Slowdown ahead?

GDP growth has slowed in the last quarter to 8.6 per cent""well below the year's projected growth rate of 9.2 per cent. The non-oil export growth rate has dropped steadily in recent months, and in the latest month total export growth has been barely 5 per cent. The property market has cooled""which should affect construction activity. Stock prices have fallen 15 per cent from their peak. The rupee has climbed despite the higher inflation rate in India. Banks have raised interest rates, and some of them have become more cautious about retail lending. The worry level about the US economy has gone up once again. There is only one conclusion that can flow from all these indicators""GDP growth will now be slower than it has been in the last couple of years.

The business cycle is about expectations as much as anything else. And there is no getting away from the fact that expectations have dimmed a bit in recent weeks. Consumers will be more cautious about borrowing. Those planning to invest in new production capacities will keep a sharper eye on demand trends, and may either defer decisions or go for more modest plans. Speculative investment will certainly get reduced because markets are no longer a one-way bet. Some of the irrational exuberance of the past few months will give way to mild uncertainty. All this is for the good. There were signs of the economy over-heating, and everyone wanted the system to cool down. That is what it is doing, and the dip in the inflation curve provides welcome relief. What we need to see now is whether the runaway credit growth too slows down.

None of this should suggest that the fundamental India story has changed. Most of the growth drivers are still in place: businesses have every intention to continue hiring, and pay hikes will remain substantial; a good rabi harvest is round the corner; savings and investment rates remain high. The problems, if anything, flow from the success story""strong capital inflow is driving up the rupee, affecting exports (which must now replace inflation as Worry No. 1). While predictions about likely GDP growth next year are hazardous in such a dynamic situation, it is probable that the number will be under 8.5 per cent. How much lower than that will depend on what the RBI does. It faces a problem that it has faced before: the sterilisation of the dollar inflow is adding to domestic money supply. The challenge is to prevent excess liquidity from creating generalised inflation. The risk is that raising interest rates further might cool the system down too much. The preferred levers for soaking up excess liquidity might therefore be the cash reserve ratio and the market stabilisation scheme. Using them in a manner that keeps real interest rates reasonable will not kill the growth impulse.