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Economy: It's again a paradox!

Aug 5, 2005

Paradox seems to be order of the day! On one hand, heavy rains ravage lives in India's financial capital and on the other the indices continue to venture into unchartered territories. On one hand, investors are wary of Foreign Institutional Investors (FIIs) money being pulled back into US markets and on the other the Japanese seem to be making India their new investment haven. Also, an evaluation of the economy's performance during 1QFY06 seems to reveal a picture no different!The Reserve Bank of India (RBI)'s report on macroeconomic and monetary developments for 1QFY06, unveiled along with its first quarterly review of monetary policy, puts up certain facts and figures that give a paradoxical view of the economy's future trajectory. Here we enlist some of them.

Domestic economy suggests upside...

  • During the first quarter of FY06, gross borrowings raised by the Centre amounted to 30% of the budget estimates. This is considered to be sufficient to keep the interest rates benign.

  • Till the end of 1QFY06, money supply expansion at 13.9% remained well within the indicative trajectory (14.5% growth) set in the Annual Policy Statement.

  • Foreign direct investment (FDI) flows picked up alongside various types of debt flows. Not to mention the incessant FII inflows that has taken the capital markets to new highs.

  • India's foreign exchange reserves at US$ 138 bn at the end of 1QFY06 are considered sufficient to finance 14 months of imports.

  • Non-oil imports recorded a sharp increase of 40% indicative of rising investment demand in the economy.

  • Industrial production was buoyant in 1QFY06 with growth accelerating in the manufacturing sector. According to the use-based classification, the capital goods sectormaintained high growth, reflecting increase in investment and export demand. The consumer durables sector picked up strongly, driven by demand for white goods and passenger cars and facilitated by the ease in availability of financing. Also, the IIP growth in the 'manufacturing' segment posted a double-digit growth of 10.5% YoY.

... but the global factors suggest otherwise!


  • Inflation remained firm worldwide in 1QFY06, driven up by high and volatile international crude oil prices. This trickling in into the Indian economy is only a matter of time.

  • Producer prices continue to lead consumer prices in most economies, reflective of the supply-side character of inflation.

  • International oil prices reached new highs, crossing US$ 62 per barrel. With this, how long will the Indian government and oil companies be able to carry the subsidy burden is a question un-answered.

  • High and volatile international crude oil prices have translated into a large expansion in the POL (petrol, oil and lubricants) import bill.

So what do we reckon?
Despite the appreciable efforts made by Indian policy makers, India does not stand insulated from the current imbalance in the global economy. Infact, with the opening up of the economy, the effects of global trends is bound to become more and more 'visible'. This may be by way of commodity (including crude oil) prices, inflationary trends or movement of capital goods.

Lead indicators
(% growth, YoY)1QFY051QFY06
Tourist arrivals30.7 19.8
Commercial vehicle production 58.8 5.7
Railway freight revenues 6.2 14.0
Cargo handled at major ports8.0 16.6
Cell phone connections35.8 14.8
Civil aviation28.3 19.7
Upgradation of highways(26.5)25.4
Aggregate deposits3.9 5.3
Non food credit3.8 5.4
Central Govt. expenditure12.6 11.6
While we do not deny the fact that the Indian economy stands on much more comfortable ground than it did a decade ago, constant aberrations tend to derail its growth momentum. Nature's wrath (like the tsunami witnessed in South India and the torrential rains in Mumbai) only makes matters worse. The country's trade deficit almost doubled from US$ 6.0 bn during 1QFY05 to US$ 11.5 bn during 1QFY06. Also, while the lead indicators of the country's progress signal positive for banking and monetary activities, the picture remains grim in terms of commercial vehicle production, civil aviation and tourist arrivals. Not to mention, the correction of commodity prices and passing on of crude price hikes are yet 'swards in the dagger'.

An investor in Indian equities needs to take into account the above aspects to gauge the long-term prospects of his investment portfolio. Besides company and sector analysis, an understanding of the macro economy can help him/her be on a firm footing when it comes to investment decisions. Not to mention, this will help the investor form an independent opinion about the longevity of the so-called 'bull run'.


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