After the frenetic pace of all-round growth experienced by India ? the economy grew by 9% plus in 2006-07 and 2007-08 ? speedbreakers seem to be springing up at regular intervals. Some of them are so awkward that they threaten to not only stem the momentum, but also derail the growth process.
Inflation is clearly the biggest hurdle. Currently hovering around 7.83%, the wholesale price index is perilously close to the 8% level and is threatening to go well beyond as well. Some call it a cyclical trend, as inflation typically moves in a growing economy (see chart: Inflation cycle), where there are periodic crests and troughs. The peak in late 2004, where the numbers were in excess of 8%, gave in to a low rate in mid-2005 and then surged again to above 6% levels in the early part of 2007. A significant low was reached in late 2007 where the rate was around 3% levels and now it is again inching towards the 8% mark. Analysts at Edelweiss Securities say, ?Reflecting all critical factors, the WPI inflation number is certain to hover above 8% in June.?
To make matters worse, this time around, there are some debilitating factors ? slower growth, higher interest rates, rising fuel prices and a depreciating rupee. A lethal combination and most of them are symptoms for stagflation.
The rate factor
For corporate India these are testing times as well. Clearly, their competitiveness is on the line. The cost of conducting business is on the rise. A study by Citigroup Global Markets titled, ?Business inflation: rising cost of doing business in India,? states, ?A look at the rising costs of setting up business over the last three years ? asset, capital and services-based ? suggests ?business inflation? could be as high as 10-35% per annum, well ahead of the 7-8% headline inflation.”
This, the report adds, broadly means that break-even periods are up 20-80% over the last three years, capital intensity is up 10-60% and distribution requires twice the sales to generate the same returns.
Here the policymakers are sitting tight. Raising interest rates at this moment could clearly derail growth. The implications could be far-reaching here. When cost of doing business rises beyond the level of nominal returns available in the market, then monies tend to flow towards the money markets from capital formation. And capital formation has a leading impact. Capacities created now stir growth three years ahead.
At the same time, monetary expansion (at around 21%) will mean that inflationary tendencies will persist. More money will chase few goods, in plain-speak economics.
There has been a proactive move to curb price movements by administering key input prices like those of cement and steel.
And these are expected to yield results. However, rising oil prices, where the government has little control over, could topple the applecart so to speak. Already, the Indian crude oil basket, a combination of prices of crude sourced from various sources, has risen above the $120 per barrel mark and spot prices above $130. And here, the depreciating rupee is making matters worse.
Currency shocks
The rupee depreciation of around 6.7% in a month has been one of the sharpest moves down in the exchange rate since December 1997 when it depreciated by 6.2% in two weeks. The scorching pace of the depreciation can have strong implications.
?A 1% rupee depreciation causes an approximately 3% increase in oil under-recoveries. Together with a fertiliser deficit, we estimate a 1% rupee fall to cause an additional Rs 7,000 crore plus in government deficits, about 0.15% of GDP. In an environment where oil, food and fertiliser deficits are nearly double those of the same time last year, the burden is costly, not just for the government but for the entire economy,? points out a Credit Suisse report on the currency movement.
The report adds that the rupee fall also exerts pressure on inflation through cost-push factors. This is despite the caps placed on the prices of many resource products. In India’s import basket are petroleum products, coal, iron ore, non-ferrous metals, etc ? many of which are raw materials whose prices are not capped.
A Morgan Stanley Asia Pacific research report puts the matter grimly and suggests that the rupee could depreciate by about 5-7% against the dollar in the next six months. It also voices its concerns, ?On a trailing four-quarter basis, the current account deficit excluding remittances (a better measure to assess the implications of the currency?s valuation for trade competitiveness) remains high at around 4.5% as of December 2007. A sharp rise in oil prices would result in further widening of the current account deficit.?
Barring exporters, particularly in the services sector, the prospects of other corporates could materially suffer because of multiple factors, says Credit Suisse. The impact is relatively muted owing to translation losses on external debt (even if completely unhedged, a 1% rupee fall would cause less than a 0.8% decline in market earnings per share for FY09 on this factor, they reckon).
Looking ahead
With India Inc?s earnings clearly under pressure, experts reckon that companies that will be able to pass on these costs to consumers will be able to weather the storm without much damage. The raw deal will be for the individual investor who is now facing negative returns from the traditionally safe fixed deposit route. And borrowers, they definitely need to postpone debt initiatives at the moment.
The real challenge, however, is for the politicians, who face an election year ahead. To make good the losses for oil marketing companies, it will require a 10-15% rise in petrol and diesel prices, in the least. And if this happens there will be blood on the street as inflation will shoot up by 1.5-2% straightaway. Delaying this rise will strain the government?s balance sheet anyways.
A marked lesson out of this predicament is that inflationary cycles can be extended or avoided by having a proactive outlook on demand and supply numbers in the economy. That the cement and steel companies are running at near capacities was known since the last two years, and some proactive steps to increase the pace of execution would have helped. And this required creating better infrastructure, especially where power, roads and ports are concerned. There has been a huge gap there, reckon economists. Of course, the oil price rise is exogenous.
Now, the industry is looking at the government and the central bank to step in and take measures. Flush with foreign exchange reserves, the Reserve Bank of India can always intervene and stem the dollar appreciation. The next three months may just be the most critical months faced by India Inc.