The Indian economy is sputtering, one group of analysts warns. Monetary tightening has gone too far, business leaders complain. Domestic interest rates need to be eased, some economists say. These are the responses to a government report early last week that showed production at factories, mines and power plants at its most anaemic in six years.
Following the release of the industrial production statistics, the 10-year bond yield in India came close to a six-week low. By the end of the week, there were few takers for the “bond-bull” scenario as inflation soared to a new three-and-a-half-year high of about 8%.
The Indian economy is slowing, though not to the extent where it makes sense to go long on bonds. For a start, the paltry 3% growth in the industrial production index during March compared with a year earlier may not be an accurate reflection of real output. “The index is based on 1993/94 and to that extent the base-year weights do not represent the present structure of industry,” Saumitra Chaudhuri, chief economist at New Delhi-based rating company Icra Ltd, wrote in a recent report.
For instance, the value of cars and sport-utility vehicles produced annually at Indian factories is three times as large as the output of two- and three-wheelers; still, the latter group is twice as important to the index as the former, Chaudhuri wrote.
Television sets, refrigerators and air-conditioning units are also under-represented on the production gauge.
That isn’t all. The index suggests a slump in the production of machines and equipment used in power distribution, even as companies such as Bharat Heavy Electricals Ltd that makes boilers and other parts continue to overbook orders.
Simply put, it isn’t lack of demand that’s acting as a brake on production of electrical equipment, says the Icra report. Either production has been disrupted, or the output is simply not showing up in the data.
Manufacturing in India is unlikely to fall off a cliff and certainly not because of a collapse in domestic demand caused by the high cost of capital. Where the drop in performance is most telling—for instance, in cotton yarn, fabrics and textiles—the culprit is lackluster foreign demand. The garment industry has failed to boost productivity to remain competitive after the rupee appreciated last year. India’s overall exports, however, don’t show a loss of competitiveness to be the general trend. Merchandise shipments from India grew 23% in the year through March, showing a slight acceleration.
The challenge for India is persistent inflation. That’s what the currency market also seems to be signalling. The rupee has tumbled more than 10% in the past three months, the second worst performer in Asia after the Korean won. For the Indian central bank to even hint it would aid growth and tolerate inflation may cause a precipitous slide in the currency.
That will make commodities, especially crude oil, more expensive to import, further stoking domestic inflationary expectations. The vicious cycle is wholly avoidable, even by sacrificing some growth, if required.
Crucially for India, the weather department has forecast monsoon rains to be near-normal this year. If that prediction proves to be on target, that’s one worry less for policymakers.
Under those circumstances, it won’t be a calamity if gross domestic product expands slightly less than 8% in the fiscal year through 31 March 2009, as is currently the expectation of most forecasters surveyed by the central bank. The deceleration from 8.7% growth in the previous 12 months doesn’t matter much. Percapita real incomes will still surge.
The central bank’s priority must be to rein in inflation. Economic growth needs attention from the government. Policymakers should enhance the productivity of agriculture. Crop yields are stagnating; small landholders with little marketable surplus are gaining nothing from higher food prices.
The other bottleneck to sustaining growth is infrastructure: power, roads, airports and seaports. It has been seven years since India started an ambitious programme to build 370,000km of village roads; wherever new roads have been built, the local economy and community have benefited.
It’s time to expedite the project, which is only about 27% complete. Meanwhile, new investments in power generation are still nowhere close to what’s required to ease the 15% shortfall in meeting peak demand.
To the extent the government needs to boost its own funding of key civic amenities and to support private investments in infrastructure with sound policies, it’s futile to express quick progress. With elections due in the next 12 months, the ruling coalition is opening the fiscal taps—not for investments but for the transfer of incomes.
Civil servants are due for a generous pay increase; farmers’ debts are being waived. High prices of fuel, food and fertilizer are being subsidized by creating liabilities for a future generation of taxpayers. In such an environment, monetary easing is highly improbable and may even be dangerous.
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