The economy is slowing down, but not fast enough. Gross domestic product (GDP) in April-June 2011 grew by 7.7%, which although lower than the 8.8% in the first quarter of 2010-11, keeps India trundling on a high growth trajectory as far as the rest of the world is concerned. Obviously Indians are buying more of everything from soap to software. But some sectors are feeling the pinch of rising interest rates. Thus construction, involving infrastructure projects that soak up a lot of debt, is sharply down to 1.2% growth from the 7.7% in the same period a year ago. Again manufacturing has slowed down from 10.6% to 7.2% in part because loans for consumer durables like cars cost so much more now. The other big dip is in social spending, including government expenditure, from 8.2% to 5.6%, which offers some consolation to the fiscal puritans.
It costs Rs 3.25 more to borrow R100 in India than it did 16 months ago. And the Reserve Bank of India (RBI) isn't done yet. Banks have raised their lending rates by two and a three-quarter percentage points since March 2010 when the central bank began a series of 11 hikes in the rate at which it lends them overnight money. This makes life tough for anybody who borrows to manufacture anything in the country. But it's tougher for producers that require consumers to borrow as well to buy their wares, like car makers and house builders. This pain is needed, the RBI feels, and it must spread to other parts of the economy.
The demand-side picture, however, remains fairly robust. Consumption shrank slightly to 60.5% of the GDP in the first quarter of 2011-12 from 61.7% in the same period a year ago. Government spending is at 10.4% down from 11.1% last year, while investment is practically flat at 31.2%. The trade deficit is now nudging 9% of GDP because imports are growing faster than exports in the world's second-fastest growing major economy. With wholesale inflation clocking 9.4% in April-June 2011, prices are still growing too fast and unless significantly more demand is deflated, the central bank will have little reason to change its hawkishness on interest rates. But monetary tightening has its limit, and we seem to be heading towards it. India's policy makers could run out of options if supply-side issues like low-farm yields and poor infrastructure are left unaddressed.