Why RBI rate hike is blow to Modi’s dream of reviving manufacturing sector that stands on weak footing

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Published: August 3, 2018 9:33:56 AM

A key spoke in the Indian economy’s wheel isn’t feeling the same optimism as the nation’s central bank, which cited strengthening economic recovery and rising inflation expectations as it delivered back-to-back interest rate increases.

Government,economy,India,parliamentThe volatility in global financial markets and higher dollar borrowing costs mean availability of finance from overseas was a problem.

A key spoke in the Indian economy’s wheel isn’t feeling the same optimism as the nation’s central bank, which cited strengthening economic recovery and rising inflation expectations as it delivered back-to-back interest rate increases. The manufacturing sector, which contributes about 15 percent of the nation’s gross domestic product, saw slack demand in the first quarter of the fiscal year ending March 2019, a survey by the Reserve Bank of India shows. Overall business sentiment deteriorated with order books, production, capacity utilization and exports taking a hit, compared with the preceding quarter.

That underlines a view that the economic rebound is likely to be a bumpy one. The central bank raising the benchmark repurchase rate Wednesday to the highest level in two years doesn’t provide the kind of support the economy needs in the face of high borrowing costs and oil prices, and a weak banking sector, according to some economists.

The volatility in global financial markets and higher dollar borrowing costs mean availability of finance from overseas was a problem, though loans from domestic sources including local banks wasn’t an issue, the survey of more than 1,200 companies shows. Expectations for the second quarter showed a deterioration in sentiment, with the outlook for selling prices being the only bright spark.

“The hike will probably deal a blow to a still-nascent recovery in growth,” Abhishek Gupta, an economist with Bloomberg Economics, wrote in a note. “We had expected a hold, based on our view inflation has already peaked.”

A separate survey of households’ inflation expectations showed that respondents were expecting prices to increase in the coming months. Another consumer sentiment survey, also conducted by the RBI, showed respondents were pessimistic about prices.

The central bank said they expect companies to pass on higher input costs to consumers, a scenario that is likely to keep policymakers vigilant on inflation. For companies, while capacity utilization rates were trending higher, growth in order books contracted sharply, boding ill for demand.

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