India's economy grew at its slowest annual pace in five quarters in January to March, as rising interest rates crimped consumption and investment, which some analysts say could temper the pace of central bank tightening to tackle inflation.
Gross domestic product rose 7.8 percent from a year earlier, lower than 8.3 percent in the previous quarter and below the median forecast of 8.2 percent in a Reuters poll.
For the full fiscal year, Asia's third-largest economy grew 8.5 percent compared with the government's 8.6 percent forecast.
Growth is slowing down as was anticipated so the Reserve Bank of India is unlikely to resort to any more single-stage 50 basis point rate hikes, said Jay Shankar, chief economist and director at Religare Capital Markets in Mumbai.
Shankar said he expects India's main policy rate of 7.25 percent to rise by 25 basis points (bps) in June and then another 50 bps by the end of the fiscal year in March 2012.
Investment growth slowed down to just 0.37 percent in January to March from 7.8 percent in the previous quarter as higher interest rates, numerous project delays as environmental clearances took longer than expected and government paralysis as it fought a series of corruption scandals took a toll.
Now that elections in five states have ended, the pace of project implementations is expected to pick up.
India's 10-year benchmark bond yield fell 2 basis points to 8.37 percent immediately after the data, which was seen to ease pressure on the central bank to tighten rates aggressively.
The benchmark 5-year swap rate dropped as much as 3 bps and the 1-year swap rate edged down 2 bps. The 30-share BSE index <.BSESN> briefly pared gains before climbing to be up 1.19 percent on the day.
Most economists expect the Reserve Bank of India to increase its main policy interest rate by 25 basis points at its next review on June 16, after it raised rates by a bigger-than-expected 50 basis points early this month.
Before Tuesday, analysts had expected a further 75 basis points of increases by the end of December.
The market had been expecting another 50-75 basis points increase in key rates but with today's GDP print the market seems to be assigning a higher probability for just another 50 bps in the rest of the year, said Sandeep Bagla, senior vice president with ICICI Securities Primary Dealership.
India's farm sector expanded at 7.5 percent during the quarter from the previous year, while manufacturing grew 5.5 percent, lower than 6.0 percent annual growth a quarter ago.
Agriculture is expected to perform well for the second straight year after the government forecast a normal monsoon.
Annual consumer spending growth in the quarter slowed to 8 percent from 8.6 percent in the previous quarter as interest rates reined in demand.
Car sales in April rose at their slowest pace in nearly two years with buyers also put off by the rising cost of fuel and vehicles.
New Delhi is likely to revise down its economic growth forecast for the current fiscal year from around 9 percent, a senior government adviser said last week.
The outlook certainly is for a growth slowdown, said Ramya Suryanarayanan, an economist at DBS Bank in Singapore.
It's not really a function of GDP as much as it's related to the worrying rise in inflation including revisions. That rise in inflation and failure of food prices to moderate suggests it will be tough ahead in terms of interest rate trajectory, she said.
The HSBC Markit Purchasing Managers' Index for April showed soaring fuel and raw material prices were driving up costs and feeding into output prices, an indication that high inflation would persist.
India's overnight indexed swap curve stayed inverted on Tuesday, reflecting expectations for tighter liquidity and more policy tightening, along with doubts over the pace of long-term economic growth.
The spread between the five-year and one-year OIS has turned negative for the first time since October 10, 2008, according to Thomson Reuters Data.
We expect this inversion to remain at least till July due to tight liquidity concerns and beyond that it will depend on how much liquidity tightness eases, said a dealer at a foreign bank.
If we use the narrowing spread as a leading indicator of GDP growth, this suggests that GDP growth is likely to slow going forward, Standard Chartered said in a note on Tuesday.
(Additional reporting by Suvashree Dey Choudhury, Swati Bhat and Neha D'Silva; Reporting by Rajesh Kumar Singh; Editing by Tony Munroe)