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Economy: Some killjoys - Views on News from Equitymaster
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  • Apr 10, 2007

    Economy: Some killjoys

    The economy seemed to be doing just fine until a couple of quarters back. Then inflation–fever gripped the RBI, making it to open a Pandora's box from where long-forgotten acronyms like the CRR, MSS, and Repo emerged.

    This was followed in February by a tuneless union budget. Global news in the form of a slowing US economy (we just woke up the fact) and Iran flexing its muscles were bad tidings in an already weak-kneed market. Within two quarters, there seems to be volte-face, where is the Incredible India? The India Shining? Back then India growing at 9% was de jure, now even 8.5% seems unattainable.

    So when did we just digress from the track? Difficult to pin point, but there were some indicators, that in hindsight, do seem important in explaining the current scenario.

    Pre-emptive moves to reduce growth

    The Reserve Bank of India (RBI) about a year ago justified its repo rate hike in June 2006, saying it was a pre-emptive measure to rein in inflationary pressures in the wake of higher fuel prices. Since October, however the pace of these rate hikes has increased. But now the reasons shifted to controlling money supply on the back of 30% plus growth in non-food credit (mostly to real estate) along with continued concerns on the inflation front.

    With the latest hike in CRR requirements, as well as the Repo rate, RBI has now raised short-term rates six times since January 2006, and hiked the CRR three times since December. There is no doubt that the credit off take will slow down as increasing amounts of money are mopped out of the economy, while this slowing down may take a few more months to come through, there are some issues that India has to face immediately.

    Though the target has been the unproductive real estate sector lending, it will invariably cause an increase in PLR across the board for all loan portfolios. Though this may not affect the larger corporate houses with recourse to ADRs GDRs and ECBs funds, it will certainly stymie the enterprising spirit of the small and midcap sectors, forced as they will be to borrow higher now.

    This will increase the costs of future production or delay it till costs come down to make such production viable. Even current margins will be threatened, reducing the depth of own pockets, translating into lower industrial production. This will cool off the industrial growth rate. Which is what the RBI means when it wants to reduce over-heating.

    Skeletons in the closet

    The Indian economy has been a real surprise for many westerners. A nation that had for long been growing at an average GDP rate of 4% has in the past two decade grown at an average GDP of 6% and has managed to attain 9% plus growth over the past two years. While this growth has been stupendous it requires to be supplemented by adequate capital formation in building up the superstructures of the economy. Efforts in that direction have been woebegone to say the least.

    There is a huge demand-supply mismatch in power. Roads that act as the nerves of the economy connecting various cities are in a dire state. Agricultural productivity seems to be settling in at the lowest end of the scale, while skilled labour for the fastest-engine of India's growth story - the service sector, is in short supply.

    These crises have been on the fringes of Indian ethos all this while, but now they loom to strangle the nascent growth story if not tackled decisively and immediately. The near 10% GDP growth that India enjoyed over the past couple of years, made us ignore their nuisance value. These are fundamental issues that we need to address if we are to ever have 8% plus sustainable GDP growth. And mind well this is well within our realms, however what we lack are policy initiatives, a strong government ethic and discipline.

    Pains of globalisation

    The hot money that globe trots, thanks to the yield spreads between the US and Japanese economy, has of late been causing increasing amounts of pain as it flutters from market to market. This has caused market cycles to be not just shorter but also more volatile causing much pain to the investing community – yes, it hurts most when you have put your hard earned money only to see it vanish on account of a your stock market's prospects falling short of expectations harboured by someone sitting in NY or Singapore.

    Feared US recession

    There is an ongoing pressures on the US Dollar owing to yawning US trade deficit. Add to this its current problems with sub prime mortgages that leaves US banks exposed to high default risks. A drop in employment and therefore consumption and there you have it! A good recipe for recession. In fact the GDP growth expected for America has been revised downwards in the latest poll conducted by 'The Economist'.

    To put together all these factors and juxtapose them with our economy one could see that in the wake of growing unemployment in the US, depreciating dollar and a plausible slowdown the first to be affected would be the Indian exporters to the US, the BPOs and the software sector (as US companies will hive of spending on new software development and instead go in for maintenance of the existing systems) an adverse impact on the Indian economy is inevitable.

    Escalating Iran tensions

    The ongoing tension between America and Iran are out in the open and things had soured to such an extent that Uncle Sam and his sidekick in Europe were all ready to go full blast and teach Iran a lesson. While there may not be an immediate war (but then who knows) one thing is for certain the ongoing tension is here to stay. The impact of such geopolitical tensions on global oil prices most analysts concur, will attach a abiding premium to them. (Oops more bad news on the inflation front!)

    Is it just us?

    Are we really digressing from our cherished 9% plus growth or is it just us over-reacting.

    They say 'fortune favours the brave' and the current level of indices may seem like a good time to enter the good company stocks, as the longer-term outlook on the Indian economy remains positive. May be we shall overcome the problems proving fears about dark and dreary future wrong (we really hope to be wrong).

    We sincerely do hope that we finally do redress the important issues and not sweep away our trash under the carpet of some positive global cue coming by and rallying the markets once again.

    For who knows how your wealth grows,
    Like your heart chose,
    Only time!



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