India growth slowdown to intensify

Economist Rajeev Malik today said the growth slowdown would intensify in India and cut the forecast for the next fiscal to 7.2 per cent from 8 per cent.

Malik, economist for Southeast Asia and India at Macquarie Capital Securities (Singapore) Pte Ltd, said: "Both consumption and investment growth are poised to moderate next year, with the latter being more worrying as it has been one of the main building blocks of the acceleration in India’s annual GDP growth".

He added that India remains a supply-constrained economy and elevated level of infrastructure-related spending will remain in play for several years. "However, that will at best only cushion, not reverse, the deceleration in overall investment spending", he said.

Malik pointed out that the Indian economy is adjusting to the reversal of the huge influx of capital inflows over the past few years, which coincided with favourable domestic structural factors and a strong global cyclical uplift.

"The combined effect of these drivers was to push up annual GDP growth well above the realisable medium-term threshold and create an overextended credit cycle, thereby worsening demand-driven inflation. The inflation threat was exacerbated by higher global food and crude oil prices", he said.

"It is payback time now. The structural story – minus the hype – remains intact but the other two drivers are now absent. Their absence will generate macroeconomic cross-currents that will have implications for the outlook for economic growth, and exchange rate and monetary management", Malik said.

Malik expects wholesale price inflation to likely remain in the low double digits for the next few months, and could still prompt a final tightening in October – unless inflation surprises on the downside – and then be on hold for a few months. "The new RBI governor is likely to be less hawkish than his predecessor, who has already done the difficult and unpopular task of tightening policy and of substantially managing inflation expectations", he said.

"We expect the RBI to begin easing from April 2009 onwards when the new governor announces the annual policy for 2009–10. Cumulatively, both the repo rate and the cash reserve ratio (CRR) will likely be cut by around 200bp in the next fiscal. CRR cuts will be required to offset the tightness in the money market arising from the RBI’s intervention in the foreign exchange market to prevent excessive rupee depreciation", Malik said.

Less favourably, the balance of payments dynamics and US dollar strength will cause the rupee to weaken. Malik expects the rupee to weaken against the US$ to 46–47 by end-December 2008, but it will likely pull back to 45 by end-March 2009. "Be prepared for more aggressive intervention by the RBI in the forex market. Also, the government is likely to ease restrictions on capital inflows in order to check the pace of the rupee’s depreciation", he said.