The Indian Economy Blog

November 10, 2008

Is India’s Economy About To Turn The Corner?

Filed under: Energy,Growth,Trade — Edward @ 2:15 pm

Indian inflation fell back again in the last week of October, as energy and commodity prices continued to fall, and the impact of the global financial turmoil and credit crunch ricocheted its way across one country after another. The IMF last week forecast annual growth for India of 6.3% in 2008 while India’s manufacturing expansion, which continued to weaken, still held out against the global trend, according to the latest JPMorgan global manufacturing PMI.

So, as we enter November, and a number of Indian indicators start to improve, it is certainly worth asking ourselves, has India turned the corner? Will India lead the emerging markets charge during the next global expansion?

I am not, I am sure, alone in feeling that this is a distinct possibility, and, indeed, a similar view was expressed only last week by Sharmila Whelan, senior economist at CLSA Asia-Pacific Markets.

“We do expect the Indian business cycle to be the first to bottom in Asia. And, it should, in theory, be first to emerge,” Sharmila Whelan, senior economist at CLSA, said “The worst will be over by mid-2009 and by 2010 you should be able to see the next investment-led business cycle taking root.”

To the two reasons Wehlan offers us as an explanation for why we should expect India to do better than most (and, perhaps of particular nore here, better than China) – the fact that Indian trade constitutes only about 32.5% percent of gross domestic product (only about half the China figure – thus India is better protected from fluctuations in global trade) and the fact that India (unlike say Russia or Brazil) will be a large net beneficiary from falling commodity prices – I would add a third, India’s very favourable demographic profile, which will mean that over the next decade India can continue to draw on the benefits of a young and rapidly growing labour force at just the time when 30 years of once child per family policy starts to bite really hard on the new labour market entrant cohorts in China (for example).

Inflation Screeches To A Halt

India’s inflation held near a five- month low at the end of October, seemingly validating the central bank decision to reduce interest rates to bolster economic growth. Wholesale prices were up 10.72 percent in the week to Oct. 25 from a year earlier after gaining 10.68 percent in the previous week, according to the latest data from the commerce ministry.

Of equal importance is the fact that the weekly rate of inflation (week on week) recently turned negative, as energy and commodity prices drop back, and as a result the wholesale price index has now been dropping for eight consecutive weeks after peaking in the August 30 week.

One of the reasons inflation is weakening is of course the fact that Indian GDP growth has been slowing, and the current growth rate is clearly significantly below the 7.9 per cent rate registered in the second quarter (2008 calendar year) a rate which was already notably lower than the 8.8 per cent one reported for the January to March quarter. But with countries from the US to Germany, to Russia and maybe even China (who knows at this point) falling into or near to negative growth, then even a 7% rate looks decidedly healthy to me. What was it they were saying not so long ago about “Hindu growth”? Better a tortoise than a hare in some contexts, but then again, a 7% tortoise is certainly no mean one.

It is interesting to note in passing that the IMF – in revising their forecast down to 6.3% for 2008 – stated that they consider this level to be considerably below India’s potential growth. For the time being, it seems, the old “overheating” debate has become a thing of the past. These days we all love India, now don’t we?

Ironically, the current global situation is also making India’s measured pace of economic reform look wiser than before. At a time when Western countries are frantically nationalising banking assets, the Indian government’s reluctance to sell more than 49% in its state-owned banks—which control some 70% of banking assets—now seems reassuring. In addition, India has not yet introduced full capital-account convertibility, which protects its currency, while its careful control of foreign borrowings by domestic companies limits dependence on the global financial system. Regulators have also periodically introduced curbs to slow the formation of potential asset bubbles, such as higher provisioning and prudential requirements on real-estate lending.
The Economist

“For India we have marked our forecast down to 6.3% of 2009 calendar year. That is considerably below what we consider to be India’s potential growth,” IMF deputy director for Asia Pacific region, Kalpana Kochhar said. “There is a specific meaning to “potential” – it is the rate at which you can grow without causing inflation. And for India we estimate that to be 7.5% to 8%. Our forecast of 6.3% would put it quite a bit below the potential,”.

Obviously there are still varying forecasts, with the RBI and the central government being rather more optimistic than most, although India’s central bank did reduce its growth forecast on October 24 down to 7.5 percent from 8 percent for the year to March 31. This prediction, if fulfilled, would mean the 2008/09 expansion would be the slowest in four years, but then in the midst of the largest global recession since the 1930s that doesn’t sound so bad, now does it?

Interest Rates Coming Down and Monetary System Stabilising

The Reserve Bank of India cut its benchmark rate on Nov. 1 for the second time in two weeks, joining policymakers across Asia in lowering borrowing costs to shield their economies from the global financial crisis. For the first time since 1997, India’s central bank on Nov. 1 deployed all three of its main tools to shore up growth after inter-bank lending rates climbed to as much as 21 percent. The move seems to have substantially improved liquidity in the financial system, and overnight call rates fell sharply.

The Reserve Bank of India lowered its benchmark repurchase rate to 7.5 percent from 8 percent. At the same time the central bank also reduced the cash reserve ratio to 5.5 percent from 6.5 percent, and and cut the amount of money lenders are required to keep in government bonds to 24 percent from 25 percent.

The RBI is also considering giving an additional 100 billion rupees ($2.1 billion) each as lines of credit to National Housing Bank and Small Industries Development Bank of India, according to Finance Minister Palaniappan Chidambaram speaking during last week. The idea here would be to increase cash flows for mortgages and for small companies.

Rupee Rises Slightly

The rupee climbed 3.8 percent last week to close at 47.66 a dollar at the 5 p.m. in Mumbai on Friday. The increase represents the biggest weekly gain since March 1996, making the rupee currently the best performer among Asia’s 10 most-active currencies outside Japan.

In addition on the foreign currency front, the Japanese Yen is also dropping back slowly against USD, which means that yen “carry” may be slowly starting to recover. A surge in USD-Yen (and hence yen carry) would be another clear sign some key emerging markets we about to start moving, in my view. As we can see from the chart – unless we have more “turmoil” to cope with moving forward – October 24 seems like it represents some kind of turning point.

Stocks Start To Tick Up Again

The Bombay Stock Exchange Sensitive Index has also rebounded, and is up 17 percent since the bottom on Oct. 27. The index added 2.4 percent on Friday. The MSCI core index for India is also up 6.74% so far this month. After all that falling over the last twelve months, it is that little upturn since the start of November (see chart below) that we would like to see consolidate and continue. Of course, this may be yet another false start, and there may be another shoe to drop, but perhaps there are reasons for just a little more optimism at this point.

And the general MSCI Emerging Markets Index also looks as if it may well have turned.

Emerging Bonds Start To Rebound Too

Emerging market bonds have also started to recover, if we look at the JPMorgan EMBI+ chart, we can see what appears to be quite a robust “bounce back”. Of course for some countries (Eastern Europe, Argentina etc) the worst is still not over, but India may well be relatively insulated from too much fall-out here.

Not Much Sign Of A Rebound In Commodities Yet

On the other hand, with growth in the OECD countries likely to be bordering on negative in 2009, and Russia and China both likely to have substantial slowdowns, there are not too many signs at this point of any recovery in commodities, if we look at the Reuters-Jefferies chart.

But since India is a large net commodities importer, this is hardly bad news. Oil prices were sedentary Friday following a large scale sell-off during the week, – and this despite a forecast from the International Energy Agency that put the price of crude at $200 per barrel by 2030. Light, sweet crude for December delivery rose 27 cents to settle at $61.04 a barrel on the New York Mercantile Exchange, although the contract had dropped below $60 in earlier overnight electronic trading for the first time 19 months. This is all now a far cry from June, when oil was trading at $147.

India’s Foreign Exchange Reserves Continue to Fall

India’s foreign exchange reserves declined again at the end of October – for the sixth consecutive week – and fell by $5.532 billion to reach $252.883 billion for the week ended October 31. India’s reserves have fallen by more than $31 billion in the past one month alone, and are now well below their $318 billion April peak. But on the other had they are still substantial and not far different from what they were 12 months ago, following a very substantial rise over the previous nine months. So if they do not fall too much further, then it isn’t evident that there is any real problem at this point.

Sustained dollar selling by the Reserve Bank of India in the forex markets, huge amounts of FII outflow from the domestic equity markets, and the revaluation of the reserves have been the main factors pressurising India’s reserves, but all these factors are symptomatic of the general pressure which has come to bear on “higher risk” emerging market economies as a whole as the financial turmoil and associated uncertainty have raged in the United States and Europe, and there is little real evidence of “India specific” factors at work here, indeed Indian exceptionalism would rather be in the fact that – absent commodity export dependence – India’s reserves have not been taking the same sort of pounding Russia and Brazil’s have.

The Reserve Bank of India (RBI) also said on Friday that it will lend foreign exchange – via foreign excahnge swaps – to banks with overseas operations to help them meet their lending requirements, a move that many Indian banks had been asking for, and which should help ensure adequate funding for their foreign subsidiaries. Following the central bank’s announcement, banks will buy dollars from RBI at the reference rate plus three-month forward premium and will return dollars to RBI after three months, in case of three month swaps.

Additionally, the central bank has also extended a lifeline to banks for funding the swaps by allowing them to borrow through its regular liquidity adjustment facility (LAF). The LAF is the window through which it lends to or accepts money from banks, for the corresponding period at the prevailing policy rate.

Banks borrow through the LAF window by pledging government bonds. They are required to invest at least 24% of their lendable funds in government bonds; this portion of their deposits is called the statutory liquidity ratio, or SLR. In view of the tight liquidity conditions, RBI reduced the SLR by 1% to 24% on 1 November. RBI also said on Friday that if a bank did not hold enough government securities to pledge, it would consider relaxing the SLR requirement if the bank approached it.

The use of swaps helps banks obtain cheaper funds for buying dollars because they can now borrow from the central bank repo window at 7.5%. Previously banks needed to convert their rupee deposits – raised at a rather costlier 10.5-11% – into dollars.

India’s Industry Resists The Global Slowdown

Despite the fact that India’s industrial output plummeted to a 1.3% year on year rate in August, there are some signs that the situation may be improving. The first of these are the September performance indicators for the coal and cement sectors, the rise in which pushed up the growth in output in the core infrastructure industries to 5.1% in September. According to government data made public on Friday, coal production was up by 10.7% in September 2008 while cement production rose by 7.9%.

Core sector growth in August was just 2.3% – and the six core industries have a weight of 26.7% in the index of industrial production (IIP). On the other hand growth in electricity generation remained weakish – at 4.4% – in September. If compared with the growth rate in August this year, electricity generation was the worst performer among the six sectors, with an abysmal growth of 0.8% in August 2008. Of the six core industries (crude oil, petroleum refinery products, coal, electricity, cement and finished carbon steel), only coal and cement really registered strong growth rates in September 2008. So I guess we have to wait till mid-week now to see the complete September figures.

However, despite what may well turn out to be an improvement in September IP over the August number, it does looks very much as if activity at Indian factories fell to its lowest level in three and a half years in October as the global financial crisis and slowing export demand hit the country’s manufacturing sector. The ABN AMRO Bank purchasing managers’ index (PMI), based on a survey of 500 companies, slumped to a seasonally adjusted 52.2 in October, its lowest since the survey began in April 2005 and sharply below September’s 57.3. A reading above 50 signals expansion while a figure below 50 suggests contraction, and the manufacturing PMIs are interesting, since they do offer us a sort of “real time” snapshot of what is actually happening.

“The outlook for the manufacturing sector appears to be bleaker in the backdrop of tough local and global economic conditions,” said ABN AMRO Bank N.V. senior economist Gaurav Kapur.

So the point here would not be that Indian industry is in absolutely perfect condition (it is obvious that it isn’t), but rather that, at a time when global manufacturing generally is taking a huge beating, Indian industry is hanging on in, by its fingernails, but it is hanging on in.

In comparison, the JPMorgan Global Manufacturing PMI posted 41.0, its lowest reading since data were first compiled in January 1998 and a level below the no-change mark of 50.0 for the fifth month in a row.

Output, total new orders and new export orders all contracted at the fastest rates in the survey history in October. With the exception of India, which again bucked the global trend, all of the national manufacturing surveys posted declines in output and new orders. The impact of the downshift in global market conditions also had a far-reaching effect on international trade volumes. Although new export orders fell at a slower rate than total new business, all of the national manufacturing sectors covered by the survey (including India) saw a reduction in new export orders.

“October manufacturing PMI data reinforce the stark retrenchment that the sector is currently facing, with production, total new business and new export orders all falling at record rates. The latest Output Index reading is consistent with a fall in global IP of almost 8%. The only positive from the surveys was a decline in input prices for the first time since August 2003.”
David Hensley, Director of Global Economics Coordination at JPMorgan

Returning finally to India, perhaps somewhat significantly the export order index in the PMI survey contracted for the first time in the survey’s history, coming in at 49.7 in October, compared with 53 in September. Manufacturers blamed poor global financial and economic conditions for the result. But this should not surprise us too much either, since India’s exports grew at their slowest pace in 18 months in September. Overseas shipments, which constitute about 15 percent of the Indian economy, were up 10.4 percent (to $13.7 billion) from a year earlier, following a 27 percent gain in August. Imports also increased – by 43.3 percent to $24.4 billion, with the result that the trade deficit widened to $10.6 billion.

“The global financial and economic headwinds adversely affected foreign demand for Indian manufactured goods,” said Gaurav Kapur, an economist at ABN Amro Bank in Mumbai. “The growth of total incoming new work to the Indian manufacturing economy lost considerable momentum.”

So, in conclusion, I am not saying that everything in the Indian garden is simply perfect, rather I am simply pointing out that during times which are hard for everyone, India has some advantages to lean back on, and looks set to have a lot less serious downturn than many other emerging economies may experience. So to end, almost where I started, with CLSA’a Sharmla Whelan, I do expect the Indian business cycle to be the first to bottom in Asia, and I would most certainly agree that “it should, in theory, be first to emerge”.

14 Comments »

  1. I can’t believe you wrote such a long essay on the Indian economy without even once mentioning the elephant in the room, and soon to be the albatross around the Indian economy’s neck – real estate!

    The Indian real-estate bubble is just starting to deflate, and many (including most recently the chairman of SBI) feel that prices will be down 50% from their peak.

    Also, debt defaults (a.k.a. “Non-Performing Assets”) are now ballooning and we have a long way before we hit bottom there as well.

    The RBI clearly sees something you don’t – hence the unprecedented “liquidity” measures. They have seen something that has put the fear of God in them.

    Your optimistic attitude reminds me of the cheerleaders in the US who claimed in 2006 that the problem was “contained” to just the subprime market. Hmm I wonder how that turned out.

    Comment by snoopy — November 10, 2008 @ 10:45 pm

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  3. @Snoopy, You’re spot on the mark!
    Nobody seems to be analyzing why real estate went up so quickly ( 300% in 2 years) when GDP growth was in double digits. Now we will see the unwinding of this asset bubble and one does not know how many thousands of crores of bank money will be locked in these NPAs, how many real estate companies will go down under. The bursting of the financial and RE bubble in USA is sure to affect the BPOs here. Remember that this was the crowd that was the “India Growth Story” who bought items at malls, spent money like it was going out of fashion and coolly took loans of 50 lakhs for 20 years.
    As they say, the jury is still out on this one. I think we have to yet reach the bottom and then we can talk of rebound.

    Comment by Cool Head — November 14, 2008 @ 8:54 pm

  4. Disinflation has provided teh RBI room for manoeuvre with cutting interest rates. Inflation is still well above the RBI comfort rate of 5%, but should fall to that level, if not lower, very soon given the sharp reduction in oil prices.

    I’d be interested to hear your thoughts on the effect on teh price level. Since inflation has been high for a year, the associated menu costs and mental impact on consumers may be important. Is it necessary to have a period of low inflation to control price level effects? This is the old inflation targeting versus price level targeting arguemnt, in which most modern central banks tend towards the former. But under such exceptional circumstances (i.e. a significant increase in inflation around the world), does there need to be a consideration of what the last year’s circumstances have done to the perception of expensive-ness for the ‘am aadmi’ at the grocery store?

    Comment by pratik — November 16, 2008 @ 2:55 pm

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  6. Agree with Snoopy about the Real Estate part. To sound very cliched, that bubble is just waiting to burst.

    Comment by Dhimant — November 20, 2008 @ 9:43 pm

  7. The conclusions are hasty and already within a fortnight, some of them are not holding up.
    India rode on the excessive liquidity and did not reform. Now, with drying liquidity, the lack of action may catch up pretty fast.
    Also India’s capacity to absorb large scale job losses is probably among the lowest in the world.

    Comment by Amit Sinha — November 24, 2008 @ 11:49 am

  8. The comments might be hasty, but not completely ruled out.
    The corrective measure by Indian government has definitely helped ease out the impact of US recession.
    The choice was not good or bad…..the choice was bad or worse.
    The job market is largely taking backstep with domination of sentiments rather than any solid downfall data, which have affected the whole market. It impacted few crucial sectors like infrastructure, but then there is no solid reason to impact the domestic market. The reactions are implications are largely sentiment driven.

    Truly speaking, this could be a dawn of new economy….who knows….

    Comment by Ameya Nisal — November 25, 2008 @ 1:19 pm

  9. Although I hate to be a Devil’s Advocate over here,

    But is the crux of Snoopy’s whole opinion is on this fact, that RBI knows ‘something’ which the intelligentsia doesnt know? And from which the logical next step is : “So they must be right”!

    You will be surprised to know how rare is this case. Take the example of the recent inflation containing, USD-INR pegging, cross currency ‘carry’ trade etc.

    The perspective which is worth mentioning is the toxic assets in Indian real estate industry. Do you really think, its true, especially when RBI holds such a tight leash on monetary policy and banking innovation. The borrowers might be leveraged due to the assurance of easy money from FIIs during the bubble, but banks will get back their moolah and some more, once the market turns.

    Liquidity:
    Liquidity is a must in this scenario, because of a host of other sham monetary fiscal policy .

    Soham

    Comment by Soham Das — December 4, 2008 @ 9:08 am

  10. No, I guess the geopolitics is not working in India’s favor. Besides, an export-oriented economy like India would be hard hit by the current global financial slump and orders for OEM or ODM from the U.S. and Europe would shirnk tremendously.

    Comment by globalshooter — December 11, 2008 @ 7:38 am

  11. I think the nature of this recession is unclear. So it will take some time to make a clear diagnosis.

    Comment by Agi Makil — December 11, 2008 @ 6:58 pm

  12. India will still be growing. Some people inside and outside India have money to spend, which was and will be helping India to grow. India’s banks are very conservative. Exposure to risky borrowers are minimal. And people don’t borrow to buy everything in India (like US where swiping card is the norm). And not only knowledge economy, old economy and industrial expansion putting lot of inputs.

    I am from a small town of West Bengal, now working and living in US. I have seen 3 major factories (PepsiCo, Senbo, ACC) and numerous small scale industry come up after 1999 in that small town and still running. Local jobs grew. Shops, transportation, telecom grew. Lot of people take taxis to Kolkata rather than over crowded train. Except the road condition didn’t change much. Here I will say two things before I finish.

    1) On my last visit, I have seen so many newspaper vendors. Lot of people reading.
    2) The taxi driver who always give me a ride when I visit my home is very optimistic. Optimistic about new roads being built, and more new customers he is getting. Last time he told me “HOBE DADA SOB HOBE DIRE DIRE”.

    Comment by Saraswat Basu — December 12, 2008 @ 7:57 am

  13. Nice article!

    At times, the blessing in disguise is good but not preferable. True that in India ‘hobe dada sob hobe dire dire’ has been a mental mould but to bring millions out of where they are living, it was necessary for India to be on the fast trek.

    Let’s hope that the Mumbai fiasco doesn’t hit India too hard.

    Comment by Dr. Sanjay Sharma — December 16, 2008 @ 9:59 am

  14. yes i do agree bthat indian economy will bounce back faster than other countries who have suffered because of recession. due to our yopung labour force & a decent growth rate.

    Comment by pratibha — December 20, 2008 @ 10:22 am

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