Many market observers are expecting markets to do much better in calendar year 2012. The argument is primarily based on interest rates peaking, with the Reserve Bank of India (RBI) moving to reverse the monetary cycle in the first half of 2012. Combine this with hopes of some impending reforms being passed, an easing of commodity prices, valuations near their long-term mean, an acceleration in corporate earnings and the picture is complete. The bulls also hope that foreign institutional investor flows into India will accelerate in 2012, as global fund managers search for domestic-driven growth stories, decoupled from the West. At some stage, domestic investors will also return to equity markets, and a reversal of the interest rate cycle will hopefully aid this asset allocation shift among the locals.
I have much sympathy for this view and believe that the odds favour India to do well next year. Weak global growth, easy liquidity conditions, stable commodity prices and a weak dollar are exactly the conditions under which India performs, and this remains the most likely scenario for the year 2012.
However, some threats to this scenario are gaining credence. First, inflation has proved far more sticky on the way down than one would have thought. The expected monetary easing cycle may be further off than what the bulls are expecting. Many investors are also expecting commodity prices to go parabolic after the announcement of a third round of quantitative easing (QE3), which can potentially derail any RBI easing.
Any attempt at QE3 will be accompanied by regulatory changes, which in turn will short-circuit a commodity price spiral. Simple changes in margin requirements or changes in rules governing physical exchange-traded funds should be sufficient to keep a lid on most commodity prices, or at least avoid liquidity-fuelled speculative excesses. The United States Federal Reserve surely understands the impact higher commodity prices have on US consumer disposable income and the headwinds to growth it creates. In the absence of liquidity-fuelled speculation, the weakness in global growth should lead to stable, if not declining, commodity prices.
At present, RBI is also sufficiently ahead of the curve, so it is unlikely that it will need to over-compensate and be hyper-aggressive to catch up.
A far greater risk to a bullish scenario is the shocking policy paralysis. My sense is that we will end up near seven to 7.5 per cent growth in FY 2012 (helped by a really good monsoon). However, the way decisions are now getting delayed in Delhi, I fear growth in FY 2013 will be still lower, maybe even six to 6.5 per cent. Before being astonished by such a low number, just think about the constituents of growth.
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Look at agriculture. Given how good the monsoons have been this year in terms of both quantity and spatial distribution, record harvests are likely. So a flat or limited growth in FY 2013 on this high base is quite likely.
As for private sector capital spending, the story is dismal: the investment or projects we are seeing today are a spillover from the projects begun earlier. Whether you speak to bankers or companies, there is just no conceptualisation of new projects. Banks maintain that no new projects are coming for sanction or even appraisal. Infrastructure in general and power in particular are so bedevilled with policy challenges that no wants to either set-up or fund a new project. Over the past few months, I have interacted with people from at least 10 of the top 20 business houses in India. No one wants to set up a new greenfield project in the country, citing land acquisition, environmental clearance, policy lacunae, non-movement of files in Delhi or, simply, fear. They are all happy to invest overseas. High interest rates, which are crippling project returns, do not help either. Given this backdrop, there is no question that capital spending will decline further in 2013.
As for government spending, if we are to meet our long-term fiscal targets, then growth in government spending in 2013 has to be subdued.
That only leaves consumption, and rural consumption at that, as the growth driver for the economy. Can this single pillar of growth deliver more than six to 6.5 per cent GDP ?
If this bearish prognosis were to be even directionally correct, it would spell disaster for markets and we would clearly have one more major leg down. The markets are not currently priced for a further slowing of growth in 2013 (most economists have growth accelerating to between eight and 8.5 per cent), and we would see significant earnings downgrades were this to happen. Price earnings multiples in India would also get compressed in this scenario, since investors drawn towards India for its long-term growth profile would get spooked. I can see many global investors throwing in the towel were this scenario to play out.
We have all forgotten how an economy growing at six per cent feels. Compared to growth of eight to nine per cent, it will feel like a recession. There will also be serious slippages in tax revenue, as revenue buoyancy collapses, and companies will continually miss growth targets.
I still think the six per cent growth scenario is not the base case for FY 2013, but the longer Delhi dithers taking basic policy actions and being seen in control, the odds will rise.
Time is running out. Governance and decisive decision making have to be demonstrated so that economic actors can regain confidence and the animal spirits of entrepreneurship and risk taking can once again resurface to drive our economy. Investors want to see an economic gameplan from the government and a willingness to take decisions in the long-term interests of the country. The longer they have to wait, the more worried we should be about 2013.
The author is fund manager and CEO of Amansa Capital