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Economy cools as inflation fears rise

Economy cools as inflation fears rise
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First Published: Sat, May 31 2008. 12 53 AM IST

Updated: Sat, May 31 2008. 12 53 AM IST
New Delhi: In a sign that the economy is set to cool, new data released by the government show that there has been a loss of stimulus to growth and inflationary pressures have increased, although India’s economic growth was revised upwards to 9% in the fiscal year that ended on 31 March, making it the second fastest growing major economy in the world after China.
Data put out by the Central Statistical Organisation reveal that the effects of the progressive increase in interest rates have not only begun to squeeze investments in the economy, but also led to a drop in the growth of manufacturing to 5.8% in the last quarter of 2007-08—the lowest in almost six years.
As a result, overall growth in manufacturing slowed to 8.8% compared with 12% in 2006-07. Similarly, in the same period, there was a sharp drop in construction activity, which grew slower at 9.8% compared with 12% a year ago, and in financing and realty-related services, that slowed from 13.9% to 11.8%.
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“The tightening is designed to affect the leveraged sectors such as construction and durables in the short term,” said Saumitra Chaudhuri, economic adviser to rating agency Icra Ltd, the India arm of Standard and Poor’s. “But as long as the investment rate remains high, medium-term growth is not too much of a worry.”
At current prices, the country’s gross domestic product is estimated at Rs43.03 trillion ($1.006 trillion) in 2007-08.
The quarterly data reveals that there is a beginning of a slowdown in investment, as measured by the gross fixed capital formation, or GFCF. Its share in GDP dropped from 32% in the first quarter to 31.6% in the fourth quarter of 2007-08.
Better rains and a higher kharif crop raised farm growth to 4.5%, over 3.8% a year ago, and an advanced estimate of only 2.6%.“The farm sector is on the brink of a real revival,” said Abhijit Sen, member of the Planning Commission.
However, analysts believe that with inflation continuing to rise, the central bank may be forced to further tighten money supply in the economy. Inflation measured by the wholesale price index rose to 8.1% on 17 May.
“The Reserve Bank would have to hike rates aggressively to contain inflation, which could touch 9% next month, and help curb growth,” said Sailesh Jha, economist with Barclays Capital at Singapore. He expected the key overnight lending rate to rise to 8.25% by end-2008 from 7.75% now.
However, finance minister P. Chidambaram continued to hold out, arguing that inflation would be tamed and the government was considering corrective measures to address the slowdown in manufacturing.
“I dare say with some degree of confidence that India will show admirable resilience and 2008-09 will also return a growth rate of not less than 8.5%, and if there is some luck I should be able to maintain my track record of 9% growth rate in 2008-09,” Chidambaram said, adding that due to uncertainties, the downward risks were much higher than in the previous year.
“If the world economy is benign, we can grow at 10% as well,” he added.
“I have no doubts in my mind that if we can sustain agriculture growth, if we can rejuvenate manufacturing, and ensure the services sector continues to grow at double digit” the economy could grow at close to 9% in 2008-09 as well, he said. He, however, admitted that “there is yet no sign of a decline in the inflation rate. We do not know if we have peaked yet”.
The government, Barclays’ Jha said, “has finally realized that it has been dead wrong on inflation. Increasingly, inflation is driven by non-tradeable goods”.
With inflation still not under control, most analysts, fearing further measures from the Reserve Bank of India, as well as another round of international oil price increases, are hedging on their growth forecasts.
Icra’s Chaudhuri said he didn’t expect growth “to go beyond 7.8% in the year, assuming there are no upside risks”. Chaudhuri is a member of the Prime Minister’s economic advisory council that had predicted a GDP growth of 8.9% for 2007-08.
Growth is aleady slowing, as reflected in the falling quarterly growth, from a high of 10.1% in the second quarter of 2006-07 to 8.8% in the fourth quarter of 2007-08.
Countering that a rate rise was imminent, Dharmakirti Joshi, principal economist at Crisil Ltd, said, “The RBI should ideally be reacting to future inflation. In trying to balance growth and inflation, they will maintain liquidity at levels consistent with 8-8.5% growth.”
But the growing demand impulses triggered by the farmers’ debt relief plan, which will cost Rs40,000 crore this year, and an expected government workers pay hike, will worsen inflation, maintains Jha.
“Inflation is becoming a serious concern,” Chaudhuri agreed, “and the current year could end with an average inflation of 7%, maybe more. We have already gone into 8-8.5%. Although food prices have come down, core inflation is very high. Even oil price inflation is 11%. It may not be much but there will obviously be a trade-off between growth and inflation.”
(PTI contributed to this story.)
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First Published: Sat, May 31 2008. 12 53 AM IST