The Indian Economy in the Next Decade: Déjà Vu with a DifferencePublished: January 06, 2010 in Knowledge@Wharton
In June 1991, the government of India pawned 67 tons of gold to the Bank of England and the Union Bank of Switzerland to shore up its dwindling foreign exchange reserves. The U.S. dollar was in great demand. By November 2009, after nearly two decades of reforms and globalization, the shoe had moved to the other foot: India bought 200 tons of gold from the International Monetary Fund (IMF). The country's reserves stood at $285 billion -- compared with $2 billion in 1991 -- and the demand for greenbacks had dimmed.
These signs point to an upbeat outlook for the Indian economy in 2010 which, in the view of some observers, seems as bright as the gold the country has recently acquired. The year could see more gold purchases; India needs to diversify its basket of foreign assets, 90% of which is still in dollars. But foreign exchange reserves -- once closely monitored -- are the least of the country's problems right now.
At the top of the agenda is inflation and its trade-off partner -- growth. "The evolving growth-inflation conditions will dictate the future course of action by the RBI [Reserve Bank of India]," Shyamala Gopinath, deputy governor of the RBI, said during a recent meeting in Bangalore. "The RBI has already started the first phase of exit in its October 2009 policy statement, though primarily in terms of signaling the stance rather than affecting liquidity conditions or interest rates." (See Will Rising Inflation Deflate India's Economic Recovery?)
Inflation will dictate the next steps of the government and the RBI. It has already reached worrisome proportions. After being in negative territory for part of 2009, wholesale price inflation jumped to 4.78% in November from 1.34% in October. Food inflation, which is more important because it affects the general population and influences voting behavior during elections, was 19% in December. "If the government starts addressing the food issue on the supply side immediately, inflation may continue to be at 4%," says Ashvin Parekh, a partner and national leader at global financial services firm Ernst & Young (E&Y). "But if oil prices go up, inflation could go up to 5% to 6%. Until about July, it is likely to be around 4% to 6%. After that, it will depend on the monsoon."
"Inflation will continue to be a serious issue," says Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB). "The stimulus is doubtless fuelling it in part, and there is no way of rolling it back. So monetary measures will have to counteract it, but there is very little maneuvering room. Inflation is likely to stay at present levels or worse for much of next year."
High inflation means that the government may have to withdraw the stimulus package, introduced to counter the economic slowdown, sooner rather than later. A hint to that effect in the October 2009 RBI policy statement had the stock markets spooked, and the finance minister had to step in with the assurance that nothing would be done until March 2010. (The Union Budget is announced at the end of February.)
Another measure to control inflation is to curb liquidity. There have been fears that the RBI may raise interest rates. Here, again, the RBI has been forced to step in with some damage control. "If [an increase in rates] has to happen, it will happen only in the January 29 monetary policy announcement," RBI deputy governor K.C. Chakrabarty said during a recent meeting in Hyderabad.
"Interest rates are likely to go up 1.5% to 2% over the year," says Sunil Bhandare, advisor (government and economic policies), Tata Strategic Management Group (TSMG), a management consulting firm. "The increase will be on three considerations: inflation, the fiscal deficit and global interest rates, which are likely to increase in the next three to six months. In the first six months of calendar 2010, interest rates in India may go up by 0.5% to 1%, and thereafter by another 1% or so." Chakrabarti of ISB believes interest rates have to rise, "but the government and RBI may be nervous about killing a fragile recovery." The State Bank of India, meanwhile, says that it doesn't see any chance of rate hikes in the next six months. On the other hand, the public sector Union Bank of India has raised some deposit rates beginning January 1. It has introduced a 555-day maturity scheme at 6.75% against 6% earlier.
Because of these imponderables, estimates of GDP growth vary widely. In the April-September quarter, GDP rose a surprising 7.9%. Prime Minister Manmohan Singh says he sees a return to the days of 9%-plus growth next year (2010-2011). The government's own estimate for 2009-2010 is 7% to 8%. Given current trends, it may end up on the high side of that range.
"I expect GDP growth to be around 7.5% in 2010," says Bhandare of TSMG. "There is still some degree of uncertainty about the global recovery -- production and private consumption have not picked up and unemployment is still high. A good global economic recovery will be an additional bonus for the Indian economy. If that happens, we could even see 8% GDP growth." Adds Chakrabarti of ISB: "It should pick up a bit, but is unlikely to be too much higher. I would say 7% to 8%, or more likely 7.5%." Madhabi Puri Buch, managing director and CEO of ICICI Securities, also sees a 9% figure as overarching. "Our economy is expected to grow at least 7.5% to 8% for many years," she says. Parekh of E&Y is among the optimists, noting that "8% to 9% seems possible." In contrast, the IMF has projected 6.4% growth in 2010.
Good news is unlikely to be heard on all fronts. "Exports will continue to lag," says Chakrabarti of ISB. "Exports to emerging market countries are likely to be slightly higher." Bhandare of TSMG says export growth could be around 10% to 12% but "nowhere near the 20% that we saw earlier." Exports have turned the corner, depending on how you look at it. In November, exports rose 18.2% to $13.2 billion after 13 months of decline. But this was on a lower base. For the first eight months of 2009-2010 (April-November), exports were down 22.3%.
The fiscal deficit is another problem area. Thanks to the stimulus package, the deficit was estimated at 6.8% of GDP for 2009-2010. According to the 2003 Fiscal Responsibility and Budget Management (FRBM) Act, the deficit was supposed to come down to 3% by 2008-2009 -- but it did not. Will the deficit surpass the extra latitude given in this crisis year? According to government figures, the deficit for April-November was $65.7 billion, or 76.4% of the full-year target. Says Chakrabarti of ISB: "The fiscal deficit, together with inflation, will be India's Achilles' Heel in 2010. The combined deficit ... will continue to be double digits."
"In 2010, governments will face the very difficult task of trying to restore fiscal discipline while also ensuring that withdrawals of stimulus measures do not kill off nascent economic recoveries," says the Economist Intelligence Unit (EIU). It estimates India's GDP growth at 6.5%, the ninth-fastest growing country. China, at 8.7%, is ahead, but others leading the pack are small economies like Qatar (24.5%).
Stock Market Rollercoaster
The most-watched indicator by foreign investors is the Bombay Stock Exchange sensitive index (Sensex). This year has been a rollercoaster ride: The Sensex ended the year at 17,464, up 114% from a low of 8,160 in March. Foreign institutional investors (FIIs) have poured in $17.5 billion during the year.
The Sensex value is one number nobody in the government will talk about on the grounds that it is speculation. "I don't expect the Sensex to go up very significantly from current levels. The stock market has recovered too fast in the current year, so the opportunity for further increase will be limited," says Bhandare of TSMG. Adds Chakrabarti of ISB: "Some appreciation is likely on the back of continued FII flows. The Sensex will be in the 18,000-21,000 range by the year-end."
Chakrabarti provides an overview: "Overall, in 2010 and beyond, the economy will continue to be strong on the domestic front. The driver of growth will continue to be internal consumption, the aspirations of a large middle class and the spread of the income base across different segments of the economy. We are now seeing the emergence of a much larger and far more powerful middle class with more buying power than ever before. The growth in the automobile sector, for instance, shows that the middle class has been sitting on a certain amount of surplus money which it is now ready to deploy. India is a very peculiar economy where the middle class has a long way to go in building a good quality of life in keeping with its aspirations. This, in itself, is a big driver of growth. The dampener to the economy, however, could come from the supply side. Food prices are a major concern. Within this, the issue is not just of poor monsoons and poor food supply, but also of food management."
Bhandare of TSMG offers his own perspective. "Three significant aspects stand out in the Indian economy at present: The economy has shown tremendous resilience, there is a lot of flexibility and there is a great deal of tolerance among the Indian people -- 20% food inflation should have normally led to great social discontent and people should have been out on the streets. Consumer confidence is still shaky, but the confidence levels of industry, foreign investors and domestic investors are very strong. All these factors will influence the performance of the economy in 2010. One has to make a few assumptions while looking at the outlook for 2010: There will not be a repeat of a bad monsoon; there will not be another oil shock, and commodity prices will be reasonable; there will be no major dip in the international economy; and the government will abide by the policy reforms that it is promising."