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The Asian Development Bank (ADB) has reduced its 2011 and 2012 fiscal year (FY) growth forecasts for India amid weaker industrial activity and investment, with persistent inflation pressures remaining a thorn in the side for policymakers.

In the Asian Development Outlook 2011 (ADO 2011), ADB forecast growth of 7.9% in the year to March 2012 (FY2011) and 8.3% in FY2012. The figures contrast with ADB’s April projections of 8.2% and 8.8% for the two years. Inflation will also remain elevated in FY2011, amidst still high food and fuel prices, with the forecast for the year raised to 8.5% from 7.8% seen in April.

Strong agricultural output, private consumption and exports helped lift the full year growth rate to 8.5% in FY2010 from 8.0% the year before. But this was tempered by a falloff in industrial activity led by manufacturing and mining, along with tempered services growth and fixed investment spending.

“Pinpointing the cause of this investment weakness is difficult, although structural and policy-related bottlenecks, land acquisition issues and rising interest rates all appear to have played a role,” said Changyong Rhee, ADB’s Chief Economist.

Inflation continued to average near double digit levels during the first four months of FY2011 despite a good monsoon that boosted agricultural output and numerous monetary policy tightening actions taken by the Reserve Bank of India.

High fuel costs, bottlenecks in food supply, a hike in minimum support prices for food production, and signs of a wage-price spiral were the main drivers. For FY2012, softer global commodity prices, and the lagged impact of monetary tightening moves should see the rate decline to 6.0%.

Higher interest rates, slumping investment and escalating input costs will keep industrial output under pressure in the near term, while private and public consumption will be dampened by rising capital costs and the government’s ongoing efforts to reduce its fiscal deficit.

The services sector and exports will remain key drivers of growth, although the outlook for trade remains clouded by the uncertain prospects for the US, Europe and other industrialized economies.

Well-calibrated policy steps should help mitigate some of the current pressures on growth, and the Government of India is moving in the right direction with planned reforms to remove food supply bottlenecks and impediments to foreign direct investment, including land acquisition barriers and the slow pace of economic liberalization.

“Recovery in investment is critical for the economy to return to a high growth path and there are some signs of policy momentum to deal with longstanding issues that have weakened the investment environment,” said Mr. Rhee. “These initiatives will help bolster investment activity and growth, although any lift they provide will be marginal through FY 2012.”

The report also cautions that there are a number of downside risks that could affect its forecasts, including delays in capital formation, a poor monsoon in the current fiscal year, a prolonged hike in domestic interest rates and any further external shocks.

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