Expected outcome

There were few surprises in the GDP numbers for the second quarter (July-September), the estimates for which were released last Friday. Aggregate GDP growth slowed somewhat to 8.9 per cent over the corresponding quarter of last year, compared with 9.3 per cent during the previous quarter. This slight deceleration was primarily caused by a significant decline in the growth rate of manufacturing, which grew by 8.6 per cent during the quarter, compared with 11.9 per cent in the previous one. This trend had been quite visible in the monthly releases of the Index of Industrial Production (IIP), which indicated that in two of the three months of the quarter, July and September, the growth rate dropped significantly below the 10 per cent mark. The impact of this on the GDP numbers would have been even sharper, had it not been for the persistence of relatively high growth in the agricultural sector, which grew by 3.6 per cent during the quarter "" marginally below its first quarter performance, but substantially above the sub-3 per cent growth rate in the second quarter of last year. Of the other sectors, construction accelerated a bit from the previous quarter to 11 per cent, while the big services category "" trade, hotels, transport and communication ""came down slightly to a still powerful 11.4 per cent. The other two services categories were also marginally below their first quarter performance.

The Central Statistical Organisation (CSO) has recently started publishing quarterly estimates on demand components "" consumption, investment, government expenditure and trade. From this perspective, investment appears to be barrelling along. Gross fixed capital formation (GFCF), a measure of how much new productive capacity is being created in the economy, increased its share of GDP from 29.6 per cent in the first quarter of this financial year to 30.3 per cent in the second, and compares with a share of 28.6 per cent in the second quarter of last year. This pattern is consistent with both the acceleration in construction, which accounts for a significant proportion of capital formation, and the robust growth shown by the machinery and equipment segment of the IIP, even when growth in the aggregate index was slowing down.

Together, these patterns are consistent with widespread perceptions about the economy reverting to a sustainable trend growth rate between 8 and 9 per cent per year. A tightening monetary policy stance over the past several quarters has apparently had the desired effect of reining in unsustainable growth, while bringing inflation to manageable levels, helped of course by the acceleration in agriculture, which has dampened food price inflation in recent months after a period of discomfort in late 2006 and early 2007. However, while macro-economic policy has impacted growth in the short term, it does not seem to have deterred businesses from expanding capacity in anticipation of the economy continuing to grow at its trend rate over the medium term. From this perspective, the monetary strategy appears to have achieved its objective. The question, going forward, is whether a combination of global forces and slowing domestic demand will push the growth rate below its trend in the coming quarters. The Reserve Bank of India will have to watch carefully for signs of this before its next quarterly announcement at the end of January 2008. It will then have to decide whether to maintain the status quo or actually cut interest rates, an option that has not been in play for quite a while.