India’s GDP up 7.7% in 2Q11

Inflation still the key concern

India’s economy slowed a little more in 2Q11, with GDP up 7.7% y-o-y (versus 7.8% y-o-y in
1Q). Private consumption growth eased (6.3% y-o-y versus 8.0% in 1Q11), but this partly reflects a base effect. Government consumption also slowed. Investment, on the other hand, rebounded (up 7.9% y-o-y versus 0.4% in 1Q), but this also partly reflected a base. While exports grew at a healthy rate, net exports slowed as there was a sharp rise in imports.

High frequency indicators show that growth is declining, particularly in the manufacturing sector.
Industrial production growth eased in annual terms in July, but this was largely because of the volatile nature of the capital goods segment. HSBC’s PMI indices for manufacturing and services also show signs of sequential deceleration, but the economy remains in expansionary territory. Moreover, private credit growth is robust.

Even so, the economy is facing the lagged effects of monetary tightening, the uncertainty associated with high inflation, and the natural speed limit imposed by tight capacity. While the domestic orientation of the economy limits the spill over from adverse global economic conditions, it is not immune, and global weakness has spilled over through the trade and confidence channels. For this reason, we have lowered our 2011 forecast to 7.4% from 7.6% and our 2012 forecast to 8.1% from 8.2%.

Despite slower growth, inflationary pressures are not abating. Excess demand is still pushing up
core inflation and is not set to disappear anytime soon. Adjustments to regulated diesel and
kerosene prices have also added to inflationary pressures, and we have not yet seen a discernable decline in global commodity prices. Consequently the inflation rate should stay elevated for awhile.

The 2011/12 central government budget target of 4.6% of GDP may not be achieved due to slower growth and a larger-than-budgeted fuel subsidy bill. Consequently, fiscal policy will at best be neutral, leaving monetary policy with the responsibility of tackling inflation. We expect the policy rate to rise another 25bp over the rest of 2011/12, taking the repo rate to 8.50%.