Mumbai: An assessment of Indian companies shows Asia’s No. 3 economy is far from full strength, even as GDP growth is poised to recover from a three-year low.

Gross domestic product probably expanded 6.4% in July to September from a year earlier, according to the median of 20 economists in a Bloomberg survey before data due Thursday, faster than 5.7% the previous quarter. However, CARE Ratings Ltd surveyed more than 1,200 companies and found that net profit fell during the same period, dragged down by tepid demand and the disruptive roll out of a new consumption tax.

Underlying weakness—accompanied by surging inflation—may complicate matters for the central bank, which decides on borrowing costs 6 December. While the stock market is surging amid sweeping policy change and Moody’s Investors Service upgraded India’s sovereign rating this month, the adjustments are creating a two-speed economy with pain persisting in the vast informal sector.

“India is witnessing a sustainable recovery in its formal sector, as growth continues to bottom out," said Teresa John, an economist at Mumbai-based brokerage Nirmal Bang Equities Pvt. “Yet, it is too early to call a full-fledged recovery as economy-wide capacity utilization is at around 70%. Interest rates have bottomed out, in our view, and are likely to move up in the next six to nine months."

Disruptions from the goods and services tax have been more severe than anticipated, according to Bloomberg economist Abhishek Gupta, who trimmed his July-September GDP forecast last week to 6.4% from 6.7%. There will be further disappointments on growth if the Reserve Bank of India doesn’t cut interest rates, he said.

Overnight index swaps data compiled by Bloomberg indicate there’s no chance the Reserve Bank of India (RBI) will ease policy next week, while the probability of tightening has risen to about 42% from 18% two months ago. The benchmark rate will stay at 6%, according to six of seven economists in a Bloomberg survey though Gupta predicts a cut to 5.75%.

Green shoots?

Sectors such as cement and commercial vehicles should improve in the months ahead as Prime Minister Narendra Modi focuses on infrastructure, and demand for certain household goods was stable during the July-September quarter, according to analysts at CARE. Moreover, the government lowered GST rates on about 200 items and eased filing norms this month to soothe businesses and curb inflation, which accelerated to a seven-month high in October.

The risk, however, comes from slower government spending. Growth in non-interest revenue expenditure slid to 0.8% July-September from 26.8% the previous quarter, said Aditi Nayar, principal economist at ICRA Ltd. The upgrade of India’s sovereign rating by Moody’s Investors Service has also made it harder for Modi to stimulate the economy, as the company’s decision is a bet that India will contain public debt.

The government is expected to unveil its budget for the year starting April 2018 in early February, which will probably be the last full budget before Modi faces re-election in 2019. Polls are also due in his home state next month, which may offer a glimpse of how the public perceives his policies. India’s main equity index has risen 1.4% in November though the rupee is among Asia’s worst performers.

“The rupee’s inability to capitalize on Moody’s upgrade highlights the growing downside risk to the long held view that the currency will be a regional out-performer," Sue Trinh, head of Asia foreign-exchange strategy at RBC Capital Markets in Hong Kong, wrote in a 23 November note. “We will reserve judgment for now, but the next three months will give a much clearer picture." Bloomberg