Is the Indian economy headed for a hard landing? A few days after finance minister Pranab Mukherjee admitted in Parliament that the economy was in a difficult spot, new data on factory output released by the government on Monday shows that the Index of Industrial Production (IIP) contracted 5.1% in October compared with the same month last year.
The fact that the industrial sector is struggling is not a surprise, though the extent of the damage is. A closer look at the data is warranted. The main damage has been from capital goods, a proxy for investment activity, which fell by 25.5%. This component of IIP is notoriously volatile. If we ignore the capital goods production data, then the dip in industrial output is 1.1%, more modest but nevertheless worrisome. It is the first contraction since June 2009.
The slowdown in industrial activity will surely hurt the tax collections of a government that is already set to overshoot its deficit targets. Corporate profit growth has been weak this year. The total profit of the BSE-500 companies grew by 2.98% in the first quarter and shrunk by 35.84% in the second quarter. The problem in corporate profits has not yet been reflected in the tax revenues of the government, which are still 7.3% higher than last year. Tax collections in the rest of the fiscal year could be anaemic.
The policy response will have to be led by the monetary authorities. The government has already painted itself into a corner, with a high fiscal deficit leaving little room for it to support effective demand. The Reserve Bank of India (RBI) has indicated that interest rates have peaked. Inflation is expected to cool off, especially as economic growth will come in lower than the trend rate for the Indian economy.
A lot of attention will be focused on the inflation numbers that will be released later this week. RBI is due to announce its interest rate decision on 16 December. The clamour for a pause had already been building up when the Indian central bank announced its previous policy in October. Five members of the six-member monetary policy committee had argued against an interest rate increase, the minutes of the meeting released on the RBI website in November show. This newspaper had also argued for a pause.
Though the focus of policy has now shifted from curbing prices to supporting growth, there is a case for the Indian central bank to hold interest rates—for now. Growth is weakening. But inflation will still be around 9%, though set to decline. And there is nothing to stop RBI from making significant reduction in policy rates in case the economy seems to be crash-landing.
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