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India economy to recover, more rate cuts seen

India’s economy will pick up this year, although more gradually than previously thought, while average inflation will be slower, giving the Reserve Bank room to cut rates by another 50 basis points during the fiscal year ending March 2013, a poll showed.

The survey showed Asia’s third-largest economy growing at an annual 6.5 percent in the three months to June, and accelerating to 7 percent in the next quarter. That is down from 6.8 percent and 7.1 percent in the January poll.

Growth is expected to clock a 7.1 percent rate for the fiscal year 2012-13. The International Monetary Fund is a little more optimistic, at 7.3 percent. Growth for the latest fiscal year ended in March is expected to be 6.8 percent.

Yet even so, growth estimates have now been cut for the fifth straight quarterly Reuters poll. The current rate, at 6.1 percent, is far below the near double-digit rates before the onset of the global financial crisis in 2008-09.

“One of the biggest challenges the economy has faced last year has been the policy inertia and that continues to remain,” said Upasana Bharadwaj at ING Vysya Bank.

But she said the surprisingly sharp 50 basis point cut from the Reserve Bank of India this week “should provide some boost to overall sentiment and help in stimulating investment.”

That was the RBI’s first rate cut in three years, following a lengthy battle to bring down inflation.

More rate cuts?

Indeed, the RBI was still raising interest rates long after many others started cutting them, severely crimping growth and punishing the rupee.

Other central banks like the U.S. Federal Reserve and the Bank of England, with interest rates at the zero barrier, have resorted to printing money to shore up their economies, with limited results thus far.

With the repo rate at 8 percent, the RBI still has room to cut. Even after the RBI’s 50 basis point cut this week, economists now expect it to be lowered to 7 percent by June next year instead of 7.5 percent in the January survey.

Once considered the engine of Asian economic growth, the Indian economy in recent years has been throttled by a combination of high inflation, tight monetary policy, weak global economic conditions and lax implementation of fiscal policies and reforms.

The Chinese economy, on the other hand, is expected to grow by 8.4 percent in 2012 and 8.6 percent next year.

While the RBI tries to restart the investment cycle, much of the work to promote India’s global investment appeal is the government’s responsibility.

The government is caught in a cross wind. On the one hand, it must reduce the fiscal deficit in order to make India attractive to foreign investors. But by raising taxes to do so, it would directly affect sentiment and hamper growth.

“The deviation of growth from its trend is modest,” RBI Governor Duvvuri Subbarao said on Wednesday, referring to the 6.1 percent growth in the quarter to December, its weakest annual pace in almost three years.

While markets cheered the rate cut, further monetary policy loosening will clearly depend on how fast inflation cools.

The poll showed India’s wholesale price index will edge lower from the current 6.9 percent to average 6.6 percent in the three months to December, and 7.0 percent in the March quarter next year largely on account of rising food and fuel prices.

“At the same time, upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates,” Subbarao added.