The International Monetary Fund’s (IMF) sharp downgrade of its growth outlook for India sparked concerns over the future direction of Asia’s third largest economy, with one expert saying a hard landing could be on the cards.
On Tuesday, the IMF said it now expects the South Asian economy to grow just 4.9 percent in 2012, compared to a previous estimate of 6.1 percent, citing weak growth in the first-half and a continued slowdown in foreign investment. It added that that the outlook for India is “unusually uncertain.”
“I think we are seeing a hard landing (in India). When you talk about China and ask whether 7.5 percent growth is a hard landing or not, (then) 5 percent growth in India absolutely is,” Steve Brice, chief investment strategist at Standard Chartered Bank, told CNBC.
The last time India’s growth rate fell below 5 percent was during the global financial crisis in 2008. While the economy rebounded in recent years, logging an average growth rate of 8.2 percent in the last three years, it took a turn for the worst this year with a gross domestic product (GDP) growth rate of 5.4 percent in the first half.
The IMF’s downgrade for India was the most aggressive among the major economies, followed by Brazil, which the fund forecasts will grow just 1.5 percent this year, compared to a previous estimate of 2.5 percent.
Vishu Varathan, market economist at Mizuho Corporate Bank, said the IMF’s GDP forecast is a “reality check” for India.
“Sub-5 percent growth is a statement; and a strong one at that, but it’s certainly not outlandish or unimaginable,” he said.
This is a reflection of the government “losing the plot on policies” earlier in the year, he added, and highlights India’s struggle to contain its deficit amid high oil prices and a weak rupee. “A fairly wide fiscal deficit and sticky inflation provide no avenue for monetary or fiscal policy to cushion growth,” he said.
The Indian government begun responding to urgent calls to ramp up investment and improve its fiscal deficit last month, by announcing a string of contentious reforms which included opening up the broadcast, retail and aviation sectors to foreign investment, as well as and cutting fuel subsidies. (Read More: Is India Getting Serious About Opening Its Economy?)
Separately, Finance Minister P. Chidambaram on Monday said the government will unveil a "credible and feasible" fiscal plan for the next five years, after a government panel said the economy was on the edge of a fiscal precipice.
Despite the moves, many India watchers remain wary about whether the new measures are enough to boost growth, and if they will be delivered in a timely manner.
“India has made some progress (on reforms), but they need to do a lot more to get their fiscal accounts back in order,” Standard Chartered Bank’s Brice said.
According to Olivier Blanchard, chief economist at the IMF, “(India) clearly has made policy mistakes; if these are repaired then India can return to fairly decent (growth) rates. However, he added that the country is unlikely to return to stellar 8 to 9 percent growth rates seen last decade.
While the IMF forecasts a pickup in India’s growth momentum to 6 percent in 2013, it maintains that current drags on business sentiment and investment and a weaker external environment will persist into next year.
IMF Overly Bearish?
Robert Prior-Wandesforde, director, Asian economics research at Credit Suisse, said the IMF’s growth forecasts for India this year are too bearish.
Credit Suisse estimates India will manage GDP growth of 5.7 percent in 2012, and 6 percent in 2013. GDP growth bottomed in the March quarter and will continue to pick up gradually over coming quarters, he said.
Wandesforde said the economy will be supported by an improvement in exports, which will continue to get a boost from prolonged weakness in the rupee as well as loosening in monetary policy. He forecasts a further 125 basis points in rate cuts by the end of the current fiscal year. (Read more: Why It's Not All Gloom and Doom for India's Economy.)
“While the full dynamic benefits of the reforms will not be felt for some time, I would be surprised if the announcements didn't lift business sentiment,” he added.
—By CNBC’s Ansuya Harjani