India's growth languishes near four-year low, shallow recovery expected

Manufacturing still weak, services flat, agriculture falters

GDP growth in October–December, at 4.5% year-over-year (y/y), is back near four-year lows, on lacklustre manufacturing, feeble agriculture, and flat services, according to India's Central Statistical Organization (CSO). Growth ticked down from July–September's 5.3% rate on a factor-cost basis during the third fiscal quarter of FY2012/13, and was lower than the 6.0% recorded during the same period a year earlier. The latest GDP print, although largely in line with IHS Global Insight's expectations of 4.7% growth, dashes government hopes of a stronger rebound and impending signs of recovery.

Manufacturing increased by a modest 2.5% y/y in the third quarter, although higher than the previous quarter's 0.8%, and industrial production continued to contract in December, averaging an anaemic 0.8% y/y in April–December. Mining and quarrying contracted 1.4% y/y in the quarter, and electricity increased 4.5%. Overall, services expanded by a comparatively healthy 6.0% y/y, although most sub-sectors decelerated slightly from the previous quarter. Construction held ground, rising 5.8% y/y with expansion in building and infrastructure activity. Trade, hotels, and transport rose 5.1 % y/y; financial, real estate, and business services increased 7.9% y/y; and community and social services rose 5.4% y/y.

More disappointingly, agricultural sector growth in the third quarter dipped to 1.1% y/y from 1.2% in the second quarter. The erratic and delayed 2012 monsoon, even with its late-season resurgence, dented the output of winter crops significantly, keeping seasonal totals subdued.

Poor investment trend persists, consumer spending stalling

Meanwhile, on the demand side, domestic demand has borne the brunt of the slowdown, although investment and consumer spending are beginning to perk up. Real GDP at market prices increased by a modest 4.1% y/y during October–December, rising from the 2.5% y/y posted during July–September, according to the CSO. Private consumption, the mainstay of India's boom, is beginning to show signs of recovery, rising from 2.7% y/y in the second quarter to 4.1% y/y in the third quarter. Public spending dropped to 1.9% y/y in the third quarter from 8.0% in the previous quarter, as the government aggressively cut spending to achieve ambitious budgetary targets. Fixed investment is beginning to recover after recent quarters' abysmal performance, rising 6.0% y/y in the third quarter following two quarters of contraction, as capital expenditures increased. Unsurprisingly, exports lost further ground in the third quarter, contacting for the first time in three years, falling 2.1% y/y, while imports declined 0.3% y/y. The still-weak rupee has not improved external balances as yet.

Recent substantial government revisions to demand-side figures have led to large swings in national-income accounts data almost every quarter, but the demand-side data reinforces the very sluggish overall economic picture.

Inflation finally retreating, markets falter mainly on budget news

The headline wholesale price index (WPI) – the primary inflation gauge – rose 6.6% year-on-year (y/y) in January 2013, dropping below the 7% mark for the first time since 2009. Prices of manufactured goods – the Reserve Bank of India's (RBI) preferred gauge of core inflation – also eased to 4.8% y/y in January. Fuel prices retreated to 7.0% in January, but food prices ticked up, still in double digits, to 11.9% in January. With the substantial decline in January's WPI, additional monetary easing will follow quickly.

Since the GDP figures were released after the market closed on 28 February, the market has not reacted as yet. In fact, the major news of the day was India's largely prudent budget. Indian shares plunged 291 points, to close below the 19,000 level, as markets were spooked by the government's surcharges on the wealthiest taxpayers and richest companies. Yields on the most commonly traded 10-year bonds rose seven basis points, while the rupee weakened slightly, to INR54.35/USD during the day.

Outlook and implications

As inflation retreats, RBI turns to supporting growth

The Reserve Bank of India (RBI) finally relented and cut the repo rate by 25 basis points, from 8.0% to 7.75% in January's policy meeting. It elected to reduce not only the repo, but also the cash reserve ratio (CRR) again, by 25 basis points, to 4.0%, to inject liquidity into the financial system. We now expect the RBI to cut the repo by an additional 25 basis points in March, after it has had time to assess the budget and its impact on government finances. Still-sluggish economic activity and retreating headline inflation will persuade the RBI to continue easing in small increments. In addition to March's cut, we expect one more 25-basis-point cut by end-December. Despite the monetary easing in our forecast, a total 50 basis points in rate cuts for the rest of 2013 remains modest, and policy rates remain relatively high. So the RBI can retain its basic inflation-fighting stance while also supporting growth. Ultimately, economic activity has remained weak much longer than official expectations, which will trigger additional rate cuts.

Near-term outlook improves slightly

The challenging current economic environment, with elevated (although receding) inflation, sluggish growth, high fiscal and current-account deficits, and a still-weak rupee, will dent hopes for a speedy recovery. Even though the external outlook has improved marginally in recent weeks, particularly in the US and China, global demand will remain subdued, providing little relief for India's sagging exports over the next year.

Although we continue to believe that the economy has bottomed out, the recovery will remain shallow and protracted. We expect no quick turnaround in the industrial and investment cycle and economic growth will remain tepid in the near term. With recent reforms restoring investor confidence and attracting capital inflows, IHS Global Insight expects a slightly improving economic outlook, starting in the second half of FY2013/14. Our current GDP forecasts call for growth accelerating from 5.1% in FY2012/13 to 6.0% in FY2013/14 and 7.0% in FY2014/15. Despite it being a pre-election year, the government must stay the course and continue with fiscal consolidation and structural reform to boost growth prospects over the near and medium terms.