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Reduced uncertainty in Europe may trigger a virtuous cycle in India

Reduced uncertainty in Europe may trigger a virtuous cycle in India
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First Published: Tue, Dec 06 2011. 12 48 AM IST

Updated: Tue, Dec 06 2011. 12 48 AM IST
The services sector has staged a strong comeback in November, according to the HSBC Services Purchasing Managers’ Index (PMI). After showing a contraction (readings below 50) in September and October, the services PMI for November rebounded to 53.2. As a result, the HSBC India Composite Index—which covers both services and manufacturing—was at 52.3, up from October’s reading of 50.3. Recall that it was the services sector that was responsible for holding up gross domestic product growth in the September quarter.
Will the bounce be sustained? One good indicator is that the rate of growth of new business among private companies in the services sector was the fastest since August. That holds out the hope that we might see a decent reading on services PMI for December, too.
The problem is the PMI data also shows an increase in input prices both for manufacturing as well as for services. Output prices, too, have remained firm, although the Wholesale Price Index for primary articles has started to fall. If the Reserve Bank of India (RBI) were to consider the PMI numbers, it would conclude that demand pressures are still strong in the economy.
But what really is RBI’s latest thinking on the subject? In a speech on 3 December, deputy governor Subir Gokarn made the following points on growth and inflation: 1) the depreciation of the rupee has heightened inflation risks; 2) amid the global turbulence, crude oil prices have remained firm; 3) in spite of the rupee depreciation, inflation will be on a downward trajectory; 4) a growth deceleration precedes an inflation deceleration, so inflation should begin to moderate over the next few months.
Also See | Gaining ground (PDF)
When will growth start seeing an uptrend once again? Gokarn says, “Over the next year, in a scenario in which global turbulence reduces, we should see inflation moderate, which would then help the growth cycle reverse.” Importantly, he also says that even in this scenario, it’s imperative to implement reforms that improve the climate for investment. Therefore, high growth will require structural reforms in the economy.
What about the current unstable global environment? Gokarn says if a sustainable solution to the European sovereign debt problem emerges soon, global portfolio rebalancing could reverse the movement in the rupee, which in turn will help moderate the inflation risk. Simply put, a solution in Europe will result in more capital inflows to Indian markets, which would lead to a stronger rupee, which would lower inflation, thus allowing the interest rate cycle to turn, which would improve growth—in short, a virtuous cycle.
Graphics by Sandeep Bhatnagar/Mint
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First Published: Tue, Dec 06 2011. 12 48 AM IST
More Topics: Mark To Market | Manas Chakravarty | PMI | GDP | HSBC |