India's Economic Growth To Slow In Near Term

Higher interest rates and a rising rupee will likely drag down India's economic growth in the near term, but strong domestic demand and a robust farm sector will help cushion the blow, according to two separate reports by Standard and Poor's and the Organization for Economic Cooperation and Development Tuesday.

S&P forecast India's economy will grow 8.6% this fiscal year, which began April 1, while the OECD said the country's economy will grow 8% in 2008. India's gross domestic product grew 9.4% in the last fiscal year - its fastest pace in 18 years. In the last four years, it has expanded at an average of 8.6%, making India one of the fastest-growing major economies in the world. "While global developments have made the environment more risky, the strength of domestic demand is expected to keep the Indian economy on a relative high-growth trajectory," S&P said. The OECD said India's current expansion has been aided by spare capacity in the economy, and rapid credit growth has fueled demand. S&P expects India's agriculture sector to grow 3.4% this fiscal year, higher than last fiscal year's 2.7%, helped by a good south-west monsoon Industrial growth will likely ease to 9.2% from 11.3% in the previous fiscal year, reflecting the cumulative impact of higher interest rates and a stronger rupee, S&P said. Interest rates in India have risen to around five-year highs after the Reserve Bank of India embarked on a rate hike cycle January 2006, raising its benchmark lending rate six times to the current 7.75% to curb inflation and prevent the economy from overheating. The rupee is currently hovering at a nine-and-a-half-year high against the U.S. dollar, powered by strong inflows of foreign funds into the country. "The pressure on the rupee to appreciate remains. Notwithstanding the widening trade deficit, the current account deficit remains well within the boundaries of expected capital inflows," said Subir Gokarn, S&P Asia Pacific's chief economist. S&P, however, expects the rupee to fall to 40.50 to a U.S. dollar by the end of this fiscal year. At 0805 GMT, it was trading at 39.51 to a dollar. India's inflation, measured by the wholesale price index, is likely to end the year with an average of 5%, S&P said. The WPI-based inflation for the week ended Sept. 22 was 3.42% on year, well below the 5% upper limit that the RBI has said it would be comfortable with for this fiscal year. "The Reserve Bank has lowered its desired medium-term inflation rate to 4%-4.5%, as measured by the wholesale price index, and this should help contain inflation expectations," the OECD report said. "In this respect, they are being helped by the appreciation of the currency." India's current account deficit at 3% of GDP is sustainable on the back of foreign inflows, which have gained momentum following reforms through the last past few years, the OECD said. "This shows how sound policies and courageous reforms can change the economic prospects for millions," OECD Secretary-General Angel Gurria told reporters. The OECD report also stressed on the need for further reforms across financial and labor sectors to boost growth.