So far, the Reserve Bank of India (RBI) has primarily had to worry about high inflation. With GDP growth averaging 5.4 per cent in the first half of 2012, it will also have to worry about flagging growth. Most economists believe the economy has bottomed out but recovery isn’t likely before next year. Elevated interest rates will only delay recovery.
Economists believe RBI will have to factor in other indicators while deciding on lending rates. For starters, the European Central Bank’s move on Thursday will help dissipate some of the fears of a contagion spreading from the Euro zone. The other data points that could influence the central bank’s decision would be continued contraction in industrial production. Economists expect the IIP in July to grow at zero per cent or contract. Indranil Sen Gupta, India economist at Bank of America Merrill Lynch, expects July industrial growth to report ‘another abysmally weak zero per cent, atop June’s 1.8 per cent contraction, with high lending rates hurting demand’.
The power grid failure in July and slowing exports are likely to be a drag on industrial production. Siddhartha Sanyal, India economist at Barclays also expects industrial production to contract marginally. Deutsche Bank, however, expects July industrial production growth to improve to one per cent year-on-year from -1.8 per cent in the previous month. Most economists are unanimous when it comes to their expectations for August inflation numbers, which is likely to be in the seven per cent region.
Though the central bank has been trying to fight inflation by holding on to rates, it's becoming apparent that the real reason for inflation might lie elsewhere. In fact, high rates are putting pressure elsewhere (read growth). Going by the high levels of stress building in the economy thanks to high interest rates (rising NPA levels for banks and slowing investments), the RBI might cut 25 basis points in September, says Bank of America Merrill Lynch. Sanyal says: “We feel that RBI is delaying the inevitable, as eventually interest rates will have to be lowered in the coming months. We expect another 100 bps of repo rate cut before the fiscal ends. A favourable inflation number and steps towards fiscal consolidation, if any, will increase chances of RBI bringing forward interest rate cuts.”
