The Reserve Bank of India (RBI) cut borrowing costs by a more than expected 50 bp in April after nearly three years, thereby reducing the benchmark borrowing rate to 8.0%. This was in response to worries about GDP growth expectations , which have sharply declined to around 6.4% compared to a higher than 7% level just two month earlier. Because of elevated inflation, further cuts are unlikely as this would increase the money supply and inflate prices above prudential mlevels.
Inflation remains a major risk to India’s economic stability and on 18 May the government reported that the CPI had risen to 10.4% on an annual basis following an increase of 9.4% in March. The wholesale price index rose by 7.2% y-o-y in April, picking up about 6.7% a month earlier. Partly because of global factors, the rupee that had depreciated against the US dollar to a record level last month regained some of its losses and appreciated by 4% over the past couple of weeks. Meanwhile, improved domestic policies and the hope that India would return to policy reforms raised investors sentiments.
However, the recent appreciation of the rupee is believed to reflect positive developments in the international economy following the Euro-zone summit and the new hopes surrounding efforts to resolve the economic crisis in the region. The question is whether this appreciation could be sustained as the economy experiences its lowest expansion in almost a decade after real GDP growth in 1Q12 was estimated only to be 5.3% y-o-y. mThe weak economic performance was led by a 0.3% y-o-y contraction in manufacturing output while the agricultural sector expanded by a lackluster 1.7%.
The government had estimated GDP growth would reach 6.9%; but because of the weak performance of the economy in the last several quarters, we estimate GDP to expand only around 6.4% this fiscal year. Many observers blame weak economic policies for the poor performance of the economy since last year. The coalition government that has been in office for the past three years has failed to introduce and implement any major reforms, which has undermined investors’ confidence in the economy. Furthermore, massive subsidies, particularly on energy and petroleum products, and welfare spending programs have fuelled inflation while preventing any effective fiscal stimulus for GDP growth.