Factory output in April, based on a revised index with fiscal 2005 as the base year, moderated to 6.3%—lower than 7.8% in March. Based on the old series, the index of industrial production, or IIP, in April grew at 4.4% year-on-year (y-o-y) versus 7.3% in April, a clear indication that growth is moderating in India.
Economic growth in the March quarter was also lower than expected—7.8% y-o-y, down from an upwardly revised 8.3% in the December quarter. This was much below the consensus estimates of 8.1% by the analysts’ community, and the lowest since December 2009.
The HSBC Purchasing Managers’ Index (PMI) for manufacturing, too, confirms that India’s economic growth is moderating. PMI was at 57.5 for May, slower than the pace of growth seen in the preceding three months.
Against this backdrop, should the Indian central bank press the pause button on its rate tightening cycle when it meets for the mid-quarter review on 16 June? After all, it has raised its key policy rate nine times in the past 15 months, from 3.25% to 7.25%, and the impact of the hikes is there for everyone to see: growth momentum in the Indian economy is slowing.
There are other factors that the Reserve Bank of India (RBI) should take into consideration while announcing its mid-quarter review. The macroeconomic indicators of neither the US nor Europe are in best of health, and there has been a sharp correction in global commodity prices in the past one month. These mean the growth in exports will slow and the pressure on inflation will also ease.
All these are encouraging a few analysts and bond dealers to clamour for a pause. They feel that RBI should wait and watch before raising its policy rate yet again, if at all that’s required. After all, it will have its quarterly review of monetary policy only after six weeks, on 26 July.
I don’t belong to this school. The time to press the pause button has not yet arrived; and if indeed RBI does so, it will end up sending a wrong signal and confusing the market.
After a series of baby steps, when RBI raised the policy rate by half a percentage point in May in its annual monetary policy for fiscal 2012, governor D. Subbarao had said unequivocally that fighting inflation is at the top of the Indian central bank’s agenda, and not balancing between growth and inflation, which had been the case till then. The annual policy document also committed to continue with its “anti-inflationary stance” and there is no reason to change its stance in six weeks.
Indeed, the wholesale price inflation has come down to 8.66% in April from 9.02% in March, and the so-called core inflation, or non-food manufacturing inflation, has dropped from 7.4% in March to 6.3% in April, but they are still high and much above RBI’s comfort zone. Besides, the April figures are provisional and, in all probability, they will be revised upwards.
The May inflation figures—to be announced on Tuesday—will be a critical input for RBI’s policy announcement; but I doubt whether they will have any bearing on the action of the central bank. I would like to believe that RBI will go for a quarter percentage point hike in its policy rate to 7.5%, and the May inflation figures—both wholesale price and, more importantly, the core inflation—will influence only the text of the policy. If it’s substantially down, RBI will be less hawkish in its approach and go slow in its rate tightening cycle in future.
One also needs to remember that the government has not raised the diesel price yet, a move widely expected after the completion of state elections. Busy fighting corruption at different levels and the shenanigans of yoga guru Baba Ramdev, the government does not seem to have time to focus on many critical things, including a hike in diesel prices. As and when that happens, there will be pressure on inflation.
The March quarter gross domestic product (GDP), April factory output data and May PMI are signs of cooling; but they should not persuade RBI to call off its fight against inflation and halt the rate tightening cycle now as growth is just moderating—there is no dramatic slowdown. The underlying momentum is not disrupted as yet. For instance, the pick-up in capital goods in April suggests that the investment scenario is not totally grim.
Similarly, the May PMI numbers are no cause for concern as they are still higher than that of September, October and December 2010, and January 2011. The PMI numbers are indicative of seasonally adjusted month-on-month increases. More than 50 indicates expansion, and less than that signals contraction. The 57.5 reading for May indicates that the Indian economy is slowing, but its rate of growth continues to be strong.
All these mean that economic slowdown is gathering pace in India, but slowly. The investment climate is getting worse but one does not know to what extent RBI’s rate tightening cycle has contributed to this as many believe it is the lack of governance at the Centre, not the higher cost of money, that is coming in the way of corporate investments.
At this juncture, RBI should go ahead with its agenda of fighting inflation as by its own estimate it will continue to remain high—around 9% till September—and hike the policy rate. And even 7.5% may not be the peak, but the pace and the quantum of rate hike beyond June will be completely driven by macroeconomic data. Apart from inflation and growth indicators, the progress of the monsoon will also play a critical role. If RBI pauses now, it will lose its credibility.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to firstname.lastname@example.org