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India Economy - February 2012

Source: OPEC 2/25/2012, Location: Asia

Since 2H11, Indian economic policy-makers have indicated that their policy objective has changed from merely curbing inflation to a more balanced approach of containing accelerating inflation and maintaining high rates of economic growth. Considering the importance of banking credit for financing economic activities in developing countries, an accommodative monetary policy is vital for economic growth. This is particularly the case for an economy with large budget deficits like India, where the government finds it difficult to increase its expenditures or cut taxes to provide fiscal stimuli for economic growths. On the other hand, maintaining a low interest rate effectively fuels inflationary pressures, which is a threat to economic and social stability of the country where a large section of the population is still poor. This clearly shows the delicate balance between high economic growth and low inflation in the present state of the Indian economy.

The country’s central bank, the Reserve Bank of India (RBI) kept interest rates on hold at its meeting on 16 December 2011, implying that its concern over decelerating economic growth is beginning to outweigh its concern about high inflation. However, to increase the availability of interbank liquidity and in a change of approach, the RBI last week cut bank reserve ratio requirements by as much as 50 basis points, from 6% to 5.50%. This was an unexpected move as the RBI has maintained that cash reserve ratio cuts would not be used for tactical liquidity management but would instead be used to signal the RBI’s monetary stance. In effect, the RBI indicated that while inflation is moderating, core inflation remains high and, therefore, the current environment is not conducive to monetary easing through rate cuts. Another cash reserve ratio cut is likely in March as part of further liquidity management that would postpone an interest rate cut to the second half of the year. India’s PMI surged for a second consecutive month in January, suggesting that the December surge was not a one-off event and that the re-acceleration of economic activities in late 2011 has been carried into 2012. Industrial production is expected to surge in February, as the PMI surge in January has been across the board and new orders have also continued to increase sharply. However, it is worth noting that inflationary pressures still remain and might cause difficulties in easing monetary policy.

In a bid to boost FDI and enhance economic growth, India’s government announced that single-brand foreign retailers may open fully-owned stores in the country. However, there are conditions attached to this market liberalization that affect its impact: (I) Foreign-owned stores will be required to source 30% of their products from small farmers and producers in India; (ii) investors wishing to own 100% of singlebrand stores must own the brands that their stores sell; and (iii) foreign companies in the single-brand retail space are not allowed to re-brand goods made by others. There are indications that India’s policy-makers are becoming more pessimistic about economic growth forecast of the Planning Commission, which had previously projected 8% growth for 2011-2012. Prime Minister Manmohan Singh was quoted as saying in mid-January that he expected the economy to grow by just 7% in 2011- 2012. The government cut its forecast for real GDP growth for 2011-2012 to 7.25% to 7.75%, while the RBI cut its growth forecast to 7.6% in October.

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