Heading For A Winter Of Discontent

Updated: Aug 26 2004, 05:30am hrs
Just a few months back, it looked as if nothing could go wrong for the Indian economy. GDP growth soared from a modest 4.4% to 8.2% in 2003-04. Corporate profits were robust and increasing in double and triple digits. Interest rates were low and falling. Suddenly, the whole environment appears to be undergoing a transformation. Are we like King Lear heading towards a winter of discontent

It is hard to say. Let us look at each of the major parameters and see whether the recent downtrend will get reversed or get accelerated. The Indian rupee has lost more than 5% in the last four months and is at a one-year low. This is despite foreign exchange reserves remaining very strong and above the $110 billion mark. True, to some extent this is on account of the recovery of the US dollar. But that is only part of the story. There is a feeling among foreign investors and NRIs that, propelled by weak trade figures and low investment sentiment, the rupee will continue to drift. There is also the firming up of the forward premia to buy forward dollars. This is a leading indicator.

The firming up of the premium for the US dollar also leads one to believe that the well-informed banking community expects the rupee to weaken in the months to come. This is not good news for the aam aadmi since a weak rupee is bound to push prices up. Fuel and transport sectors represent a large portion of the price index and as we pay more for our petro-product imports, inflation will remain high. There is no doubt that the falling rupee has contributed to inflation touching 8%.

The sober feeling that people have on the interest rate front is also strengthening. It seems like yesterday that the yields on premium government bonds were at 5%; now that seems a distant past. It is about 6.5% and not abating. The risk spread on corporate bonds is also firming up. This is going to have a major adverse impact on both consumer spending and corporate profits, two key drivers of future growth. The housing and automobile sectors have seen unprecedented growth in the last two years due to falling interest rates. These two are large sectors of the economy and when they witness growth, supplier industries like steel, cement also joined the party. There is considerable fear that as interest rates march north, consumer spending on automobiles and home durables will fall.

Passenger car sales have already dipped over the last fortnight and big discounting is taking place. Housing starts are not monitored in India like the US, but my sense is that these will also start dipping as the market sends signals of hikes in home loan rates. If this scenario on interest rate continues, corporate profits will really fall apart. The manufacturing sector has had a great time cutting interest costs. But that trend would reverse. Banks would feel the heat even more. Their profits have been good on account of investment gains but may change direction. There are some sceptics who even talk of public sector banks going into the red in the next 12 months.

It is now fashionable in Delhi to look down on the stock market as a den for gamblers. I belong to the old school which believes that the market factors in all economic factors in a cold calculating way and is the best leading indicator of the economy. If that were so, the signals from Dalal Street have been nervous and tentative. After tanking in April and May they have stabilised but are ridden by fears of low foreign fund participation and rising interest rates. Markets staying in a close range is a good indicator of the pulls and pressures in the broad economy.

With this as a background, it is not surprising that there are very few optimists doing the rounds. There are however positives and these need to be emphasised. Corporate profits are still robust and there are as yet no signs that these are tanking. Fore reserves are still very strong in absolute terms. Credit offtake is good and tax receipts are strong. The emphasis being placed by the Prime Minister on completing ongoing projects should increase productivity and remove supply constraints over time.

Its imperative that those in power should attack the macro weaknesses with hardheaded decisions. There appears to be too much of politics in decision making. The previous government, despite being a huge and unwieldy coalition, could take hard decisions when it came to the crunch because of the vision and influence of Mr Vajpayee. This government needs to do the same thing even if it means a disagreement with its Left friends. Unfortunately, by throwing the disinvestment of PSUs out of the window and turning the clock back on dismantling of the administrative pricing mechanism, the government has positioned itself as a champion of government taking back the commanding heights of the economy. Back to Methuselah

The next 12 months will determine whether the Indian economy will continue to march forward. There is no doubt that globally economies are making a strong recovery. Leading investment firms like Morgan Stanley are predicting that emerging market economies will take a big hit due to spiraling oil prices. This is a warning, which we would be foolish to ignore.

We should cut populism out (free power, subsided fuel) and concentrate on bringing back a regime of stable currencies, low interest rates which alone will keep growth up. The government should adhere to its commitment on opening up foreign investment. It should try not to backtrack on VAT and should go forward on the Kelkar recommendations. It is not going to be easy since every measure that will open up the economy and make the cake bigger will be opposed by the Leftists. An angry opposition hurt by numerous pinpricks is in no mood to bale out the government. In the last one week, I have been stuck in traffic jams near the Parliament as truckers, bankers, etc show their teeth. The government should not appear toothless.

The author is a Delhi-based investment banker and Convenor of the BJP Central Economic Cell. These are his personal views