Despite indicators which strongly suggest a deceleration, most forecasters are cautiously optimistic about economic growth while a few remain as optimistic as ever. It maybe time to take a pretty hard look at their number. By Shivshankar Verma

It is hard to find a more optimistic economic forecaster than CMIE these days. During the second half of last year, when the rest of the forecasting community started fretting about a possible slowdown in growth, CMIE was extremely brave in upping its GDP growth forecast for 07-08 to 9 per cent from its earlier forecast of 8.5 per cent.

It based its confidence on the 'broad-based', 'investment-driven' nature of India's economic growth. Back then, the research firm was certain that 'inflation will remain steady or may even decline a tad in the coming months' and 'the prevailing high interest rates have not hampered' industrial projects.

Such unbridled optimism doesn't often pay off in times of heightened uncertainty. Inflation touched a high of 7.41 per cent for the last week of March, the highest level for the closing week of a financial year in 13 years, and the number may be higher when the revision happens next month.

The official GDP growth estimate of 8.7 per cent for 07-08 appears a tad optimistic and the actual growth rate, when it is announced next month, may be closer to CMIE's earlier prediction of 8.5 per cent.

When optimism, or pessimism for that matter, is embedded in a forecaster, it is difficult to hold back. Unfazed by the off-target prediction for the last financial year, CMIE has come out with an even more optimistic growth rate forecast of 9.5 per cent for 08-09.

That is an impressive and braver increase from its earlier forecast of 9.1 per cent. Yet again, the optimism is based on the continuing ''capex boom with more and more fresh investments getting announced quarter after quarter'', which CMIE expects will push up industrial growth to 11.4 per cent.

The only negative it can see on the horizon is inflation, which it expects to average 5.5 per cent this year, but doesn't foresee this affecting growth momentum. Even our chronically optimistic finance minister will find it tough to match the folks at CMIE.

The less optimistic lot
Don't get me wrong, I am not an incurable pessimist or someone who is naturally antagonistic towards optimists. It is just that I prefer forecasters who are judicious enough not to jump at a single data point and who would wait for a trend to emerge before opening their mouths. In this instance, CMIE's forecast is based on the recovery in February industrial growth to 8.6 per cent – after many months of anaemic growth numbers. The February IIP number could be an aberration or other indicators may worsen. In any case, there is a long road to travel from February's 8.6 per cent industrial growth and CMIE's full year forecast of 11.4 per cent for 08-09.

Be that as it may, other forecasters are much more guarded. From an overtly pessimistic forecast of 7 per cent by JP Morgan and HSBC to a hopeful 8 – 8.5 per cent by HDFC, most others expect economic growth for the current financial year to be lower than last year's.

The rationales behind these cautious forecasts are similar – tighter monetary policies to fight inflation, strong rupee, slowing global growth and weakness in asset markets.

7 per cent growth forecast for 08-09 would have invited much derision, just a few months back. But, the reports from JP Morgan, HSBC and Morgan Stanley – which predicts 7.1 per cent - have found a more receptive audience – obviously shaken by the ongoing turmoil in global financial markets.

Predictions that were once considered improbable have happened, often surprising even those who made the predictions. Crude oil is way past $100 per barrel and is now forecast to average in three digits for 2008.

Estimates of total losses from the global credit crisis are all set to touch $1 trillion – a number so far used only to describe the size of the largest economies. Even way-off-the-mark forecasts are no longer considered improbable as pessimism about economic prospects is slowly replacing the gung-ho excitement that prevailed until last year.

We're in for a phase of moderate growth, no doubt
After expanding at over 8.5 per cent for four years in a row, most economies are likely to slow down – unless of course we are talking about China. Most growth upswings hit a ceiling when bottlenecks and hindrances crop up in the form of capacity constraints, external weaknesses, financial and asset market turmoil, inflation which results in higher interest rates and so on. China managed to keep these obstacles at bay for a prolonged period through massive capital investments, inflation management even through data manipulation and currency manipulation to support exports. Even the Chinese are finding it difficult to sustain these efforts this year and, consequently, their GDP growth is expected to moderate from last year's levels.

In India, we haven't done even a fraction of what the Chinese have been doing for a longer period. Capital investments have gathered pace only recently and are nowhere near Chinese levels. The rupee jumped against the dollar last year when the Chinese renminbi barely crawled.

Our inflation is at a multi-year high when the Chinese are slowly discovering that it is tough to keep price levels down only by playing around with data. Successive governments in India have been talking about second generation reforms for nearly a decade and it is difficult to even hope for a major reform initiative when the political mandate is likely to remain splintered even after the next elections.

Given all these, it was a bit premature on our part to take it for granted that economic growth is all set to touch double digits very soon and a slowdown was considered improbable even in the medium term. Despite

Sacrifice ratio or the price of inflation fighting
Calming inflationary pressures is definitely the big challenge for the government. To make life difficult for the managers of our economy, the price rise is more marked in food and other primary articles. As elections draw close, inflation is a very touchy subject with huge political costs perceived to be attached to it.

And the government is leaving no stone unturned in its fight against inflation and some of the steps really look desperate, from bullying steel and cement producers to banning futures trading in sensitive commodities. Import duties of some commodities have been cut while exports of other commodities have been banned.

The state governments have started their own initiatives like various market intervention schemes, even though they have failed in the past. The RBI, as expected, chipped in and hiked the CRR to suck out liquidity and bring down money supply. It is another matter that these measures are unlikely to have any significant impact on inflation in the short term as the price increases in commodities is not a domestic phenomenon, but a truly global one.

But, the inflation fighting measures will definitely have a calming effect on overall economic growth – which in turn will lead to a decline in demand growth, if not absolute demand, and eventually to lower inflation. The decline in growth is the price we will pay for achieving lower, or the so called manageable, inflation levels. There are economists who argue that we should not worry much about inflation, as long as we can sustain higher growth rates. There is some merit to that argument if inflation is not way above the comfort zone. That is not the case anymore.

Can the price to be paid in terms of lower growth be quantified? The RBI itself had done a study some years back, which concluded that overall growth will drop by 2 percentage points for every percentage point drop in inflation. If that thumb rule holds good, then growth has to slip to around 5 per cent to bring down inflation even close to RBI's acceptable range. That seems excessive, but there is no question that the growth rate will fall as the government gets more aggressive with its anti-inflationary measures.