Growth forecast points to rate rise, lowered stimulus

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India said on Monday its economy would grow 7.2% this fiscal year, picking up from a six-year low the previous year and underlining expectations that the central bank will raise rates in coming months.

It also backed the market view that the government could announce steps to unwind its stimulus measures in the annual 2010/11 budget presentation on February 26 as a recovery in Asia's third-biggest economy shows a more solid footing.

Markets have already priced in expectations for a rise in interest rates and the estimate on Monday did little to change that. At 12:41 p.m. (0711 GMT), the yield on the benchmark 10-year bond was at 7.66%, below Friday's closing of 7.68%.

Still, Rajiv Kumar, chief executive of ICRIER, a Delhi-based think-tank, said the Reserve Bank of India (RBI) would watch the budget before making a decision on interest rates.

"The RBI will probably watch the government action on the stimulus exit in the budget before taking a call on interest rates," he said.

The official forecast released on Monday was largely in line with other estimates that point to an economy picking up after growth weakened to a six-year low of 6.7% in 2008/09.

The economy has rebounded quickly with data showing strength in industrial output, although a damaging drought has hit the agricultural sector.

The Congress Party-led government introduced various stimulus measures during the downturn, including more relaxed repayment schedules for export credit.

It has tried to reassure Indians that it would not do anything to jeopardise growth in withdrawing its stimulus. But analysts say that with the economy recovering, it is treading a thin line between supporting the economy and inflaming inflation.

In addition, reduced spending would help eat into its 2009/10 fiscal deficit, which is at a 16-year high of 6.8% of GDP.

The Reserve Bank of India (RBI) has already raised bank reserve requirements as it starts to withdraw its crisis measures and it has warned of mounting inflation pressures, setting the stage for rates to rise.

Breakdown

The Central Statistical Organisation forecast said it expected the economy in the year to the end of March to expand 7.2%.

It said manufacturing, a key growth driver, would grow 8.9%, a sharp pick up from 2.4% in the previous year.

Farm output would contract 0.2% after the worst monsoon in 37 years, swinging from year-earlier growth of 1.6 percent. Still, the latest forecast is higher than a 2 percent contraction forecast by the prime minister's economic advisory commission in October.

"If, despite drought, we are showing a -0.2% performance, that is very good," said Montek Singh Ahluwalia, deputy chairman of the Planning Commission, which advises the government on policy.

"We have no foodstock problem. Food prices are coming down and I am sure they will further come down."

Food prices were growing at an annual rate of more than 17% in the second half of January but had been closer to 20%.

Last month, the RBI revised up its growth estimate for 2009/10 to 7.5% from 6.5% and lifted its forecast for wholesale price inflation to 8.5% from 6.5%.

Policymakers, including the Prime Minister Manmohan Singh, have said they expect the economy to grow around 7.5% in the 2009/10 fiscal year.

Earlier this moth, the International Monetary Fund forecast growth in 2009/10 of 6.75%.