Bumps ahead

These are early days yet, But there are signs that the appreciation of the rupee and the Reserve Bank of India’s tight monetary policy, which is resulting in higher interest rates, are hurting overall economic growth. The economy seems to be showing signs of wear and tear; the latest Index of Industrial Production (IIP) data for September are disappointing. IIP growth is down to 6.4 per cent, compared to 12 per cent last September. This is the slowest industrial growth recorded since October last year, when the index rose 4.5 per cent.

The main culprit is the manufacturing sector, which decelerated to 6.6 per cent compared to about 13 per cent in September last year. The consumer durables segment, in particular, has been hit hard, registering a 7.6 per cent fall in output in September. There’s more bad news. For the first half of this financial year, IIP growth fell to 9.2 per cent, against 11 per cent last year.

So, is the Indian growth story slowing down? Finance Minister P. Chidambaram doesn’t think so. Putting up a brave front, Chidambaram said people should “take a long-term view” and reiterated that the services and manufacturing sectors are likely to grow at 10 per cent this year. He also pointed out that the capital goods industry “retains its vibrancy”.

Economists, however, don’t share the FM’s optimism. They attribute the manufacturing slowdown to high interest rates, appreciating rupee and cheaper imports from countries like Thailand and Malaysia. Says Siddhartha Roy, Economic Advisor, Tata Group: “It’s now evident that higher interest rates are hurting domestic industry. This is already apparent in the auto and consumer durables sectors.

Then, the strengthening rupee is beating down Indian exports, forcing many exporters in labour-intensive industries like textiles, leather and handicrafts to downsize drastically. The Federation of Indian Export Organisations estimates that almost 8 million jobs may be lost this year.

That’s not all. There are now concerns that the US, the world’s largest economy and a major market for Indian exports, is heading for an imminent slowdown, driven in part by the subprime crisis. A worried US Federal Reserve has already lowered rates twice in order to energise the economy. But this has driven more foreign money into India, resulting in a further appreciation of the rupee. Says Roy: “High domestic interest rates offer foreign investors massive arbitrage opportunities and more money will flow into the country.”

In the immediate future, things are unlikely to change. Inflation, which has been the RBI’s main worry recently and one of the main reasons for the high interest rate regime, appears to have been tamed for the time being; it is hovering at around 3 per cent.

This is well below RBI’s comfort zone of 4-4.5 per cent, but it is unlikely to relent just yet. Why? Because global crude oil prices are within kissing distance of $100 (Rs 4,000) per barrel and the government, which has so far refrained from raising domestic oil prices, will soon be left with little choice in the matter. If the government does raise prices, it will force companies across the board to raise prices, stoking inflation.

The RBI then might prefer to combat inflationary tendencies in the economy through a further tightening of monetary policy. Says Roy: “If there is a major price revision, it could push inflation to over 4.5 per cent. That will definitely hurt GDP growth.”

Despite this, economists agree that India’s long-term growth story remains intact.