We have drawn a parallel between climbing Mount Everest and the Indian economy. Above 8,000 metres, called the death zone, it is difficult for human beings to survive for more than eight hours due to low oxygen levels and below-freezing temperatures.
The Indian economy has been plagued by eight per cent + inflation and eight per cent + fiscal deficit (combined for states) for two years. This is having a crippling impact on businesses. India is also faced with a slew of scams, policy paralysis and retroactive policy changes — and it feels like now there is an avalanche, too. Thankfully, there is oxygen available in the form of sustained fund inflows from foreign institutional investors (FIIs).
Indian markets have gained from the rising global liquidity and have seen a sharp surge in inflows, notching up $9 bn year-to-date. Historically, following surges in FII inflows, the markets deliver negative forward returns over the next 12 months. We think there’s a fair chance of QE3 coming through, which would imply that FII inflows will likely last for another couple of months. Can the Indian economy recover by 2H to counter lower inflows? Will we see interest rate cuts and a boost in domestic liquidity? Will the government push investments in the pre-election year, as seen historically? There are no signs of such optimism as yet.
With all major near-term events over, the market seems to have lost its sense of direction and is oscillating with news flows. The Union Budget was disappointing, and all hopes were pinned on the annual monetary policy. And the RBI surprised the markets with a 50 bps repo rate cut. But it also said something very pertinent — that the reduction in repo rate was based on an assessment of growth having slowed and at the same time, it acknowledged that upside risks to inflation persist. It meant something. With so much pessimism around India’s macro environment it was an opportune moment to cut rates as inflation had moderated recently. However, with no clarity on fiscal consolidation and dormant inflation in the prices of fuel, electricity, coal, fertilisers and indirect taxes, RBI does see the risk of inflation spiking again, and hence limited the rates cuts. Which means lending rates would come down but only gradually, as and when the cost of funds for banks comes down.
This may have implications for private investment, which remains subdued. The private corporate capex. that was the main driver of the upturn in the investment cycle, remained weak at 12.1 per cent of GDP in FY11 (vs the peak of 17.3 per cent in FY08). While some activity in the public sector may become visible in FY13, private capex will likely respond with a lag as firms strive to improve their return on equity, which has fallen from 25 per cent to 17 per cent.
We continue to expect India’s GDP growth to remain weak at 6.9 per cent in FY13, similar to levels seen in FY12, supported mainly by consumption demand. We believe the growth outlook is impaired by a slowdown in investment in view of deteriorating private corporate sentiment, and lack of policy reforms in the context of weak global economic environment. The inflationary concerns and widening current account deficit remain recurring concerns. Is an early election the only way out?
The author is managing director and head of research, Macquarie Research India
