Down but not out

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: Sentiment in global financial markets seemed to have turned rather quickly from one of ‘irrational exuberance’ to one of ‘irrational pessimism’. Both extreme exuberance and pessimism can create potential disasters in the short term. Thus it is imperative that financial market players and policymakers like the central bank take a hard look at fundamentals while taking decisions.

What does an objective assessment of India’s fundamentals reveal? While India is not entirely insulated from the problems of the global economy, its prospects are still fair to middling. Thus while India could be hurt by the global economic crisis, it is likely to fare better than a number of its peers.

Why? It is important to emphasise some of the structural supports that the Indian economy and financial markets enjoy. For one, while the contribution of India’s exports to gross domestic product has been rising, it is still low compared to the majority of emerging markets, particularly those in Asia. India’s overall exports are just about 23% of GDP, of which just 13% is to the US. In a scenario where global growth is slowing down, led by a sharp decline in US growth, this is likely to work in India’s favour. India’s growth continues to be driven by domestic consumption that accounts for about 67% of aggregate demand. This protects us to some degree from global shocks.

Growth in domestic demand for services is likely to continue and even if the US slowdown were to take the shine off service (IT) exports, a 10% growth rate seems realistic. With a share of 50% in GDP, the sector will be the key driver of growth. Overall GDP growth is likely to moderate but for the current fiscal year, a 7.5-8% growth appears viable.

Turning to the financial sector, there is enough evidence to show that it has successfully ‘by-passed’ the sub-prime crisis. The central bank has established its credibility and has a wide range of options to manage short term fluctuations as they emerge. The financial system consequent to measures relating to NPA recognition, provisioning norms, ALM management, Basel-II compliance, market efficiency, is robust.

The RBI has been moving with care on market liberalisation. In short, checks and balances are in place and will help in steering the economy through waters that are likely to remain choppy for a while to come.