A journalist friend called me recently to ask whether India was headed for a “soft patch” or a “hard landing”. I must confess that although I use these phrases rather freely, I hadn’t given much thought to precisely what hard landing means in terms of growth rates. To remedy this I turned to our resident number cruncher Jyotinder and got her to plot a fine trend line through the growth data for the last 20 years. If I were to use this trend as the potential growth rate for the economy, it works out to be about 8.5 per cent. I then claim that a one percentage point reduction from this trend growth would constitute a threshold for hard landing. Thus, if the Indian economy were to grow at anything less than 7.5 per cent, it would have “hard landed”.
If I look at market forecasts, I see the majority of them (particularly those from the heavyweight investment banks) are in the ballpark of 7.5 per cent. Thus, the consensus appears to be that the economy is due to hard land or at least come close to hard landing. There is a minority view that believes that 2011-12 will be a “soft patch” for the economy. That is, while growth will certainly “moderate”, it is unlikely to go much below 8 per cent. This is incidentally a view that the government shares.
Colleagues accuse me of being pathologically bearish in my forecasts. Some of them who know me closely claim that this is a natural extension of personality. I concede that I am a bit of a worrier. If I sit under a tree I fret about the likelihood of getting concussed by a falling branch. However, I am in the optimist’s camp on this one. (Click here for graph)
My sense is that the “hard landing” camp is perhaps a little too bearish on the prospects for investment demand. Though there is no doubt that there has been moderation in capex and infrastructure projects for a variety of reasons, investments haven’t quite collapsed. In fact, in the last quarter of 2010-11, which many believe was the low point in the investment cycle, sequential (quarter-on-quarter) investments actually increased, while a strong and adverse “base effect” pulled the year-on-year growth down, giving the impression of a collapse. How are investments likely to behave going forward? I get the impression that though some of the bigger companies have delayed their projects, there is a lot happening with small- and mid-scale companies. I would use the external commercial borrowing numbers to make my case. A raft of small- and mid-size companies has been steadily raising external debt and unless most of it is used to refinance old debt (which is unlikely) this money must be going somewhere, most likely towards capacity creation.
There are a couple of other reasons investments could actually pick up further going forward. First, while the average capacity utilisation for manufacturing as a whole remains low compared to the earlier 2006-07 peak, a number of sectors (steel, fertilisers, oil and gas, chemicals, auto and auto components) are operating at significantly higher levels .Thus, firms need to expand capacity. Second, physical investments in India might take a lot of time to get off the ground but have historically been somewhat insensitive to interest rates. This does not seem to have changed. Respondents to a recent nation-wide survey conducted by the Confederation of Indian Industry said the cost of funds was not an important constraint in their investment decisions yet. Third, I have reason to believe that the government is extremely concerned about the state of investments and it is likely that it will step up efforts to remove some of the regulatory issues that have been playing spoilsport.
There are two other things I would like to mention. One, friends in government tell me there is a raft of foreign direct investment proposals stuck at the Foreign Investment Promotion Board that the government is trying to clear. Were that to happen, the bunched-up increase in foreign investment could add traction to investments. Also, there is a stirring of activity in the long somnolent infrastructure behemoth. For example, after 10 months of complete stasis, the National Highways Authority of India started awarding road contracts in May.
The second “big picture” theme that I want to address is the role of the rural economy in contributing to growth. I have a feeling that few people understand the enormity of the changes that have taken place in the rural economy, which has traditionally been a reservoir of cheap labour. We have seen a slew of wage data recently that seems to suggest that both agricultural wages and those in public works programmes have shot through the roof, outstripping the rate of food inflation, so in real terms wages have gone up. This has, in turn, impacted on wage rates in sectors like construction. The obvious beneficiaries of this wage escalation are sectors like fast-moving consumer goods and low-end white goods.
But that’s not the end of the story. Consumption patterns of the rural rich are also showing significant changes. A recent survey sponsored by Morgan Stanley showed that for categories like “vacations and recreation” or “luxury items”, the percentage of rural households that reported non-price related increases outstripped those of urban households. Banks are beginning to realise that not only are they a rich source of deposits, they are now also willing to borrow to spend. Leveraged consumption in rural areas has been increasing dramatically.
So, what’s my verdict on growth prospects for the next year? Soft patch? Yes, and this could last awhile. Hard landing? Nah!
The author is chief economist, HDFC Bank
