India's economy may be headed for a sharper slowdown than most are expecting, and could see its worst growth rate since the depths of the credit crisis, according to economists at Morgan Stanley.
"Clear signs of slowdown have emerged over the last 3-4 months," Chetan Ahya, an economist at the bank said in a report. Morgan Stanley cut its growth forecast for the fiscal year ending March 2012 to 7.2 percent from 7.7 percent. That's far below the government's forecast for growth of 8.2 percent for the current fiscal year.
"We believe a combination of factors - including persistently high inflation, higher cost of capital, cut in fiscal spending to GDP, weak global capital markets environment and slow pace of investment - will cause a further slowdown in growth," the report said.
Other economists are also warning of a slowdown. Credit Suisse see India's growth rate easing to 7.5 percent for the next 2 years, with more risks to the downside.
"Significant pockets of vulnerability do exist in the Indian economy, with real estate, big-ticket consumer durables and capital goods set for a particularly tough eighteen months or so," the bank said in a report.
The latest sign of a slowdown came on Monday, with data showing factory expansion was at its weakest in 20 months in July. That's on top of a moderation in car and retail sales as well as construction and investment spending in July.
India's economy was able to hold up relatively well during the economic crisis thanks to monetary and fiscal stimulus, but that stimulus has come back to bite the economy in the form of high inflation, say analysts.
"Persistently higher inflation is eroding consumer purchasing power," Morgan Stanley's Ahya wrote.
India's inflation measured by the wholesale price index (WPI) - remains elevated at 9.4 percent. Little wonder, the central bank has been forced to hike interest rates, despite slowing growth. The monetary tightening will be accompanied by more fiscal tightening, according to Morgan Stanley, which says the government will be forced to cut back on spending to meet its fiscal deficit target of 4.7 percent of GDP.
Taken together, Morgan Stanley believes India's equity market - already the worst performing in Asia this year, could fall further.
"With slowdown in overall growth, we believe investment sentiment could remain weak over the next two quarters."