Reliance Industries, India’s biggest company by market capitalization, on April 21 announced its fourth quarter and annual results. The company reported a net profit (excluding exceptional items) of Rs.15,261 crore ($3.8 billion) on annual revenues of Rs. 139,269 crore ($34.4 billion). “Reliance beats Street estimates,” said Thomson Financial News. “Reliance misses estimates,” said Bloomberg.

Estimates can, of course, vary. But, at a time when nobody seems to know how to read the future of India’s economy, such mismatched interpretations of corporate performance just add to the confusion. “The market has decoupled from reality,” says Nandan Chakraborty, head of research at financial services provider Enam.

It seemed so simple a few months ago when the BSE sensitive index (Sensex) touched an all-time high of 21,207 on 10 January. Finance minister P. Chidambaram spoke optimistically about a 9% rate of GDP growth. Reserve Bank of India (RBI) governor Y.V. Reddy was reported to be considering an interest rate cut to boost investment. And stock analysts were gung-ho about the so-called decoupling theory: How the stock markets in rapidly-growing economies like India and China would be unaffected by the impending recession in the U.S.

Today the Indian markets have crashed. The first quarter of calendar 2008 was the worst since 1992. Market indices have fallen 28% in dollar terms. Some stocks are down more than 50%.

Now opinions vary widely on GDP growth in 2008-09. The Delhi-based Oxus Research & Investments is perhaps the most optimistic; it toes the Chidambaram line of “9% is still possible.” Deutsche Bank estimates it at 8.4% and UBS 8.2%. Occupying the middle ground are the Asian Development Bank (8.0%), the International Monetary Fund (7.9%, for calendar 2008) and Lehman Brothers (7.6%). Bringing up the rear are HSBC, JP Morgan Chase and Morgan Stanley (all 7%). Meanwhile, rating agency Crisil (a Standard & Poor’s company) has reduced its estimate to 8.1% from its earlier forecast of 8.5%.

Raising Interest Rates

Chidambaram, too, has tempered his GDP growth estimates. “The choice is clear,” he told the Indian Merchants’ Chamber at the end of March. “If we want to check inflation, we must be prepared for a slightly lower rate of growth… If the RBI decides to raise the CRR (cash reserve ratio) and interest rates to counter inflationary trends, it would certainly affect the rate of GDP growth.”

The RBI has already raised the CRR, the percentage of their deposits banks must park with the central bank, from 7.5% to 8%. This will be done in two phases by May 10. In its credit policy statement of 29 April, the RBI left interest rates unchanged. However, it raised CRR by another 0.25%. Banks will have to maintain a CRR of 8.25% from May 24.

The acknowledged villain of the piece is, of course, inflation. The RBI, which says that its prime mandate is to contain rising prices, had earlier indicated that its comfort zone was 4.5% to 5%. Over the past few weeks, the numbers have risen way past that limit. In January 2008, the wholesale price index inflation was 3.8%. By March 29, it had risen to 7.41%. It then dropped to 7.1% for the week ending April 5 but rose again to 7.33% the following week. No one expects prices to go down any time soon. According to a recent survey by global management consultants McKinsey & Co, 64% of the Indian executives polled believed that inflation would go up in the next six months.

“The most immediate concern at present is inflation,” says Rajesh Chakrabarti, a professor of finance at the Hyderabad-based Indian School of Business (ISB). “There is no denying that inflation has gone up much more than what the government would have wanted. In recent years, the government has been very specific in saying that it wants to contain inflation to less than 5%, and now it has gone to 7%.

“The trouble with inflation management seems to be that the government will resist raising interest rates because the interest rate differential with the U.S. is already quite large and they wouldn’t want to widen it further,” Chakrabarti explains. “One of the things that the government is trying to do is put in price ceilings and quantitative controls, which have historically not worked, not just in India, but elsewhere also. These are difficult to administer. This is a 1970s-80s kind of solution. But one can understand the government’s need to do this as they don’t want to touch the monetary policy at this point in time because of foreign investments, etc. The government is constrained by what is called the impossible trinity of international finance (the perceived irreconcilability of the three objectives — capital freedom, exchange rate maintenance and independence of monetary policy).”

The solutions that Chakrabarti is talking about are manifesting themselves everywhere. The government has been squabbling with cement and steel manufacturers, arm-twisting them to hold down prices. “It is my view that cement manufacturers and, to some extent, steel producers are behaving like a cartel,” Chidambaram told Parliament in late April. “We are looking at the legal and administrative provisions that are available.” Steel companies, on their part, point to rising input costs. An uneasy truce has been reached with manufacturers agreeing to hold prices for a couple of months. But this could break down if companies see themselves slipping into the red.

The government has taken several other steps, including various export bans and import duty cuts. Even the annual export-import policy was revised. For example, this year, what made headlines was a total ban on cement exports and the withdrawal of all incentives on the export of primary steel. The export target for 2008-09 has been increased to $200 billion — an increase of 23% over the $155 billion achieved in 2007-08. This was short of the $160 billion target for the year.

Increase in steel and cement prices leads to pressure on user industries. Two-wheeler manufacturer Hero Honda has announced a price hike. Car manufacturers are being forced to the wall. And the Tata group’s Rs. 100,000 ($2,500) Nano, the inexpensive car due to roll off the assembly lines soon, may be impossible to manufacture at such a low price.

Soaring Food Prices

But this is not where the crisis is most acute. The price increases that hurt, especially in an election year, are those of food grains. “Another big concern is that in India and also globally there seems to be somewhat unbalanced growth (in the composition of the growth itself),” says Chakrabarti of ISB. “This seems to put pressure on food prices internationally. Food exports are also being limited, and Vietnam and other countries are not exporting as much rice as they did in the past. Given India’s income distribution and poverty levels, rising food prices are of particular concern here. Food prices going up will mean a significant reduction in the standard of living for a very large part of the population. Normally, the stopgap arrangement has been through imports. But this time it will not be so easy because the rising food prices seem to be global.”

For public consumption, the government has to be seen to be taking steps. But most experts are doubtful whether they will do any good. “I feel that the [inflation] numbers are going to be around 6% — above the 5% magic benchmark,” says Ajit Ranade, chief economist of the Aditya Birla group. “The inflation numbers for seasonal goods like fruits and vegetables may come down. There might be some moderation in food grains. But I don’t see overall inflation numbers coming down very quickly. This is a global problem.” The United Nations World Food Program (WFP) has compared the crisis to a silent tsunami and said that 100 million people are at risk. Wheat and rice prices have risen to record levels. “A wave of food-price inflation is moving through the world, leaving riots and shaken governments in its wake,” as The Economist recently wrote in a cover story on the subject. “Agriculture is now in limbo. The world of cheap food has gone.”

Oil prices in India have crossed $110 a barrel, though these are not reflected in the inflation numbers as the government subsidizes fuel prices. Still, oil refineries are feeling the pinch. Indian Oil Corporation says it is losing Rs. 238 crore ($59 million) a day on retail fuel sales.

There are other worries. The Index of Industrial Production (IIP) plunged to 5.8% in January. It recovered to 8.6% in February, but that was much below the 11.2% recorded in February 2007. For the first 11 months of fiscal 2007-2008, the IIP has come down to 8.7%, compared to 11.2% for the same period last year. Growth has taken a backseat. “There is a crisis of confidence too,” says Chakraborty of Enam.

Subprime Losses

Ripples of the subprime crisis in the U.S. have spread to India — but they are ripples, not waves. Perhaps the only major sufferer among the banks and financial institutions is ICICI Bank, which had a mark-to-market loss of $264 million as of January 31. The bank explained that it had provided $90 million already and would provide another $70 million. But the losses hit the headlines only after the answer to a Parliament question brought out the details. This gave rise to the feeling that there could be other losses hidden in the banking system.

According to one estimate, the total losses could add up to Rs. 20,000 crore ($5 billion). The RBI, however, says there is no systemic risk. Given the cautious nature of India’s central bank, observers believe that the losses could be lower. The State Bank of India, the country’s largest bank, says that its clients’ derivative losses could be around Rs. 700 crore ($173 million). Unfortunately, not all banks are being open about their exposure. This has added to market fears that more shoes could drop in the future.

The corporate results so far have been a mixed bag. Even within sectors, there are no clear signals. Infosys created much enthusiasm within the information technology (IT) industry when it announced upbeat performance and strong prospects for the future. A few days later, India’s largest IT company — Tata Consultancy Services (TCS) — poured cold water over the euphoria. “The TCS performance is below par,” says Manik Taneja, an analyst with Emkay Share and Stock Brokers. Even so, some optimism lingers. Raamdeo Agarwal, joint managing director of Motilal Oswal Securities, says that if companies report the expected 18% to 20% growth in profits, the markets will recover.

According to Enam’s Chakraborty, “In January 2008, the Indian market was banking on global and domestic liquidity, despite its over-leverage, combined with pockets of over-valuation and over-ownership. Since then, India has been one of the worst performing markets, even as most global markets have bounced back, banking on being rescued by the U.S. Federal Reserve, while commodity inflation has aided Brazil and Russia.”

Chakrabarti of ISB says that what happens in the U.S. matters enormously to India. “On the export front, if the global slowdown continues — and worldwide there is an expectation that the U.S. economy will be slow for at least the next few quarters — then exports are likely to drop. How deep the drop will be depends largely upon the U.S. market because, historically, when America slows down, most other economies also follow. It now remains to be seen if the slowdown will be as global as it has been in earlier times.

“In the medium term, things don’t look too good for India. But given the structural changes that India has made, I believe that it will be only a temporary blip. In the long run things will be back on track. The question is when? I believe that in 12 to 18 months we will be back to where we were. I don’t expect a long term slowing down.”

Subir Gokarn, chief economist of Standard & Poor’s Asia Pacific, agrees. In his April review of the economy — CRISIL EcoView — he writes: “The recent downturn in investment activity has clearly contributed to the overall deceleration in manufacturing. This, and other indicators, such as credit growth, point to the onset of a cyclical downturn in the economy. This is obviously a matter of concern, but, at this point, our expectation is that the downturn will be both shallow and short. Remember that barely five years ago, GDP growth was less than 6% a year. Compared to that, we are now worrying about it falling to 8%. That is perhaps the best reflection of how dramatically the economy and its investment climate have changed in such a short span of time.”