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Sandip Dhole's Blog
Indian Economy at Crossroads: Q2-2012 Report
Jul 01 2012 | 2 Comments | 4226 Views

"The biggest risk is not taking one"

About Author
Dr. Sandip Dhole
Assistant professor
Indian School of Business,Hyderabad

Now consider this, if the housing market grows at 15% annually (quite natural for Indian real estate market), rupee remains stable, and inflation is 7%, then you have an annual real return of 8% (=15%-7%) which implies a doubling of your investment in slightly less than nine years.
Yes, we are betting on quick turnaround for Indian economy even though it appears foolhardy at this moment. These are anxiety- ridden times for the global economy. US growth is stalling and the euro zone is in suspended animation. Thanks to the ever present Damocles sword of impending Greek exit (it has caught the imagination so well that there is a word for it now: Grexit), continuing trouble in Spain, Portugal, and Ireland, people perceive risk everywhere. A lot has been written about the woes of Indian economy and many paint a dire picture. We take a more balanced view of the economy, and apart from pointing out key weaknesses; we highlight several bright features that are currently overlooked (due to widespread nervousness about the emerging markets). We conclude with an investment advice for the NRIs. We start by dispensing the obvious bad news first.
Four things Indians should be worried about
  1. Low GDP growth rate and high interest rate

    Hovering storm clouds ...

    • Plunging GDP growth rate and credit crippling interest rate
    • Growth in Manufacturing, agriculture, and mining sectors are gridning to a halt
    • Falling Rupee, sky rocketing current account deficit, stagnant forex reserve, and ballooning petroleum import bill spell dange for the future

    The plot below says it all. From the dizzying height of above 8% growth rate in Q2-2010 we have reached a growth rate of only 5.3% for Q1-2012 and the interest rate remains stubbornly high. The reason for the lack of RBI's aggressive monetary policy has been primarily driven by a desire to tame inflation rate that has remained high until recently.

    Moving in the wrong direction:
    Interest Rate High and GDP Growth Rate Dropping
    Low GDP growth rate and high interest rate

  2. Industrial production has stalled

    The following graph demonstrates the dramatic drop in industrial activity (Index of industrial production growth rate dropped from 8.3% Year over Year (YoY) in 2010-11 to only 3.6% (projection) in 2011-12. Moreover, there has been an overall slowing down of the economy as key sectors like agriculture, mining, and manufacturing have experienced dramatic slowdown.

    Index of Industrial Production YoY change (%):
    Economy running out of steam
    Industrial production has stalled
    Year Over Year (YoY) Sectoral Growth Rate:
    Economy Grinding to a Halt
    Industrial production has stalled
  3. Balance of Payment is worsening

    The current account deficit has worsened and is expected to reach 3.6% of the GDP. Combine this with stagnant Forex reserve (in last three years), and you have a dangerous combination. While it is a far cry from the crisis time of 1991, still it is worrisome in an environment in which global financial community is only looking for super safe assets only.

    Current Account Deficit (% of GDP):
    Time to Ring the Alarm Bell
    Industrial production has stalled

    Forex Reserve ($B): Stunted Growth Industrial production has stalled
  4. Exchange Rate has consistently depreciated

    Rupee depreciation is already a stale story but still worth mentioning in a panicky international financial market. As days pass by, the rupee surprises us by reaching new historic lows. Rupee depreciation combined with the burgeoning petroleum import may put further pressure on our balance of payment in the near future.

    Rupee Dollar Exchange Rate
    Rupee getting Weaker
    Industrial production has stalled
    Crude Oil and Petroleum Import (US $MM):
    Getting Out of Control
    Industrial production has stalled

To summarize, there is plenty for the pessimists to harp about:
  • Plunging GDP growth rate and credit crippling interest rate are dragging the economy in the wrong direction.
  • Significant slowdown of overall economic activity as growth in manufacturing, agriculture, and mining sectors has sputtered.
  • Flashing red lights from the external sector in the form of plunging rupee, sky rocketing current account deficit, and stagnant Forex reserve, and ballooning petroleum import bill.

Now we turn to some strong positive factors that leads us to believe that there are good reasons to celebrate and expect a speedy rebound of the Indian economy.

Four things to open the champagne bottle for
  1. Per-capita GDP is rising and consumption remains strong

    ...But the silver linings are unmistakable

    • Indian Purchasing Power (per capita income) is rising
    • Consumption growth remains robust
    • Debt to GDP ratio and fiscal deficit: Europe's Envy
    • Services sector (the dynamo of Indian economy) is expected to grow at 9% for 2011-12

    In all the gloom and doom about the GDP growth slowdown, it is easy to ignore the ever growing per-capita GDP (thus ever expanding purchasing power that will boost the economy). Furthermore, consumption expenditure growth, a key component of the GDP, has recovered quickly after the temporary drop in the eve of 2008 global economic meltdown. While developed countries saw consumption plummet, Indian economy has been remarkably resilient in the last three years. As we look ahead, it is our strong belief that our 250 million strong middle class consumers will provide the necessary impetus to economic growth through higher consumption growth once the supply bottlenecks are cleared.

    Per Capital GDP (US $):
    Purchasing Power Continues to Grow
    Industrial production has stalled
    Private Final Consumption YoY Growth (%):
    still alive and kicking
    Industrial production has stalled
  2. Inflation, some silver lining in the cloud
    Inflation Rate: High but Stabilizing Inflation, some silver lining in the cloud

    While others lament high inflation rate, we look at the silver lining. As the graph below shows the consistent tight monetary policy by RBI has finally tamed the alarming growth in the inflation rate and we have observed a decrease in last couple of years. We acknowledge the fact that inflation still remains a high priority for the RBI as it is unwilling to reduce the interest rate to promote investment and demand driven growth. We suspect that if high inflation were the only factor, then RBI would have opened the monetary tap to boost the economy. It is the depreciating rupee that is tipping the balance in favor of a wait and sees policy from RBI. Once rupee stabilizes, we expect RBI to come around to an expansionary monetary policy.

    Rupee Dollar Exchange Rate and Crude Oil Price: Oil Import Burden may go down Inflation, some silver lining in the cloud

    There is another factor relating to inflation which is not receiving the attention it deserves. While there is a wide spread discussion about the debilitating impact of depreciating rupee on the petro product import (thus our rising current account deficit), it is worth mentioning that the crude price is dropping fast (see plot along side) and is expected to remain low due to global slowdown. This new development will reduce the import bill (thus taking some pressure off rupee). This will also put downward pressure on inflation if our policy makers pass some of the price reduction to the economy by reducing the petroleum prices (they should do this fast).

  3. Debt and deficit is under control

    This is the most under- rated aspect of the Indian economy. Our debt to GDP ratio is below 70% and is consistently going down. Compare this to the more than 100% debt to GDP ratio for US and above 80% ratio for Germany (the epitome of fiscal discipline). While the fiscal deficit is high by 2006-08 standards, we have seen consistent improvement in last couple of years. We disagree with the usual prescription of spending cuts to reduce deficit as a low deficit is not an end in itself (ask Japan that runs a perpetual surplus, but is trapped in a low growth path). In time of economic slowdown it is strongly recommended that our policy makers take proactive steps to clear supply bottlenecks, improve infrastructure, and create conducive investment climate. If this entails a short run rise in budget deficit then so be it. Our low debt to GDP ratio should provide the requisite breathing space to implement a fiscal policy driven recovery.

    Debt Ratio: Europe's Envy Industrial production has stalled
    Gross Fiscal Deficit (% of GDP):Also Europe's Envy Industrial production has stalled
  4. Services sector is doing well

    It is well known that the services sector is increasingly the prime mover of the Indian economy (close to 60% of the GDP) and as the graph below shows, it has weathered the slow down quite well . The YoY growth rate is expected to drop by only 1 percent age point from last year, and has been fairly stable from 2009-10 onwards.

    Services Sector YoY Growth Rate (%): Growth Still Stable and Robust
    Services sector is doing well

Let us recap the good bits again:
  • Per capita income rising and consumption growth robust
  • Inflation stabilizing (albeit still high) and proactive policy will go long way to reduce it further
  • Excellent debt to GDP ratio, and fiscal deficit stable
  • Services sector (the dynamo of Indian economy) has been relatively immune to overall slowdown

Now dear reader, it is your call. Let us know whether you see the glass half full or half empty. As for us, we are leaning towards the half full view.

We conclude this article with a valuable suggestion for the NRI investors.

Real estate Investment opportunity for NRIs

Indian housing market has been healthy in the last few years given the spectacular drops we have seen in parts of Europe (read Spain and Ireland) and US (north of 30% price drop from the 2006 peak on average). The chart below shows the average growth in NHB RESIDEX index (obtained by averaging the index for the key 1st tier and 2nd tier cities). The noteworthy factor is that even during the global recession of 2008-09, the index grew at a rate close to 10%. Remarkably we saw a significant spike in 2010, after which we have observed a relative slowdown to above 10% (note that any developed country will kill for that low growth). We strongly believe that it is a temporary blip and we will see an overall recovery by end of 2012 and beyond. Given this outlook, in itself real estate investment is an attractive investment in a world where the returns from equity and bond are nothing to write home about. Now add to this current drop in value of rupee due to global aversion for anything related to emerging market. In the long run rupee is expected to recover its value (once Euro region settles down and US economic engine picks up), thus the current time period presents a good opportunity to take advantage of a weak rupee and relative lull in the housing market to enter the Indian real estate market ( and many NRI are already doing so).

National RESIDEX YoY growth: Good time for NRIs
Real estate Investment opportunity for NRIs

A bit of a quick math here

Dear NRIs: 10% rupee depreciation effectively means that your dream house is 10% cheaper.

Now consider this, if the housing market grows at 15% annually (quite natural for Indian real estate market), rupee remains stable, and inflation is 7%, then you have an annual real return of 8% (=15%-7%) which implies a doubling of your investment in less than nine years.

DISCLAIMER:The views and opinions expressed here are those of the author and and may not reflect the position of Indian School of Business(ISB)


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