New Delhi: Pressure mounted on the Reserve Bank of India (RBI) to further reduce interest rates after the government said on Friday that the Indian economy, in the third quarter (Q3) of the current fiscal year, grew at its slowest rate since 2003.
Growth in the quarter came in at 5.3%, far lower than the 7.6% clocked in the second quarter. Farm output fell unexpectedly and capital spending slumped while government consumption spending soared, because of an increase in public sector pay in Q3 and helped support growth. Services and private consumer spending did not spring any major surprises, largely slowing in tandem with the economy as a whole.
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The slowdown in economic activity was much sharper than most economists had expected. The consensus forecast was 6.1%. Growth will have to rebound to at least 7.6% in the fourth quarter (Q4) if the government’s first estimate of a 7.1% rate of economic growth for the full year is to be met.
Government economists said the latest numbers were expected and that Q4 would be better. “The 5.3% growth is broadly in line with our expectation. Generally, the fourth quarter contribution to GDP growth is normally better,” economic affairs secretary Ashok Chawla told reporters. “Our expectation for (the) fourth quarter is that it will show robust growth, which will add up close to 7% for the whole year.” GDP, or gross domestic product, is a measure of the national economic output.
Reacting to the data, Prime Minister’s economic advisory council chairman Suresh Tendulkar said the economy seemed to have bottomed out during Q3.
“You can look at the data differently. My assessment is that growth has bottomed out and things will start improving from the next quarter onwards as a result of the two fiscal packages announced by the government previously. If growth in the fourth quarter is above 6.5%, we can still register a growth rate of 7% during 2008-09. However, export-related sectors will continue to be affected,” he said.
Many private sector economists are sceptical. “The economy is expected to go down further, as there is no good news in sight,” said Dharmakirti Joshi, principal economist at ratings firm Crisil Ltd. “With an expected fourth quarter GDP growth of close to 5%, overall GDP growth may come down to around 6.5%.”
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“The government’s advance estimate of 7% for the current fiscal year will certainly be missed,” Sherman Chan, a Moody’s Economy.com economist, said in a note in which the growth numbers were termed “disappointing”.
“From the policy perspective, the onus is now squarely on monetary policy. The government has already announced large fiscal stimulus measures and no further fiscal announcements will be made once elections are announced. Moreover, we judge that monetary policy needs to be expansionary to accommodate the government. Therefore, we continue to expect the Reserve Bank of India to cut both the repo and reverse repo rates by 50bp (basis points) any time between now and the end of March, and by a further 100bp by mid-2009,” said Sonal Varma, an economist with Nomura Financial Advisory and Securities (India) Pvt. Ltd. A basis point is one-hundredth of a percentage point.
India’s chief statistician Pronob Sen feels the central bank has to walk a tightrope: There is a contradiction in managing higher government borrowings and bringing down interest rates.
“This is because the large amount of government bonds issued by RBI on behalf of the government will push up the yield curve in government securities (and put upward pressure on interest rates),” Sen said.
The sharp growth slowdown shook the financial markets for some time. Traders responded with an early wave of selling of equities and the rupee. Shares recovered later in the day on expectations of a reduction in interest rates. The Bombay Stock Exchange’s benchmark Sensex ended Friday at 8,891.61, down 63.25 points from its closing level on Thursday, but above an intra-day low of 8,728.66.
“The recovery (in stock prices) was only because of rate-cut expectations,” said R. Murali Krishnan, head of research at equity brokerage Ambit Capital Pvt. Ltd. “The GDP numbers came much below our expectations.”
“Fund managers expect 50-100 basis points cut in both repo and reverse repo over the weekend or next week,” said the head of equity sales at a large foreign brokerage operating in India, who cannot officially speak to the media. “Bond traders also are betting on rate cuts. One bond trader pointed (out) that the yield on AAA-rated one-year paper is now lower than its lowest point in 2008.”
The rupee, too, weakened, partly because the dollar rose against most Asian currencies as well as due to the growing worries that the sharp rise in the government’s fiscal deficit could lead to a ratings downgrade for India later in the year.
The rupee touched a record low of 51.17 a dollar in intra-day trade and closed at 51.14, an all-time low. Offshore forward contracts were pricing a further fall in the rupee because of the slowing Indian economy: 51.50 to a dollar in a month and 52.48 in three months. Dealers said RBI did step in through state-owned banks to sell dollars in a bid to stabilize the rupee on Friday, but later withdrew.
The unexpected drop in farm output worried economists. “This could be due to a high base as agriculture sector grew 6.9% during the same quarter a year ago. This could also be due to the erratic rainfall in parts of the country producing pulses,” said Joshi.
Companies have been betting on strong demand from rural markets to keep their factories humming. “Is the rural consumption story at risk?” asked Citi economist Rohini Malkani in a report.
Anup Roy and Nesil Staney in Mumbai and Reuters contributed to this story.
Video by Rahul Sharma
Graphics by Ahmed Raza Khan / Mint