Why the Indian economy will weather the crisis - Emirates24|7

Why the Indian economy will weather the crisis

The domino effect of the credit crisis that evolved in US is now evident in almost every nation including those in the Middle East, Asia and Far East. However, few nations have managed to escape the full fallout of the global slowdown and have been able to weather the crisis more strongly due to the very inherent structure of their economy. The Associated Chambers of Commerce and Industry of India (Assocham) believes India along with China and Russia are likely to be few nations, which may emerge stronger out of the current crisis as they enjoy strong economic foundations based on foreign exchange reserves, higher GDP growth rates per capita and sound monetary policy measures.

Prima facie, India is a domestic economy with exports including software contributing to only around 17 per cent and 20 per cent of total GDP. Hence, internal consumption and the domestic service sector along with agriculture could provide the impetus for the economy to proceed ahead in difficult times like this. India's farm sector employs about 60 per cent of India's 1.14 billion people. Strong domestic consumption helps insulate nations from global slowdown. The export sector has certainly seen a massive slide in revenues with media reporting that Indian exporters have already cut about 65,500 jobs to reduce their working capital expenses. The industrial sector has also seen serious downgrades with manufacturing activity contracting for the second consecutive month in December to its lowest in more than four years as the impact of the global slowdown. (Manufacturing makes up about 16 per cent of India's gross domestic product).

Despite this most economists are expecting that India might still manage to show a GDP growth of between 5.5 per cent and 6.8 per cent in 2009 and 2010. In comparison to the expectations of a recession and extended downturn in other key economies like US, UK and EU, such a growth rate is quite remarkable.

In addition to this, India has sufficient room to slash interest rates further down in order to prop up the economy. On January 2, 2009, the Reserve Bank of India cut its key lending rate to an 8-1/2-year low of 5.5 per cent and the government opened the corporate bond market to more foreign investment, eased overseas borrowing rules and promised more capital to state-run banks. RBI also lowered its reverse repo rate, or the rate at which it mops up surplus cash from banks, by 100 basis points to four per cent. Both reductions were effective immediately. It also announced a reduction in the cash reserve ratio, or the proportion of deposits that banks must keep with it, by 50 basis points to five per cent. Many traders and economists believe there is a high likelihood of the RBI cutting rates once again in the next couple of months.

However, policy-makers in India cannot be complacent as the monetary policy systems in India has a lot of strings attached to it. Political framework and election year, partly interferes in the policies. For example, with a high number of government and quasi-government employees benefiting from the Employees' Provident Fund Organisation (EPFO), extensive cut in interest rates mandated for EPFO, can result in political pressure for the government.

With elections due this year, such a process might also make it difficult for the current government to return to power with a high majority. High internal demand also means that there would be sufficient demand for credit, which directly means that loans/credit cannot be priced too cheap.

High availability of credit at low rates during times of lower growth periods might bring inflation back to the economy and also result in higher loan payback defaults.

India's policy-makers are certainly cautious on the possibility of these developments and are thus moving policies smartly. This explains why at a time when the global turmoil has claimed several major US and UK banks – none of India's banks have gone bust.

One soothing positive development amid this is the easing of inflation rates by more than 50 per cent from peaks of 12.91 per cent seen in August 2008. The latest inflation rate is around 5.91 per cent (as of the week ended December 27). The figure was 3.83 per cent during the corresponding week of the previous year. With an additional round of cuts in fuel prices announced during this week, inflation might ease further down in the coming months. As commodity prices, especially oil, stabilise at lower rates, current inflation might come down below the RBI's target rate of five per cent.

On the financial market side, the credit crunch has certainly been mildly positive for India. Excess liquidity that would have otherwise flowed in to complex structured products in key developed economies has flowed in to the Indian markets and large junk of it is waiting at bay to be parked after the market steadies. This has been partly responsible for short rebound in equity markets from the lows of 7,697 (BSE Sensex) to around 9373 currently. As foreign institutional investors flock the markets, the stock indices might prop up, but might be slow, with intermittent corrections on the way.

Indian currency has been vividly reflecting stock market sentiments with the currency weakening to as low as 50.58 to a dollar in early December, 2008. The currency might get marginally stronger in the coming months, but gains might be limited to between 46.50 and 46 as the recovery in stocks might be slow and steady. Nevertheless extended weakness beyond 51 is also not envisaged in the short term; meaning a wide-trading range is most likely in the coming quarters. Only a slide below recent lows of 50.58 would open the gates for l52.40 or even 55.00 levels. Dubai Gold and Commodities Exchange offers Indian rupee futures contracts and it is an excellent tool to hedge currency risk. Smaller size contracts with lower margins and narrower spread turns this contract an ideal one for expatriates, exporters and importers dealing with India.

India thus has enough ammunition to weather the current crisis and could probably escape with only a minor slowdown in growth, but this entirely depends upon how quick the fiscal stimulus manages to support infrastructure development and keep industrial production going. India is distinctly frugal and might not be a dragon like China, but is certainly a slow moving elephant that continues to move despite the path being rugged.


- The writer is a Senior Research Analyst at Richcomm Global Services at DMCC

 

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