Economy: Will it be a smooth landing?

After the blazing FY07, the economic slowdown in FY08 has been a view occasionally echoed by the CMIE, the central bank, corporates, bankers and economists alike. After sustaining strong growth for about nine quarters, there are clear signs that the growth trend is moderating. Higher inflation and interest rates, coupled with the rupee appreciation have only accelerated the meltdown. Infact, the key cyclical growth indicators have started reflecting the slowdown in 1QFY08 itself.

Automobile sales: The earliest indicator to reflect the slowdown has been automobile sales growth. Growth in all three segments - passenger, two-wheeler and commercial vehicles has decelerated significantly in the first quarter of FY08. Infact, the two-wheeler sales growth has been declining on a year-on-year basis for the past two months now, while passenger car and commercial vehicle sales growth have dipped to single-digit levels. This reflects the impact of higher interest rates on automobile loans as well.

Bank credit: Bank credit growth moderated to 25.6% YoY at the end of June 2007, with the deposit growth rates catching up with the same for the first time in the last 3 years. The key drivers of the slowdown have been mortgage and high-risk sensitive loans that attract high provisioning. Banks expect the loan moderation to continue in FY08 even in the absence of further spurt in the interest rates.

Goods exports: The 8.5% appreciation in the rupee against the US dollar since March 2007 (well ahead of other regional currencies) has had a telling impact on the country's exports. Sectors like textile and software, which have a huge exposure to the US currency, have largely borne the brunt of the same. The dip in India's export value, primarily on account of the appreciating rupee, has translated into a 10% to 15% dip in the realisation for most textile exporters. India's exports of textile and apparel products to the US declined 0.4% in value terms even as export volumes surged 7.5% YoY in the first half of 2007. China, on the other hand, has registered increases in both volume and value terms by 25% and 47% respectively. Other key exporting nations such as Pakistan, Sri Lanka and Indonesia, where local currencies have depreciated against the US dollar, have seen higher growth in value terms, even though export volume growth has not been significant. It is also understood that the real impact of the rupee is yet to be reflected in exports growth due to the time lag between the export orders' receipt and execution.

The landing though certain...

In addition to monetary tightening through the repo and CRR hikes, since early March, the RBI has shifted its exchange rate management approach, allowing faster appreciation of the currency. Appreciation in the exchange rate has, to an extent, been helping to reduce the overheating pressures. First, it resulted in a rapid reduction in global commodity-linked product prices (that have a 37% weightage in the WPI) in rupee terms. Second, it reduced pressure on domestic capacity utilisation, as the exports growth decelerated. Although one can argue that controlling overheating through currency appreciation will not be sustainable and the ideal outcome, considering the given mandate of achieving rapid control on inflation, the RBI has fewer options left. Having said that, the RBI policy has ensured that the real GDP growth rate is tempered in this fiscal.

...will be smooth due to the liquidity flush

The accretions to the RBI's forex assets are currently at 125% of the reserve money. With the global capital market environment remaining supportive, there is a possibility that capital inflows increase way above the average amount received over the past 12 months. Indian companies are planning fresh equity issuances worth around US$ 15 bn (excluding the recent DLF and ICICI Bank equity issuances) in the next six months. If all these equity issuances do come through and if the ECB/FCCB issuances spike up further, this would only increase domestic liquidity, challenging the RBI's efforts to slow domestic demand.

While we believe that, under such a scenario, the RBI may demonstrate its commitment to maintaining control over inflation via further tightening, the economic slowdown will not be very sudden and abrasive, due to the availability of sufficient liquidity in the medium term.