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S&P Global Ratings on Tuesday pared down its projection about the extent of contraction Indian economy will see in FY21 to 7.7% from 9% dip estimated earlier, holding that it is surprised by the vigour of economic recovery in Asia's third largest economy, especially given the tepid policy response from the government underpinning it.

The rating agency said rising demand and falling infection rates have tempered its expectation of the pandemic’s hit on the Indian economy. “Our revision reflects a faster-than-expected recovery in the quarter through September. India (is) learning to live with the virus, even though the pandemic is far from defeated. Reported cases have fallen by more than half from peak levels, to about 40,000 per day. The feared resurgence following the recent holiday season has yet to materialize. People are moving around much more, with Google data suggesting mobility in retail locations is 25%-30% below pre-covid levels in recent months. This compares with over 70% below normal in the quarter through June 2020," S&P said.

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In September quarter, India’s GDP contraction came at a negative 7.5% improving from a historic low of negative 23.9% in June quarter, mostly because of surprise resilience exhibited by the industry sector. Since then many economic agencies have revised upward their growth forecasts for India. The Asian Development Bank has projected the Indian economy to contract at a slower pace of 8% against its earlier estimate of 9% in FY21 on the back of faster recovery in Asia’s third largest economy. The Reserve Bank of India (RBI) earlier this month projected the Indian economy to contract 7.5% in FY21, shallower than 9.5% contraction it projected just two months ago, on the back of a host of lead indicators, suggesting sustained economic recovery.

S&P said like in many other economies, the demand for goods—not services—drives India's recovery. “Household savings have risen, due to an unusually uncertain outlook and the constraints of social distancing, but demand for durables is rising. If consumers cannot or will not spend money on a vacation or eating out, they will divert some of that spending to goods. Vehicle sales, both two-wheelers and cars, have rebounded sharply since the trough seen in the fiscal first quarter, although momentum has faded a touch recently," it added.

"It is no surprise that India is following the path of most economies across Asia-Pacific in experiencing a faster-than-expected recovery in manufacturing production," said S&P Global Ratings Asia-Pacific chief economist Shaun Roache.

However, “the fly in the ointment", S&P said, is inflation, which could dampen growth in a few ways. “First, it may deter the central bank from policy easing. Given financial conditions are already so loose, this may not be too harmful to growth. Second, it eats into the disposable income of households, especially lower income households. This could dampen any resurgence in demand. Third, it raises uncertainty about the outlook and could undermine confidence, both domestically but also of foreign investors," it added.

The rating agency said it continues to see some upside risks to its forecasts, especially for FY22, from its current unchanged projection of 10% growth over a low base. “Rolling out vaccines to India's huge population will be challenging. However, the aim to inoculate 300 million people by August 2021, combined with an existing high infection rate in some parts of the country, could result in a pronounced decline in reported cases later next year. This would speed up the transition to a new normal," it added.

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