Will The RBI Maintain Status Quo For The Next One Quarter?

India’s economy grew by 5.3 per cent during the last quarter of the financial year 2011-12, exhibiting the eighth successive quarterly slowdown and the slowest pace in nine years. This gross domestic product (GDP) growth was considerable lower than estimates of a 6.1 per cent growth.

The key driver for this quarter’s upswing was the service sector with 7.9 per cent growth. However, the service sector’s growth moderated in Q4FY12 from 10.6 per cent in Q4FY11. Moreover, the agricultural and industrial sectors displayed slightly less than 2 per cent growth in Q4FY12. The industrial sector’s growth weakened to 1.9 per cent in Q4FY12 from 7 per cent in Q4FY11, reflecting the poor performance of the manufacturing and construction industry. Surprisingly, the growth performance of the mining sector improved to 4.3 per cent in Q4FY12 from a marginal 0.6 per cent in Q4FY11. The agricultural sector growth declined sharply to 1.7 per cent in Q4FY12 from 7.5 per cent in Q4FY11.

Earlier, the index of industrial production (IIP) contracted by 3.5 per cent in March 2012 as compared to expectations of 1.5 per cent growth and a robust 9.4 per cent growth in March 2011. The IIP weakened considerably in March 2012 relative to the 4.1 per cent growth in February 2012. This was primarily because of de-growth of 4.4 per cent in the manufacturing sector and 1.3 per cent in the mining sector.

Largely, the IIP data for March 2012 and the Q4FY12 GDP data highlights the poor core sector performance, weak momentum of industrial activity and the sluggish demand for finished goods. However, with base effect reflecting the decline in growth to 5.3 per cent in April 2011 from 9.4 per cent in March 2011, the IIP growth performance is expected to improve in April 2012 as compared to the de-growth in March 2012. But there is no need to cheer as the IIP growth is expected to remain rather stagnant in the coming few months considering the continuing challenges being faced by the manufacturing, mining and electricity sectors.

The last quarter of any financial year is supposed to be a stronger quarter, exhibiting better growth rates than the other quarters. Further, industrial production contributes almost 20 per cent to India’s GDP. The contraction in IIP in March 2012 and the unsatisfactory GDP number in Q4FY12 are a definitive indication of the slowdown in the domestic market. One can recall here the GDP growth for FY09 when the global economic crisis was at 6.8 per cent, better than a growth rate of 6.5 per cent in FY12.

The indication of slowing policy reforms and sluggish industrial activity also fueled the rupee’s depreciation against the US dollar. The rupee’s fall to all-time lows has set up expectations about potential intervention from the Reserve Bank of India (RBI). The rupee has been the worst-performing Asian currency this year, and is down by more than 6 per cent in May, and on course to its biggest monthly fall in six months. The only positive expectation to this gloomy outlook is that most economists now expect inflation to remain capped at around the current levels. However, all eyes are now on the RBI with expectations that the central bank may cut the interest rates at its June 18 meeting.

However, factors like GDP growth at the lowest level in the last nine years, the lacklustre approach towards policy reforms, a mix of various poor economic indicators and uncertain global environment are a matter of concern for the government as well as the RBI. The slow GDP growth with high inflation is expected to worsen the situation. Hence, it is a difficult job for the RBI to maintain a balance between growth and inflation. It has already thrown its cards by cutting the repo rate by 50 basis points in the last review meet. Therefore, we expect the RBI to maintain status quo for next one quarter. Further, if the RBI has made up its mind, it may not be more than 25 basis points. That may lead to some cheer in the domestic markets over a short term but be prepared to admit deteriorating market sentiments.