India: Growth gaining momentum gradually Asia Pacific Economic Outlook, January 2015

Economic growth has been gradually picking up since the beginning of the fiscal year. However, factors such as the pace and quality of fiscal consolidation and high inflation pose downside risks.


Economic growth has been gradually picking up since the beginning of FY 2014–15. GDP grew at a healthy rate of 5.5 percent year over year in the first half of FY 2014–15, while economic imbalances have reduced.1 Although growth was slightly lower in Q2 at 5.3 percent, it was higher than market expectations, thanks to growth in services and stronger-than-expected farming. Subsectors in the services sector that registered significant growth in Q2 were electricity, gas, and water supply, which grew 8.7 percent; construction, which grew 4.6 percent; community, social, and personal services, which grew 9.6 percent; and financing, insurance, real estate, and business services, which grew 9.5 percent. The growth rate of agriculture, forestry, and fishing is estimated to be 3.2 percent. However, poor performance in the industrial sector, specifically in the manufacturing sector, hampered growth. The mining and quarrying sector grew 1.9 percent, while the manufacturing sector grew 0.1 percent.

Growth in real private consumption expenditure remained steady at 5.8 percent in Q2. Although quarter-over-quarter growth in government consumption expenditure fell 13.1 percent relative to the previous quarter, year-over-year growth of 10.1 percent helped boost GDP. Poor performances in exports and private investments, which contracted 1.6 percent and 0.3 percent, respectively, caused the biggest drag on GDP.

Businesses are waiting for a more predictable taxation system, faster regulatory clearances, and industry-friendly land acquisition and labor laws before they commit to long-term investments.

A pickup in project clearances and reform initiatives by the government and improved business sentiments in the last six months have failed to affect the GDP numbers. A Q2 decrease in capital formation indicates that poor global demand, limited improvement in capacity utilization levels, and uncertainties around the implementation of reforms are weighing on investment decisions. Businesses are waiting for a more predictable taxation system, faster regulatory clearances, and industry-friendly land acquisition and labor laws before they commit to long-term investments.

Falling prices have brought some relief to both policymakers and the general public. The wholesale price index grew 1.8 percent in October, which is the slowest increase in the past five years. Consistently falling food prices and declining international fuel prices have helped contain inflation. The fall in food prices was in part due to several factors: the monsoon’s recovery; government actions such as lowering minimum support prices and selling stocks more efficiently; and benign global food prices. However, structural problems such as poor infrastructure, improper storage, and a lack of transportation facilities continue to exist. Unless these factors, which have contributed to rising food prices in the last decade, are addressed, the fall in prices may be short-lived. Inflation is expected to remain high, which implies significant upside risks.

Business sentiments are improving fast, as evidenced by the Manufacturing Leadership Survey 2014, which was conducted jointly by an industry lobby comprising the Confederation of Indian Industry and the Boston Consulting Group.2 The survey was launched to gauge industry leaders’ thoughts on the current scenario and future prospects of the Indian manufacturing sector; over 100 heads of Indian incorporations participated. The survey shows a distinct rise in confidence, with 85 percent of those surveyed expecting manufacturing growth to rise between 5 percent and 10 percent over the next five years (compared with expectations over the past five years of growth rising 3.4 percent). According to a survey by the Reserve Bank of India (RBI), the business expectation index has been rising sharply in the past few quarters.3 The industrial outlook survey suggests that the overall business, production, and financial situations in India are perceived to be as good as they were in 2010.

A few challenges

However, a few economic indicators suggest that the economy is still not out of the woods. Factors such as the pace and quality of fiscal consolidation, high inflation, a poor performance by the manufacturing sector, poor exports, and the deteriorating quality of the banking sector’s assets pose downside risks to the economy. So far, fiscal consolidation is mainly led by curbing government expenses rather than revenues rising. Tax collection remains poor, while the pace of disinvestment remains slow. It will be important for the government to find alternatives for raising revenue if the fiscal balance is to be met without impacting growth. While the current account deficit has narrowed since 2013 due to tight monetary policy, restrictions on gold imports, and a fall in crude imports, export growth has remained weak in the last three months.

The Indian rupee has weakened against the US dollar in the past month, primarily due to the spillover effect of both a stronger US dollar and transient factors such as a sudden rise in dollar demand to pay for imports. That said, the currency has firmed against the euro, British pound, and Japanese yen, while the real effective exchange rate suggests that the rupee is appreciating against the currencies of India’s peers.

The index of industrial production continues to remain weak as the manufacturing sector remains highly vulnerable. Growth in capital goods has been on an unsustainable trajectory, while contraction in the consumer durable goods sector indicates a poor outlook for consumer demand. Poor exports also contributed to the index’s weakness. Activity is likely to be subdued in Q3 because of a moderate kharif harvest, deficiency in the northeast monsoon rainfall (which could affect the rabi harvest), and slow growth momentum in exports.

Recent monetary policy actions

The RBI has been under immense pressure for some time, both from the industry and from policymakers, to cut rates as inflation rates ease while economic performance remains modest. However, the RBI governor decided to keep key policy rates unchanged in the recent monetary policy in line with market expectations, citing significant upside risks to inflation.4 The RBI noted that the recent easing is because of transitory factors and favorable base effects. Factors such as administered price corrections, weaker-than-anticipated agricultural production in the coming months, the ability of the government to consolidate fiscal balance, and a possible rise in energy prices may alter the benign outlook. The inflation expectation continues to remain high.

The RBI also revealed that its baseline forecast for the consumer price index is now 6 percent for March 2015, and it expects inflation to be around 6 percent over the next year. If the inflation trajectory ends up being similar to the RBI’s current policy stance, then the scope of easing in 2015 will be limited. Any rate cut could increase upside risks. However, the governor has also hinted that if inflation continues to remain steady and fiscal developments are encouraging, there might be a change in monetary policy stance early next year, including outside the policy review cycle. Most likely, the easing may be modest in 2015, unless the inflation trajectory significantly undershoots the RBI’s projected path.