RBI cuts growth prospects to 5.5% in 2013-14

The Indian economy will grow at a slower pace of 5.5 per cent in the current financial year, as recovery from the sluggish fourth quarter of the 2012-13 fiscal takes time, the Reserve Bank of India (RBI) governor D Subbarao said at the apex bank's annual macroeconomic review.

''Leading indicators do not suggest immediate improvement in production activity and a slow-paced recovery is likely to take shape only later in 2013-14, supported by good monsoon that could shore up rural demand,'' RBI said.

While the progress of monsoon has been encouraging and agricultural growth is likely to pick up, RBI noted that industrial growth remained subdued and supply-side bottlenecks are constraining core industries. Service sector growth also showed signs of moderation in Q1 of 2013-14, it added.

RBI's survey of order books, inventory and capacity utilisation showed that the capacity utilisation recorded a seasonal increase in Q4 of 2012-13 over the previous quarter. However, it remained well below the peaks observed in Q4 of 2010-11 and 2011-12.

Aggregate demand continues to be weak with deceleration in consumption and investment and much will depend on government's initiatives in addressing infrastructure bottlenecks. As of now, however, nearly half of 566 large central sector projects are delayed and have cost overruns of about 18 per cent, the survey pointed out.

Based on data from banks and financial institutions on projects sanctioned for financial assistance, the investment in new projects improved somewhat in Q4 of 2012-13, but the full year investment in 2012-13 at Rs2,00,000 crore remained almost unchanged from the previous year and below the Rs3,80,000 crore sanctioned in 2010-11.

Sales growth of 2,419 non-government, non-financial companies decelerated further to 4.9 per cent during Q4 of 2012-13 from 9.4 per cent in Q3. Early results for Q1 of 2013-14 indicate further deceleration in sales.

The central government's tax collection has remained weak during 2013-14 so far. Any shortfall in revenues from budget estimates would force a cutback in expenditure. The government will need to restrain its subsidy commitments and increase public investment to crowd-in private investments.

The CAD factor
RBI estimates put the country's current account deficit at 3.8 per cent of GDP against the 3.8 per cent of the end of the previous fiscal from a historic high of 6.5 per cent in the third quarter of 2012-13. However, indications are that it may have widened again in Q1 of 2013-14.

India's trade deficit has widened in Q1 of 2013-14 on account of contraction in exports and sharp increase in gold imports, RBI pointed out.

Going forward, RBI expects the current account to show improvement. The demand for gold is likely to decline with increase in customs duty and rationalisation of gold import policy.

While CAD may fall in 2013-14, risks to CAD financing have increased with firming up of US yields that caused global bond selloff and capital outflows from emerging and developing economies, including India.

Although vulnerability indicators of the external sector have deteriorated, short-term debt (residual maturity) constituted 44 per cent of the total debt at end-March 2013. India's net international investment position was (-) 16.7 per cent of GDP. In this milieu, structural policy reforms are needed to reduce CAD and to improve its financing by attracting more stable capital flows to the Indian economy, RBI said.

Liquidity conditions
The Reserve Bank eased monetary policy in 2012-13 and in early May 2013 with 125 bps cut in policy rate. This has helped to reduce the weighted average lending rates of banks by 47 bps, according to RBI.

RBI, however, has tightened banks' liquidity in July 2013, with a view to restoring stability to the foreign exchange market. It raised the marginal standing facility rate and the bank rate, restricted access to borrowing under liquidity adjustment facility, stipulated higher daily maintenance of cash reserve ratio and undertook open market sales of government securities.

Broad money (M3) growth stayed in line with the indicative trajectory, but the deceleration in domestic growth and deterioration in asset quality of the banking sector has kept credit growth below the indicative trajectory in Q1 of 2013-14, RBI noted.

Going forward, RBI said, it would endeavour to actively manage liquidity to reinforce monetary transmission that is consistent with the growth-inflation balance and macro-financial stability.

Financial markets
RBI expects the contagion from global bond sell off to generate stress in Indian financial markets as well. The policy statements by the US Fed in May 2013 accentuated the global bond sell off. It also made markets jittery, leading to significant volatility in bonds, currencies, commodities and equities across markets in Asia, including India, according to RBI.

The tightening of liquidity was a policy reaction to the loose dollar policy aimed at helping to stabilise exchange rate of the rupee, though money market rates and bond yields hardened. The exchange rate of the rupee that had depreciated by 7.5 per cent till 15 July has since appreciated by 1.9 per cent till 26 July following the Reserve Bank measures.

The Reserve Bank's House Price Index (HPI) increased by 19.4 per cent y-o-y and 2.1 per cent q-o-q in Q4 of 2012-13.

Inflation rate
A moderation of global commodity prices, negative output gap and past monetary policy actions contributed to a fall in headline WPI inflation. Non-food manufactured products inflation declined sharply to its lowest level in the past three years. CPI inflation, however, has hovered around double digit-levels for the last 15 months.

Food inflation rose in May and June 2013 and put pressures on general price-level. These pressures could moderate somewhat if the monsoon remains on track during the rest of the season.

Recent currency depreciation and upward revisions in fuel prices have increased upside risks to both wholesale and consumer price inflation.