Is India staring at low growth plus high inflation?

Aug 3, 2010

In this issue:
» Rising wheat prices - India partly to blame
» China could crash, says Marc Faber
» Global factory output is witnessing a slowdown
» SEBI wants to check price rigging
» ...and more!!

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India's central bank, the RBI, has received a lot of praise in the past. After all, its policies and independent thinking ensured that Indian banks did not suffer the same fate as their Western counterparts.

India, infact, recovered strongly and since then its GDP has been growing nicely. And the government is aiming for growth in double-digits. But the scenario may not be as hunky dory as it seems. This is because India has a much bigger problem to deal with i.e. inflation. Food prices in the past one year have stubbornly refused to cool down. Non food prices are also now seeing a rise in prices.

So, how has the RBI been dealing with this issue?

It raised the repo and reverse repo rates in its recent monetary policy. The CRR, however, was left unchanged. And more hardening of interest rates would ensue. But is this enough?

After all, the two most relevant rates, the repo and cash reserve ratio, are still considerably below where they were before the central bank started slashing interest rates in late 2008. Further, the government has raised the tolerable wholesale price inflation rate to 6%. This limit was 5.5% in April and around 4% a couple of years ago. Thus, rather than bring inflation down, the government is finding it easier to conveniently readjust its 'comfort' level. This hardly expresses efficiency on its part.

At the height of the crisis, the central bank relaxed rates and pumped in stimulus measures to fuel growth. But the problem is that when it came to withdrawing these measures, it has not been nimble and aggressive enough. Unless the RBI really goes on the frontfoot, India will have to deal with what is known as stagflation - low GDP growth coupled with double-digit inflation. Not a promising prospect indeed!

 Chart of the day
India's exports faced heavy weather in 2008 and the first half of 2009. That was when the financial crisis was at its peak. And so, dampened demand in the rich world meant that India's exports were hit hard. But come November 2009, and things started taking a turn for the better. As today's chart of the day shows, India's export growth has witnessed a robust recovery although the pace of this growth has slowed down in recent months. Imports, meanwhile, have also increased and because of this the trade deficit has not really reduced.

Data Source: CMIE


Image Source: Wall Street Journal
Food crisis was the buzzword in 2008. Led by rising prices of food grains, there were riots across countries. The US President even blamed people in China and India to have caused the crisis, given the rising consumption levels in these countries! Then came 2009 when, led by a global economic recovery (sort of), noises against rising food prices went silent. Now in 2010, fear mongers have raised their heads again. And the matter really seems serious.

Take the case of wheat, whose prices are expected to surge led by a global shortage of the commodity. The Wall Street Journal reports that global wheat prices have staged the most drastic rise in more than 50 years. This is on the back of a drought in Russia that has fueled worries that it could lead to a global shortage of the grain.

India, world's second-largest wheat grower, can be part of the blame for rising wheat prices as well. And the blame lies on the poor storage facilities that have led to tonnes of wheat rotting under open skies. The rotting grains have contributed to India's rising food prices. Wheat prices in the country have risen by around 12% per 100 kilogram in the past three months alone!

Stock prices are something that we tend to take for granted. Indeed, they serve as our reference points. They help us determine whether a stock is going too out of line or falling too much from a given price. It will not be an understatement to say that stock prices are certainly our guiding lights. Thus, imagine what would happen if there are no stock prices that we can relate too. Imagine a priceless stock that is likely to get listed on the bourses and whose price is likely to get determined by the investors only at the end of the day. This would indeed be a stock manipulators dream come true. In the absence of any historical pricing data, they could send the prices soaring and then bring them down with equal alacrity.

There have already been a few instances in the Indian stock markets in the recent past. And this certainly has our market watchdog SEBI worried. The SEBI wants to bring in a mechanism that could check price rigging in cases where the stock is being listed after a long layoff.

As mentioned earlier, such stocks are fertile grounds for manipulation on account of absence of recent price history. And this could thus end up hurting the retail investor. Fixing price bands before hand was considered as an option. But it was being felt that this was coming too much in the way of honest price discovery mechanism. However recently, a call auction was proposed. Here, price gets discovered in the first few minutes of trade after matching all the buy and sell orders. Hmm, yet another retail investor friendly step by the SEBI we should say.

The crash is imminent. And once it is here, it could impact global growth. No we are not repeating the forecast about the double dip recession in the US, or even its repercussion on the US stock markets. Instead these are the views of eminent investor Marc Faber on the Chinese economy.

Faber believes that the Chinese markets are discounting the slowdown in economic growth too soon. Also that the Chinese property markets could lead the bubble to burst. "China could crash" is Mark Faber's latest predicament in an interview to Bloomberg. A crash in Chinese stock markets could send investors to other emerging markets like India in search of better returns. Having said that, a crash in commodity prices could bode very well for the future profitability of Indian manufacturers.

The US is often said to be in a 'recovery'. But according to its Federal Reserve chairman Ben Bernanke, a full recovery is anything but close by. In a recent speech he is known to have said that the US still has a considerable way to go to achieve a full recovery. More so considering that many Americans are still grappling with unemployment, foreclosures and lost savings. The pace of the US economy's growth slowed from a rate of 3.7% in the March 2010 quarter to 2.4% in the June quarter. Not a very encouraging sign. Many US state and local governments in different parts of the country remain in a dire fiscal condition. The US stockmarkets have seen a swift recovery from the crisis. Seems like the real economy is not about to follow anytime soon.

If the West was holding on to any hopes of an economic recovery, it now seems more distant than ever before. As reported by the Financial Times, a survey of purchase managers indicates a slowdown in global factory output. Even if one were to concede that the global recovery showed promise earlier this year, it was lopsided. The pattern of industrial output was similar to imbalanced economic growth of the decade before the global financial crisis. Europe remains largely dependent on German manufacturing. As far as Asia is concerned, a economic growth is likely to slacken as governments cut back on fiscal spending. However, it is likely that they would continue to outperform because they generally did not have debt problems and their banking system remained healthy.

The Indian stock market had a volatile trading session today led by alternate bouts of buying and selling across index heavyweights. At the time of writing, the BSE Sensex was trading higher by around 21 points (up 0.1%). Gains were largely seen in oil & gas and banking stocks, while IT and FMCG stocks were at the receiving end.

 Today's investing mantra
"Individuals who cannot master their emotions are ill-suited to profit from the investment process." - Benjamin Graham

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