis points. But it is no magic pill, which will reverse sluggish economic growth and even slower investments. Given the slowdown in global growth and Europe’s unending woes, any pullback will not be easy. Also, transmission of a rate cut will take time, as deposit growth has been slowing in the past few months and banks will not want to cut rates aggressively.
Leif Eskesen, chief economist for India and Asean, HSBC, says this is the wrong medicine to boost growth. “Instead, the right prescription is a heavy dose of supply-side reform. Moreover, the room for aggressive policy rate cuts is limited by the persistent inflation pressures, which are partly the residue of the supply-led slowdown in growth and the sizable twin deficits. The continued struggles of the exchange rate also limit the room for rate cuts
