Interest rates may remain unmoved by the dip in industrial growth

Interest rates may remain unmoved by the dip in industrial growth

If there was any confirmation needed that the economy is in the grip of a slowdown, this is it. Dodgy though they might be, the Index of Industrial Production (IIP) numbers for October show the first contraction since June 2009. As the chart alongside shows, even the three-month moving average indicates that the metric is at a 27-month low since the carnage caused by the global financial crisis.

Of course, the 5.1% decline might be a bit exaggerated due to the shifting holiday season and the base effect. But even excluding the highly unreliable and volatile capital goods segment, industrial goods production contracted 1.1% from a year ago.

It is not difficult to figure out why. The monetary tightening and the macroeconomic uncertainty, both at home and abroad, have affected not only companies, which have shied away from capital investment, but also consumers who seem to have stopped shopping for the moment. The $9 billion (around 47,160 crore) overstatement in exports sort of confirms waning demand for Indian goods in the overseas markets as well.

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Does this mean that the Reserve Bank of India (RBI) will change its stance and start cutting rates soon?

There is no doubt that falling economic growth indicators will put more pressure on RBI, which is waging a lone fight against inflation, to change its stance. The last time it had fought such high inflation, economic growth was much stronger. Now the government has washed its hands of fighting inflation and a burgeoning fiscal deficit means the central bank won’t easily turn into a dove.

Of course, slowing economic growth will lead to a fall in the inflation rate. However, inflation is still likely to stay at around 9% for some time. The track record of both RBI and the government in predicting future inflation is less than encouraging. This means the central bank is likely to stay its hand and maintain interest rates at the current level. Although companies and pundits have been demanding a cut in rates, the steep fall in stocks in the rate-sensitive sectors means that the markets are not betting on the possibility of a reversal in the monetary policy anytime soon.

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Also See | Contraction mode (PDF)

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