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.”
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 IndianSchool 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.
GDP Growth
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. Chakrabarti of ISB
says: “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 adds: “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.”
