Growth holds up for now. Inflation clouds outlook

Why in the News

Global agencies have raised their full year growth estimates for India to about 7 per cent. The upgrades follow the first quarter Gross Domestic Product (GDP) estimates. Those estimates recorded stronger economic momentum than expected. The same agencies expect that momentum to fade in the second half of the fiscal year. They also project average inflation of 5.1 per cent and a higher policy rate. The growth upgrade therefore arrives with the case for tighter money attached to it.

Why have the growth forecasts been raised?

1. Asian Development Bank: The bank now pegs growth at 7 per cent for the year. Its earlier forecast was 6.6 per cent.
2. S&P Global: The agency forecasts the economy to grow at 7 per cent.
3. Organisation for Economic Cooperation and Development (OECD): The OECD has raised its projection from 6.3 per cent to 7.1 per cent.
4. Moody’s: The agency had earlier raised its growth forecast for the year to 7 per cent, up from 6 per cent.

What is carrying growth in the first half?

1. Conflict in West Asia: Concerns persist over economic activity being affected by the conflict in West Asia. Growth has held up through those concerns.
2. Industrial production: The Index of Industrial Production (IIP), a volume measure of output in mining, manufacturing and electricity, grew at 6.3 per cent during April to July. Manufacturing grew at 7 per cent.
3. Central capital spending: Capital expenditure by the Centre has surged by almost 30 per cent during April to July this year.
4. Merchandise exports: Goods exports grew at 17.8 per cent during April to August. A weak currency aided that growth.

Why is the second half expected to be weaker?

1. Fading tax tailwinds: S&P Global expects growth to ease in the second half of the fiscal year as the tailwinds from sales tax rationalisation and income tax cuts diminish.
2. Momentum into 2027: The OECD expects momentum to weaken before a gradual recovery takes place in 2027.
3. Farm sector risk: The farm sector has emerged as a key area of risk. The Asian Development Bank states that an El Nino worse than expected could reduce agricultural output and raise food inflation across the wider region.

What do the same forecasts imply for monetary policy?

1. Price pressures: Price pressures are building up in the economy. Expectations of higher interest rates have gained traction.
2. Inflation path and the policy rate: S&P Global expects inflation to average 5.1 per cent. It expects the Reserve Bank of India (RBI) to raise its policy rate by 25 basis points in the current fiscal year.
3. A temporary rise in rates: The OECD projects India to raise policy rates temporarily to offset stronger inflationary pressures.
4. The next decision point: The central bank’s monetary policy committee meets in a few weeks. The growth and inflation dynamics tilt the scales towards tighter policy.

Conclusion

Growth readings and price readings are now pointing in opposite directions. The upgrades rest on a first half that the forecasters themselves do not expect to repeat. What remains unsettled is whether output can hold its pace once borrowing costs rise and a poor farm season arrives together. The next monetary policy review is the first place that question gets tested.

Back2Basics: India’s Inflation Targeting Framework

1. The target: The government has retained a Consumer Price Index (CPI) inflation target of 4 per cent for the period April 2026 to March 2031.
2. Legal basis: Section 45ZA of the Reserve Bank of India Act, 1934 requires the target to be reset every five years.
3. Who sets the rate: A six member monetary policy committee sets the repo rate. The combined Consumer Price Index published by the National Statistical Office is the target measure.
4. Accountability: A breach of the 2 to 6 per cent tolerance band for three consecutive quarters obliges the RBI to report to the government.

Matching Previous Year Question

“[2019, GS3, 10 marks] Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments.”