Time for a rate cut

The estimates for GDP during the third quarter (October-December) of 2007-08, released last Friday, show it growing by 8.4 per cent over the corresponding quarter of the previous year. This is a noticeable decline compared to the first two quarters of the year, which clocked in at 9.3 per cent and 8.9 per cent, respectively. The lower third-quarter number was already anticipated by the Advance Estimates for the full year's GDP, which were released about a month ago and put the growth rate at 8.7 per cent for 2007-08. Rough calculations suggest that the fourth-quarter growth rate, to be announced at the end of May, will clock around 8.2 per cent, validating the general perceptions about a deceleration having set in.

The sectoral patterns of growth during the quarter reveal the links between the overall macro-economic environment and growth performance. Manufacturing, somewhat contrary to expectations, has actually done better than in the previous quarter, accelerating from 8.6 per cent to 9.3 per cent. When value added (which is what the GDP indicator measures) grows faster than production, it usually implies that input prices have softened and margins have increased. This may bode well for the sector in the coming quarters and also has implications for the outlook on inflation. By contrast, the construction sector decelerated sharply as compared to the previous quarter, with its growth rate coming down from 11.1 per cent to 8.4 per cent. High interest rates have been widely cited as a factor in slowing down demand for real estate, and this is apparently showing up in moderating construction activity. The services sectors, by and large, are not showing any signs of deceleration and look like carrying their momentum into the year ahead.

From the demand perspective, the most significant change from recent quarters is the decline in the investment/GDP ratio. Fixed capital formation as a ratio to GDP declined from 33.7 per cent in the second quarter to 31.6 per cent in the third. Although this may appear to be a small change, this ratio has been consistently rising over the past four years and many people have wondered when the investment cycle would turn down. These numbers give the first indication that this may be happening. However, the ratio is still high enough to inspire confidence that investment activity remains healthy.

Taken in their entirely, the numbers strengthen the case for a policy stimulus. The Budget contains several measures that will provide an immediate stimulus to growth "" income tax reductions and the expansion of the rural safety net "" as well as some easing of inflationary pressures, primarily because of the lowering of indirect tax rates across the board. The latter should give the Reserve Bank of India a little more room to consider a policy rate cut in its April announcement, if not before. If effective input prices into manufacturing are softening because of global market conditions, rupee appreciation and other factors, that room increases correspondingly. The challenge will be to prevent what is so far a mild deceleration from consolidating, making it more difficult to intervene later on in the year. The combined impact of a fiscal and monetary stimulus should take GDP growth back to the 8.5-9 per cent range during 2008-09, provided of course that the monsoons are not sub-normal.