Inflation down, GDP growth up: Goldilocks is back but will she stay?

All is well when economic growth is high and inflation is low. The Indian economy seems to have finally come to this happy place as the latest set of data showed that factories increased production faster while retail inflation softened for the second straight month. The Goldilocks economy, with higher growth and lower inflation, is back both in India and globally, a welcome change from the recent inflation scare.

The Index of Industrial Production grew by 7.47% in January, with manufacturing maintaining its impressive pace of expansion at 8.69%. The pace is faster than expected and coupled with softening inflation comes as a pleasant surprise to the markets.

A broad-based industrial recovery is on track and investment too seems to be reviving, albeit slowly. Capital goods held on to the impressive 14% growth, and the driver of consumer goods growth was durables.

Of course, there is a bit of a base effect at play given that a year back, the economy was coming out of the shadow of demonetisation. Another caveat is that effects of the goods and services tax (GST) may not have entirely played out. But on the face of it, industrial output is on a firm footing.

What is more comforting is that all this quickening in growth is not adding to inflationary pressure. Retail inflation’s fall to 4.44% in February from 5.07% the previous month should please policymakers, although they’re likely to see through the fall in vegetable and pulse prices. Core inflation, a reflection of demand pressures on the economy, too has softened but by only a small margin.

These trends in India echo what is emerging globally. The US is seeing its employment rate improving sharply but receding wage pressures could mean inflation won’t spiral enough to warrant faster rate hikes by the central bank. The US stock and bond markets have taken note of this, with indices rising and yields steady.

Back home, most analysts believe that both stock and bond markets in India will extend their recent gains. But the big question is whether Goldilocks is here to stay.

So what can go wrong?

Globally, US President Donald Trump’s fiscal stimulus could still lead to inflation, as will his protectionism. In India, GST implementation is still a work in progress and export growth is a problem. Higher minimum support prices and other sops could put pressure on government borrowing. Any revival in investment requires unbridled flow of funding to the economy. That funding is threatened now as the banking sector is reeling under rising bad loans and a loss of trust due to fraud. The massive erosion in market value of public sector banks mirrors this predicament.

Hence it is not a surprise that Indian markets have underperformed their global peers. On Monday, the Nifty rose by 1.9% as it joined a global equity rally but it continues to underperform the US market and even its regional peers such as Indonesia, Malaysia, and Hong Kong.

Fixing bank balance sheets and its own books is what the government must do if it wants Goldilocks to stay.livemint