India's economy showed further signs of slowdown on Monday, with July factory expansion the weakest in 20 months, a government panel cutting its growth forecasts and its top carmaker posting a steep drop in sales. But central bank Governor Duvvuri Subbarao, who last week surprised markets with a steeper-than-expected interest rate increase of 50 basis points - India's 11th rate rise since March 2010 - stuck to his anti-inflationary stance.
"We need to raise rates in order to restrain inflation. That hurts growth. So people say, are you not hurting growth in order to contain inflation? Our response is that, you need to restrain inflation in order to ensure that our middle-term growth is sustainable," he said in a speech in south India.
Morgan Stanley became the latest bank to cut its outlook for Asia's third-largest economy, predicting economic growth in the fiscal year that ends in March of 7.2 percent, down from 7.7 percent earlier. "A combination of factors - including persistently high inflation, higher cost of capital, a cut in the ratio of fiscal spending to GDP, a weak global capital markets environment, and the slow pace of investment - will cause a further slowdown in growth," Morgan Stanley economist Chetan Ahya wrote on Monday.
The HSBC Markit Business Activity Index , based on a survey of around 500 companies, fell to 53.6 in July from 55.3 in June, its third straight decline, although it remained above the 50 mark that separates growth from contraction for the 28th consecutive month. Monday's PMI reading reflected the impact of a steady rise in interest rates as well as the dampening of demand from key markets such as the United States and the eurozone, which are reeling from their own respective debt crises.
A top Indian government economic advisory panel on Monday cut its growth forecast for the fiscal year to 8.2 percent, from a 9 percent target in February. The central bank expects growth of roughly 8 percent this fiscal year. The panel said inflation will remain around 9 percent until October, and ease to 6.5 percent by March, adding that the central bank "will have to continue a tight monetary policy till inflation shows definite signs of decline."
The prime minister's Economic Advisory Council also said that fiscal targets set in the government's annual budget "present a significant challenge." It said India's fiscal deficit could touch 4.7 percent of GDP in the year to March 2012, slightly above New Delhi's target of 4.6 percent, and advised stronger measures to increase revenue and cut spending.
Economists have long been skeptical of the deficit target. "We see challenges not just from expenditure but also in terms of revenue," said Shubhada Rao, chief economist at Yes Bank in Mumbai. India grew at 8.5 percent in the year that ended in March. Economists have trimmed their growth forecasts for major Asian economies, including China, for this year and next.
Despite the Indian central bank's steady increase in rates, which makes it one of the world's most aggressive inflation-fighters over the past year, wholesale price index inflation was 9.44 percent in June. Inflation is being driven by structural pressures on food prices as rising incomes lead to better diets; crude oil and commodity prices; and wage and demand pressures, Subbarao said during a university lecture in south India.