While wholesale price inflation reached an annualized rate of 6% in the third week of January 2007, it is expected to soften and then remain steady at 5% in both FY2007 and FY2008. This moderation is due to tighter monetary policy, a rise in agricultural planting, an expected good spring harvest and cuts in import duties on key commodities, ADO 2007 says.
“A soft landing is a likely outcome,” says Ifzal Ali, Chief Economist of the Manila-based multilateral development bank.
Monetary policy will play a key role. Faced with demand-led inflation, the Reserve Bank of India needs to decrease expenditures. In doing so, it will be important not to reduce the credit available for expanding manufacturing capacity more than is necessary to contain inflation. These capacity expansions are vital for enhancing growth potential in the medium to long term. Credit provision needs to be curtailed, but also redirected away from overactive real estate markets.
Rising interest rates will have wide ranging consequences. The loss of construction momentum will persist in FY2007 with some knock on effects for other components of demand. Higher interest rates will induce delays in consumption and in investment. Modest appreciation could contain export growth.
The correction will not be sharp because several drivers will continue to hold sway. With the emergence of industrial capacity constraints, investment will remain high. Consumer durable sales will remain brisk. Demand for India’s exports will remain healthy.
With robust growth, the federal fiscal deficit is projected to decline to 3.3% of GDP in FY 2007 from 3.7% in FY2006.
A key long-term structural challenge in India is sluggish agricultural performance, ADO 2007 says. In addition to contributing substantially to inflation through rising food prices, shortcomings in the agricultural sector are a key driver of poverty and underemployment.
While agriculture and related activities employ around 60% of India’s labor force, they only make up 18.5% of GDP. As a result, there is pressure to transfer land to higher productivity industry and other economic sectors. Such transfers, which displace agricultural workers, have led to social unrest.
Employment growth has picked up in other sectors. In particular, manufacturing has generated jobs for many of the less educated who are squeezed out of agriculture.
The challenge, therefore, is to simultaneously boost agricultural productivity, while creating enough non-agricultural opportunities that are suited to those displaced, many of whom have very low education levels.
“As the agrarian challenge unfolds, substantial job creation in infrastructure-scarce manufacturing sector is the key issue confronting policymakers,” says Mr. Ali.
