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State of the Economy: Moody’s foresees slowing of GDP growth to 7.7%

	May 19, 2008

Moody’s Investor Services foresees India’s gross domestic product (GDP) growth rate to slow from 8.7 per cent in fiscal 2007-08 to 7.7 per cent in the current fiscal. This is in contrast to the latest assessment by the Chairman of the Economic Advisory Council to the Prime Minister, Dr. C. Rangarajan, when he said that GDP growth would hover in 8-8.5 per cent range this fiscal.



It said external fundamentals remain robust enough to withstand “a wide range of potential shocks, such as sudden reversals in short-tem capital flows, a sharp slowdown in global growth, as well as weak government finances or a slowdown in structural reforms on account of coalition politics”.



Moody’s assessment of a one percentage decline in GDP anticipated for the current fiscal stems from a medley of factors, the chief ones being prolonged monetary tightening and a weaker global environment stating that the Reserve Bank of India’s monetary tightening and stricter oversight of bank lending led to the containment of inflation to within 5 per cent and a cooling of consumer and property lending through 2007.



Moody’s said the RBI’s monetary tasks have been complicated by “a surge in foreign capital inflows that has caused the monetary base to grow by 22 per cent, far above its 18 per cent year-on-year broad money growth target”. Besides, the supply side constraints have also exacerbated RBI’s policy manoeuvring elbowroom. Moody’s has stated that in the absence of higher absorptive capacities within the economy, it was always of the view that the RBI’s dilemma could lead to a prolonged tightening bias in its monetary policy.



The RBI’s response to large capital inflows has consisted of allowing some rupee appreciation, raising the issue limit of Monetary Stabilisation Scheme (MSS) to over 5 per cent of GDP and hiking banks’ reserve requirements by 350 basis points since January 2007 to mop up excess liquidity from the financial system.



While extensive MSS issuance is slowing down the reduction of the Government’s debt burden, the objective of restraining inflation and maintaining a competitive exchange rate with additional task of ensuring high rates of foreign investment and capital formation is growing notably more difficult, it said.



Moody’s also noted that on account of supplemental oil, food and fertiliser subsidies, several sizable fiscal liabilities have been accrued but kept off-budget by the Union Government. These accumulated off-budget liabilities would need additional market financing to the tune of nearly one per cent of GDP in fiscal 2008-09. “At a time of decelerating economic growth (and sustained oil price shocks), these subsidies would slow down reductions in the Government’s debt burden,” it warned.



Outlook on foreign & local currency stable: In its latest annual report released last Wednesday, it said that the strong fundamentals, combined with upturn in savings and investment as well as rising rate of potential growth, supports the Indian government's foreign currency sovereign medium investment grade (Baa3) bond rating and local currency speculative grade (Ba2) bond rating. "The government's local currency bond rating of Ba2 balances a high level of indebtedness with a favourable debt structure," Moody's Vice-President and author of the latest annual update on India Aninda Mitra said.



Meanwhile, the report notes that the Indian government's Baa3 rating further reflects the country's low external debt and strong external payments capacity. India’s Ba2 local-currency bond rating is one of the few instances where Moody’s has opened a gap between the foreign and local currency bond ratings in favour of the former. This implicitly recognises the low likelihood of any spillovers of domestic fiscal problems onto the government’s stronger external balance sheet (due to regulatory and capital account restrictions) as well as improved financial sector soundness and further strengthening of the country’s external balance sheet.



Structural factors that bolster the rating include a private-sector induced upturn in savings and investment and a rising rate of potential growth.



Moody’s reports are widely used sources for credit rating, research and risk analysis by investors across the world. The report said that despite a worsening global milieu and softer domestic economic conditions, the outlook on the foreign and local currency government ratings for India is stable.



"At the same time, concerns about the size and servicing burden of the government debt is somewhat mitigated by the latter's high local currency content, long tenor, growing domestic savings and a stable creditor base dominated by domestic institutions," Mitra, who is also a Senior Analyst, said.



Besides, the near-term macroeconomic challenges include maintaining monetary stability amid food and fuel price pressures, containing fiscal reversals and managing fiscal consequences after the implementation of hike in civil servants' pay by 40 per cent.

It also includes ensuring more "inclusive growth" that raises incomes in the poorer and slower-growing farm sector in a sustainable fashion.



However, a major challenge for the country's physical, financial and social infrastructure is the weak government finances, he added.



CMIE retains GDP growth forecast at 9.5% this fiscal: Even as Moody’s Investor Services foresees slowing down of India’s GDP growth rate to 7.7 per cent this fiscal, private economic research firm, Centre for Monitoring Indian Economy (CMIE) has retained its GDP growth projection at 9.5 per cent for the current fiscal despite fears of high inflation and slowdown in industrial output.

In its May issue of the monthly review, CMIE said, “We expect the Indian economy to continue on its robust growth trajectory, clocking a 9.5 per cent growth in 2008-09”. This is higher than the 8-8.5 per cent growth projected by the Reserve Bank of India in its annual policy statement for 2008, released last month.

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India's growth robust, irreversible: World Bank



According to Praful Patel, World Bank South Asia Region Vice-President, India's growth, despite current crisis of spiraling inflation, was robust and irreversible. Addressing media last week, he stated that in the crisis situation growth can reduce but has the capacity to spring back. "However, to sustain and improve it further, the country will have to increase agricultural productivity by moving towards two crops per year, improved irrigation processes and recharge of groundwater," he added.



India can undertake several interventions like managing flood, prevent drought, improve storage of water and expanding irrigation by bringing in technologies. Since the average farmland is reduced and cannot be expanded, it is appropriate to use efficient technology, high-yielding seeds, right kind of fertilizers and promoting public-private partnership.



Patel said that India has to work in coordination and cohesiveness within the country as well as the region.



Stating that the early arrival of monsoons was good sign for crops, Patel said India was expected to produce 10 million tonnes of wheat which would make it self-sufficient and may provide surplus for exports.

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CMIE has based its projections on various assumptions. It said the factors which were earlier hinting at a possible slowdown have turned out be false alarm or less potential than feared. The rapid rise in inflation had led to fears of the RBI tightening its monetary policy in April. But the RBI had only hiked CRR and not any policy rates. CMIE said the slowdown in GDP and the IIP growth figures witnessed in the December 2007 quarter was only an aberration and the economy would continue to grow at brisk pace backed by the huge capital investments happening in the country.

The review said projects worth Rs 3.4 lakh crore scheduled for commissioning would generate employment, and hence, demand for primary and intermediate goods and their completion would eliminate the supply side constraints currently faced by a few sectors. Even if all these projects are not commissioned in 2008-09, their implementation will generate employment, and hence, demand for goods. The low growth of 4.9 per cent and 5.8 per cent in the IIP in November 2007 and January 2008, respectively, and the meagre 2.3 per cent growth reported in production of capital goods in January 2008 had led to fears of possible slowdown in the demand and industrial activity. However, IIP bounced back in February 2008, making a healthy year-on-year growth of 8.6 per cent.

The international crude oil prices crossed $120 a barrel. But, CMIE said oil price will unlikely to have any impact on the demand for goods and services as Indian consumers are well protected through administered pricing.

The oil prices has also not hurt the balance of payments as the strengthening of the rupee against the dollar partially mitigated the rise in prices.