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This article was first published 12 years ago

Why is RBI caught between inflation and slowdown

Last updated on: March 1, 2012 11:48 IST



For a second straight quarter, the Indian economy has grown at a rate under seven per cent, which, according to Reserve Bank of India' s Governor D Subbarao, is the 'new normal.'

The country's real growth in gross domestic product in the third quarter of this financial year was 6.1 per cent year-on-year.

Undoubtedly, the last year saw several global and domestic headwinds, so, the growth has come in well below even the most bearish estimates.

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Why is RBI caught between inflation and slowdown


Thanks to the abysmal performance of the economy in Q3, the downside pressure to the seven per cent growth estimates for the full year also increases substantially.

The broad-based slowdown, as was apparent from the numbers, made Q3 growth the lowest since March 2009.

As Leif Eskesen, chief economist for Asia and Asean, at HSBC Global Research explains, "On the supply side the main drag came from manufacturing, mining and financial services.

"On the demand side, net exports were the main culprit."

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Why is RBI caught between inflation and slowdown


Back to back quarters of sub-trend growth have generated a negative carry-over effect, explains chief economist Mole Hau at BNP Paribas, suggesting headline Y-o-Y growth remains on course to hover around six per cent for another quarter.

Interestingly, consumption rebounded in Q3, even as investments continued to show contraction.

Policy paralysis and weakening global macro-economic conditions have severely dented corporate sentiments, resulting in investments contracting by 1.2 per cent Y-o-Y in Q3.

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Why is RBI caught between inflation and slowdown


However, private consumption growth seems to have revived as is evident from the 6.2 per cent Y-o-Y growth compared to the 2.9 per cent seen in the second quarter.

Anubhuti Sahay and Samiran Chakraborty at Standard Chartered Global Research believe: "The data suggests a revival in consumption (without any policy support) and a still-wide gap between investment and consumption (which is highly inflationary) -- which would not justify monetary easing soon."

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Why is RBI caught between inflation and slowdown


While sub-trend growth definitely calls for policy easing, both inflation and rising crude oil prices will put the central bank in a quandary.

Going by the timing of this year's Union Budget, a day after the March policy review, Mole Hau believes that the first reduction in the repo rate may be delayed until April.

Sahay and Chakraborty too expect a total of 150 basis points of repo rate cuts (from the current 8.5 per cent) in the next financial year, unless inflation proves to be sticky.

 

Source: source