Are we headed for another Slowdown? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 17 December 2011
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Are we headed for another Slowdown? A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
The latest spate of economic data is worrying. GDP growth is now at its lowest level since mid-2009, at 6.9% per year. Industrial production has fallen for the first time since 2009, one of the main contributors to the falling GDP growth rate. Inflation has seen a small fall, but still remains above 9%. Finally, the rupee has suffered a fall of over 20% against the dollar since April of this year.

The poor economic performance is not limited to India; it is occurring around the world. For example, in China, GDP growth has also at its lowest level sine 2009. The Eurozone countries are likely to enter recession next year due to the ongoing negative effects of the debt crisis. Financial markets around the world are suffering from high volatility and large falls due to the ongoing crisis.

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Given that growth in India is falling, and growth around the world is falling, is there anything that we can do to reverse the trend? It will help to look at what has caused the slowdown in India's growth. Mostly we are interested in knowing if it is due to internal factors that we can change, or external factors that we have little control over.

One of the negative drags on GDP growth has been the worsening current account deficit. First, exports have been falling. This should not be a huge surprise, given that the countries we export to are experiencing economic problems. Second, imports are rising. This is due to a weaker rupee and higher commodity prices. In both instances, external factors are the primary culprit, and from a domestic policy perspective, there is little we can do.

The other negative drag on GDP growth has been falling industrial production. In the previous month, industrial production suffered a 5% annual fall. Industrial production accounts for around one-quarter of the economy's total production, so this figure is obviously very important. Industrial production has not seen a fall of this magnitude for a very long time.

If we look deeper into the falling industrial production figure, the main standout is capital goods production. Capital goods production was down 25%, and this is extremely worrying. Capital goods are investment goods, so any fall in this will directly lead to a future fall in production.

This leads to the question of what can be done to help the situation. When it comes to industrial production, this is primarily a domestic issue, so the correct policy should help the situation. First, we should probably assume that the current government can do nothing, given their weakness and recent history. This leaves policy in the hands of the RBI.

As we know, the RBI has been relentlessly raising interest rates over nearly the last two years. This has been done to combat higher inflation. This policy had some success early on, but recently has faltered. Over the last 1 year, inflation has remained steady at around 9%. At the same time, the GDP growth rate has been consistently falling.

Thus, the RBI's policy of raising interest rates has done little to help the inflation probably, and has likely contributed to falling growth. Industrial production is heavily impacted by interest rates, because large investment projects require considerable borrowing to fund them. Thus, higher interest rates have reduced investment.

The best policy for the RBI going forward would be to ease monetary policy and lower interest rates. A policy of raising interest rates over the last year has worked poorly, and now we are seeing the consequences of this. At a time when the global economy is slowing down, the RBI should do what it can to keep growth in India at high levels. Lowering rates would be a good start, as it should improve borrowing and investment.

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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