The debate about whether the US is in recession is pointless in a technical sense. The requirement of two continuous quarters of real GDP decline isn?t met. However, given macro numbers, and these now go beyond the subprime crisis, a serious downturn seems certain.
This brings one to the decoupling debate. It is fact that India?s exports are more broadbased now, destination-wise, and it is also true that India is more insulated than China is. But exports, including software, aren?t the main issue. If one had to rank the US slowdown vis-a-vis rupee appreciation as export deterrents, most will opt for the latter. At worst, and this is not a figure that can be statistically defended, the US slowdown alone probably shaves off 0.5% from India?s real GDP growth. That is hardly an indication of India catching a cold because of an American sneeze. However, decoupling of the real sector is not the same as decoupling of the financial sector. India?s capital market is much more integrated with US developments, and in this, behaves no differently from other Asian markets. There may well come a time when the Indian stockmarket is broadened and becomes less sensitive to foreign institutional investments (FIIs). Nor are there enough scrips floating around.
Finally, unwarranted hysteria surrounds the Sensex, which represents only one segment of the Indian capital market. How much of the Sensex decline, accepting it as a surrogate indicator, is due to Budget 2008-09 as opposed to global developments? The fall in bank share prices after the farm debt waiver indicates a sectoral element. If one ignores this angle, in the aggregate, barring the increase in short-term capital gains tax, the Sensex fall can be traced to global factors.
What is India?s expected real GDP growth in 2008-09? The Budget is never transparent about projected growth. One has to work backwards from the deficit numbers. Nominal GDP growth in 2008-09 is expected to be 14.5%, closer to 15%. Assuming 5% inflation, this requires 9.5% real growth. This doesn?t seem likely, and tax revenue and deficit projections are thus likely to go wrong. More to the point, there is a cyclical downturn, and the Budget does nothing to reverse this. The euphoria over greater personal disposable income and manufacturing growth triggered by excise duty cuts doesn?t factor in inevitable interest rate hikes and higher service sector taxation. Real growth of 8-8.5% seems more plausible.
It could have been better, but the picture isn?t dismal. To use a cliche, there isn?t anything dramatically wrong with India?s economic fundamentals, economic and political uncertainty notwithstanding. Nominal GDP growth of at least 12% should mean an increase in average corporate profitability by at least 18%, though there will be inter-sectoral and inter-company variations. The competitive strengths of Indian companies will not disappear overnight. Ipso facto, the question whether the Sensex will be higher or lower in March 2009, compared to March 2008, is a fallacious one. It is certain to be higher. The real question is, how much higher? No one has a satisfactory answer to that.
But consider the following. First, economic fundamentals and corporate fundamentals are strong. Second, the US Federal Reserve is certain to lower interest rates further, thereby increasing the differential in interest rates. Once the papering over of subprime losses is over, FII and other capital inflows will be back, creating a further problem of exchange rate and inflation management for RBI. How many countries in the world can guarantee such returns? Third, again subject to inter-sectoral and inter-company variations, P/E ratios in India are low and have become even more attractive. The India Shining story of bullishness remains, despite the tempering.
In the longer term, the case for staying invested remains. However, there are several caveats, particularly from the retail perspective. First, a myth of high returns and low risk has been created. Every retail investor, regardless of expertise, perceives himself/herself to be knowledgeable. Partly thanks to media hype, investing in the stockmarket has been reduced to the status of horse-racing. Witness the prevalence of tips and scramble for IPOs, even in instances where a company hasn?t even existed six months ago. Second, diversification of risk by retail investors requires mutual funds, not dabbling in individual scrips. Third, no regulator can guard against human greed and stupidity. If some investors have been hurt by the notional erosion of their net worth, they were asking for trouble. Thankfully, unlike episodes in the 1990s, so far, spectres of scams and cartels haven?t been raised. Fourth, if the correction, even if it is more than warranted, serves the purpose of making investment decisions more sensible and delinked from hype and hysteria, that will have been a lesson well learnt. After all, the moral of reforms is to encourage more savers to invest in equity, rather than fixed-return investments, depending on one?s appetite for risk. In this perspective, looking for a quick buck is the wrong attitude. The prospect of long-term returns remains.
?The author is an economist. These are his personal views