India's economy posts weakest growth in six quarters

UPDATE 3

India's economy grew at its weakest pace in six quarters but outperformed even gloomier predictions, reinforcing expectations the Reserve Bank of India (RBI) will keep raising interest rates to put a lid on inflation.

Gross domestic product (GDP) growth in Asia's third-largest economy slipped to 7.7 per cent in the three months through June, slightly exceeding the median forecast in a Reuters poll for an annual rise of 7.6 per cent.

"The latest growth number reinforces the view that although growth is slowing down, it is not collapsing as feared by some," said Ashutosh Datar, economist at IIFL in Mumbai, who said another 25 basis point increase at the central bank's next policy review on Sept. 16 was likely.

India's economy grew 7.8 per cent in the previous quarter.

The RBI's 11 interest rate increases since March 2010, including a sharper-than-expected 50 basis point increase last month, have failed to bring inflation under control, but have undermined sentiment and demand in an economy that grew at 8.5 per cent in the fiscal year that ended in March.

Wholesale prices grew 9.22 per cent in July, the latest inflation data shows, a tad below June's 9.44 per cent, but well above the central bank's 4-4.5 per cent comfort zone.

India's slowing growth is the latest sign of cooling in the big emerging BRIC economies. Brazil's economic activity fell in June from a month earlier, the first such drop since late 2008, while China posted slower growth in its June quarter.

India's benchmark 10-year federal bond yield rose 2 basis points to 8.35 per cent after the data failed to weaken the case for a rate increase at the next policy review in September.

The 1-year overnight indexed swap (OIS) rate rose 5 basis points to 7.85 per cent while the 5-year rose 3 basis points to 7.03 per cent. Dealers said the move reflected expectations of a maximum 50 basis points more rate increases in 2011, after which the RBI may press the pause button.

Construction was a dark spot in the data, rising just 1.2 per cent annually, down from 7.7 per cent a year earlier, as higher interest rates dampened the housing market and big-ticket projects were plagued by delays in approvals.

In Mumbai, India's biggest and most expensive city for real estate, residential sales slumped to a 30-month low in the quarter to end-June, leaving the city with more than 100 million square feet of unsold real estate, according to data by Liases Foras Real Estate Rating and Research.

"The slowdown in construction is less pleasing at face value, but overall this robust report should leave RBI on track for one more 25 basis point hike this year," said Sean Callow, senior currency strategist at Westpac Institutional Bank in Sydney.

India's manufacturing sector grew 7.2 per cent in April-June from a year earlier, data released on Tuesday showed, an improvement from the previous quarter but below the 10.6 per cent growth clocked a year earlier.

Farm output rose an annual 3.9 per cent for the same period, down from its previous quarter growth but above 2.4 per cent expansion a year earlier.

A steady rise in interest rates combined with stubbornly high inflation are curbing demand in India and squeezing credit-sensitive industries, prompting many economists to slash their growth forecasts for the current fiscal year.

With the government preoccupied by corruption scandals that have stalled approval of legislation and projects that could help ease bottlenecks in the economy, the RBI has struggled in its battle with inflation.

The RBI has made clear that containing prices is its priority, even as debt woes in the United States and Europe darken the global outlook.

"The only wild card here is heightened turmoil in the global financial markets and worries over global growth outlook which could pose downside risks to domestic growth driver," said Radhika Rao, economist at Forecast Pte in Singapore, who expects a 25 basis point rate rise next month.