India growth outlook clouded by oil price, inflation – MoneyControl

Posted on March 18, 2011 by


Domestic and global factors are conspiring to darken India’s once-shining growth outlook, with inflation and sluggish investment likely to keep economic expansion well below the government’s target of 9% in the coming year.

While Thursday’s interest rate increase was expected, the Reserve Bank of India‘s hawkish tone and warnings about risks to growth and inflation posed by high energy prices are clouding near-term prospects for Asia’s third-largest economy.

Eight rate increases since last March, with more on the way, have failed to kill off inflation that topped expectations at 8.3% in February. They have, however, begun to crimp demand.

That threatens to worsen an investment climate already soured by bureaucratic delays and a government that has been crippled by a string of corruption scandals.

Sluggish investment, in turn, is slowing the addition of much-needed infrastructure and industrial capacity in an economy plagued by supply-side bottlenecks. Industrial output rose just 3.7% in January, its strongest in three months.

“We really need infrastructure growth but you cannot create infrastructure at such high rates, so it’s a double whammy situation,” said K.G. Mantri, senior vice president at Mumbai-based Man Industries, which makes steel pipes.

Investment in India grew just 6 percent in the December quarter, far behind the 18% growth in the six months through September, according to Citigroup.

The Reserve Bank of India warned on Thursday of fragile investment conditions.

“Continuing uncertainty about energy and commodity prices may vitiate the investment climate, posing a threat to the current growth trajectory,” the RBI said.

Global portfolio investors, meanwhile, have fled India this year. The benchmark Bombay share index has tumbled 12%, making it the worst performing major stock market in Asia along with Japan, where the unfolding nuclear crisis threatens to add to a broader global environment of risk aversion.

Oil Pain

With global oil prices above USD 100 and threatening to remain elevated, fuel has replaced food as India’s key inflation worry.

New Delhi faces the dilemma of maintaining diesel and cooking fuel subsidies and taking the hit to government finances, or making the politically unpopular and inflationary choice to pass along price rises to end-users. Neither option is attractive for a country that imports two-thirds of its energy.

While India’s longer-term prospects remain bright, at least three major banks have recently cut growth forecasts for India in the year starting in April. Few economists share New Delhi’s optimism for growth and deficit management.

“The combined impact of the oil price rise and, much more importantly, the lagged effects of the interest rate increases so far are already actually leading to slowdown in activity,” said Credit Suisse economist Robert Prior-Wandesforde, who forecasts 7.7% growth in the upcoming fiscal year.

Opportunity lost?

Slowing growth could help India stave off overheating and allow capacity to catch up with demand, but India is in danger of missing that opportunity if investment doesn’t accelerate.

“The investment recovery is weaker than what we would have anticipated. That has less to do with interest rates and demand and more to do with the execution side,” said Rajeev Malik, senior economist at CLSA in Singapore.

While there are encouraging recent signs — BP will pour USD 7.2 billion into energy projects developed by India’s Reliance Industries and a USD 12 billion steel plant planned by South Korea’s POSCO won clearance after years of delay — India does not make investment easy.

Graft scandals distract the government and scare investors. Delays in approvals have stalled infrastructure projects, while difficulties securing coal have slowed the construction of much-needed power plants.

An embattled Congress party-led government will soon face voters in five states. While New Delhi has said it is in talks to liberalise foreign direct investment, the current government has lacked the muscle and unity to push through reforms.

“Given all the scandals and so on that’s been going on recently, that’s going to have some impact no doubt on the way foreign investors view India. I’m not convinced that this is a blip and a one-off. I think we could see a fairly persistent underperformance in terms of FDI,” Prior-Wandesforde said.

It’s not only foreign direct investment that suffers. Top Indian power equipment maker Bharat Heavy Electricals Ltd told Reuters recently it may miss its new order target for the current fiscal year due to a slowdown in domestic orders.

Even under the best circumstances, it takes time for new capacity — whether factories or power plants — to begin addressing shortfalls in an economy.

Current circumstances are far from ideal, and higher interest rates will add to the challenge on the supply side.

“This industry is completely debt driven. Already, for many companies, the debt-equity ratio is in the range of 2:1 or 3:1,” said Sunil Agrawal, chief executive of ARSS Infrastructure Projects, a construction firm based in Orissa.

“The costs will rise over the next six months or so.”

Posted in: India