Double Digit Growth is looking even more Distant - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 27 August 2011
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Double Digit Growth is looking even more Distant A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
Not long ago, maybe a year back, commentators, analysts, and politicians were talking about double-digit growth. In early 2010, India's growth rate crossed 9% for the first time since 2008. All hopes were that this growth momentum would propel itself forward, and GDP growth could hit the magic double-digit figure of 10%, perhaps even greater.

Unfortunately, it has not turned out this way. In the last 5 quarters, GDP growth has fallen every single quarter, and the most recent figure is 7.8% growth for the first quarter of 2011. The analyst expectation is for this figure to fall even further in the second quarter of 2011.

So what went wrong? Why has there been a steady decline in the GDP growth rate? There are numerous reasons for the decline in the growth rate, and many of the problems have not gone away. The near to medium outlook for the growth rate is not fantastic, meaning that double-digit growth is still some time away.

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One of the biggest problems facing the economy is inflation. Inflation currently stands at 8.6% as of June 2011, which is much too high. The good news is that inflation has been falling over the last year and a half. In early 2010, inflation went above 16%, and now it has nearly halved. In the last six months, inflation has remained steady between 8% and 10%.

The inflation concerns have led to the RBI raising interest rates regularly in the past year and a half. Interest rates have been increased 11 times since March 2010. The current expectation is that the rate hikes will continue, until inflation is brought down. The interest rate hikes are one of the reasons economic growth has slowed. Higher interest rates translate into higher borrowing costs, hence less investment and growth.

Recently, there have been reports that bad loans are on the rise. Banks are starting to put aside greater provisions to cover losses from bad loans, a result of higher interest rates and the slowdown in growth. Many companies have been forced to restructure or default on their debt amidst the slowdown, the main contributing factor worsening asset quality. So there is the potential for a credit crunch, and this is made worse due to rising interest rates.

Another factor affecting economic growth has been the lack of a positive contribution from the government. Many economic reforms that were due to take place have stalled, and the persistent corruption scandals do not help. The political debate in India has recently been solely focused on corruption, and as a consequence, many essential economic reforms have been put on hold.

Of course, tackling corruption is an extremely important issue for India's long-term economic prosperity. It is difficult to put a number of the impact of corruption (i.e. by how much has growth been reduced due to corruption), but most agree that it is significant, and that without corruption growth would be higher. Tackling corruption is probably one of the biggest challenges facing the economy, and it is essential in order to keep growth rates high and living standards rising.

In addition to domestic issues like inflation, rising interest rates, and corruption, a number of external factors have also led to the slowdown in growth. The economic slowdown in America and Europe, combined with the debt crises in these countries, has put a lid on demand for Indian exports. A slowdown in the West thus has a negative affect on India's economic growth.

External factors have also created an environment of volatile financial markets. In particular, we have seen volatile and falling stock markets that are denting investor confidence. If the slowdown and debt problems in the West continue, global and Indian stock markets will keep falling. And this too reduces growth. Falling stock markets reduce wealth, reduce investment, and reduce investor confidence.

One financial market particularly relevant for economic growth is the market for gold. As we have seen, gold prices have skyrocket recently, as investor demand increases in the face of adverse economic conditions. Demand for gold from Indian investors has been particularly strong. But how does this actually affect economic growth?

When investors put money into gold, it is a sign that confidence is low. It is a sign that the appetite for investment into productive resources is low. When investors prefer to put their money into gold, it means less money is invested in businesses (i.e. stocks) that are responsible for generating economic growth, employment, goods, services, etc. Of course, investors are perfectly entitled to invest in gold; it has after all proven to be an effective store of value. But from a macroeconomic perspective, it is an indication that economic growth is likely to slowdown.

Given the factors we have discussed, we can conclude that double-digit growth is currently a distant possibility for India. Of course, our outlook and discussion has primarily focused on short and medium term factors. So double-digit growth may not occur anytime soon, but it could certainly occur sometime in the future. In fact, the long-term outlook is considerably better than the short-term and medium-term outlook. From an investor's perspective, markets will recover eventually, but we could be in for a rollercoaster ride in the meantime.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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2 Responses to "Double Digit Growth is looking even more Distant"

Gaurav Gupta

Aug 30, 2011

Please do not put Assad Dossani's comments in the Daily reckoning by Bill Bonner, as it causes unnecessary confusion, it should be in a separate heading, since both the posts are about very different things (India v/s US economy for starters),
regards
Dr Gupta

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Rahul

Aug 28, 2011

Sir, Who really decides that the inflation will come down?

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