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India faces a 'temporary soft patch' ahead, says global investment bank

India faces a 'temporary soft patch' ahead, says global investment bank

Global investment bank Lehman Brothers said on Tuesday that it has lowered India's 2007 GDP forecast to 9.1 percent, but structural drivers remain intact.
"India's economy appears to be entering a cyclical slowdown, and we have revised down our GDP forecast for 2007 to 9.1 percent year-on-year (from 9.6 percent) and for (fiscal year 2008) to 9.1 percent (from 9.8 percent). However, India's structural economic drivers are still intact. We expect the economy to bounce back from this soft patch with 10 percent growth in 2008," Lehman Brothers said.
According to the bank's report, tighter monetary conditions are the main reason for the soft patch, which is reflected in recent declines in business confidence and in its composite leading economic index:
"Our composite leading indicator (CLI) for India, which had risen since the 2000 trough, peaked in September 2006 and has declined since then. Our CLI, which combines seven variables from the production, financial and monetary sectors, is designed to project non-agriculture GDP growth two quarters ahead," the bank said.
"The decline in our CLI reflects a slower growth rate in real money supply, BSE Sensex (Bombay Stock Exchange), real bank credit and repo interest rate hikes, all of which point to slower domestic demand growth in 2007."
Overall monetary conditions in India have moved into the restrictive zone, suggesting that the growth slowdown has been induced largely by policy, the report added.
"We constructed a monetary conditions index (MCI) for India by taking a weighted average of the real effective exchange rate (REER) and real policy rates, with the weights derived from a reduced form equation that relates the output gap to the real effective exchange rate and the real policy rates," Lehman Brothers said.
"According to our MCI, monetary conditions in India have tightened by 230 basis points since April 2007, and now are at their most restrictive, reflecting the rising real repo rate and rapid rupee appreciation. This has hurt the interest rate-sensitive consumer durables sector and the exchange rate-sensitive textiles, leather and food product sectors."
Falling business confidence is another indicator, it added.
According to the Reserve Bank of India's (RBI) industrial outlook survey, the business expectations index declined by 5.8 percent quarter-on-quarter in the second quarter, and by a further three percent in the third quarter, according to the report.
Firms reported less favorable conditions in production, working capital finance, order books, capacity utilisation, exports, employment and profit margin.
"Part of the reason for revising down our (fiscal year 2008) GDP growth forecast is because we expect (fiscal year 2007) GDP growth, initially reported at 9.4 percent, to be revised up to around 9.6 percent due to better agriculture and manufacturing sector performance. The fourth advance estimate revised up the total food grains output to 216.1 million tons (mt) in (fiscal year 2007) from 211.8mt earlier. Hence, we expect agriculture GDP growth in FY07 to be revised up to 3.7 percent from 2.7 percent estimated earlier," said Lehman Brothers.
"Meanwhile, we expect industrial growth to be revised up by 0.1pp due to recent upward revisions to historical industrial output data."
The investment bank said it was not overly concerned about India's economy entering a soft patch, partly because at 9.1 percent in 2007, GDP growth would still be strong and well above the average of the past three years of 8.5 percent, but also because it expects this soft patch to be short lived.
"We expect GDP growth to bounce back to 10 percent in 2008, because the structural underpinnings of the Indian economy's 'takeoff' remain intact," said the bank.


Updated : 2021-10-28 00:51 GMT+08:00