Storm clouds over the economy

Storm clouds over the economy

There are growing signs that the Indian economy has hit a rough patch. Demand for cars continued to shrink in July thanks to higher interest rates, more expensive fuel and general economic uncertainty. There are also early signs that construction activity is dampening because of higher interest rates. Meanwhile, the HSBC Purchasing Managers’ Index (PMI) for July suggests that the manufacturing slowdown is set to worsen.

Economists continue to cut their growth forecasts for the current fiscal year. Investment bank Morgan Stanley cut its growth estimate to 7.2% on Monday. The Prime Minister’s Economic Advisory Council has also said that it now expects the Indian economy to grow 8.2% this year, 80 basis points lower than its earlier estimate. Citibank has also cut its estimate from 8.1% to 7.6%, though Citi economist Rohini Malkani terms it a slowdown rather than a slump.

But will the economic slowdown be even worse? A new factor to consider is the US debt deal that is based on an agreement to cut federal government spending by at least $2 trillion over the next 10 years. The US economy is already slowing down. Growth in the second quarter was an unexpectedly weak 1.3%. Significant reductions in government spending could hurt growth further, though in it quite likely that the Obama agreement will not front load the spending cuts, pushing them as far back as possible within the agreed time frame.

A slowing US economy and the continued troubles in Europe could throw sand into one of the main engines of Indian economic growth in recent quarters --- exports. Trade data for June released by the commerce ministry shows that foreign demand for Indian goods continues to be strong, a particularly good piece of news given the fact that domestic demand has begun to wane.

However, one good thing that may come out of a global slowdown --- even Chinese manufacturing growth is slipping --- is that commodity prices could soften as global demand weakens. The Reserve Bank of India had said in its June policy statement that the direction of global commodity prices would be an important factor in its outlook for domestic inflation.

But that is only a possibility right now. As my colleague Manas Chakravarty noted in his Mark to Market column on Tuesday, the PMI data shows that input and output prices for the manufacturing sector rose in July, a sign that core inflation has not yet retreated.

This could mean that the slowdown will have to be even sharper than now before inflation is finally brought to heel. There could be a lot of pain in the quarters ahead. No wonder Indian equities slipped on Tuesday, with the Sensex down 204 points to close at a five-week low.