Has India lost its steam and its will to reform?

Despite all the strengths and advantages espoused in favour of the India shining story,

If the policy inertia continues with no major reform initiatives forthcoming and the fiscal situation continues to worsen India could see itself facing an external liquidity crisis akin, early 1990s.

  • Why is still there a sense of pessimism and anxiety amongst both investors and international observers alike?
  • Why is the mood on the street downbeat?
  • Why is growth faltering when, India to a great extent was supposed to be buffered to external shocks? At least this is what investors were given to understand and supported to a certain extent by India’s quick recovery from the 2008 crisis. Recovery that was largely attributed to the low global exposure of India’s economy.

Facts on the ground speak otherwise. Links between India’s financial and corporate sector and global financial markets are diverse and manifold and this “financial” channel, notwithstanding the capital controls, is now a powerful mechanism to transmit global shocks to the Indian economy. (Source: New research by Ajay Shah and Ila Patnaik, BS edition 14-Jan-2012)

Were Europe to get into a full blown crisis, we are really not sure what would be the government’s strategy now given the severe loss of reputation for economic and political management that it has suffered.  If the policy inertia continues with no major reform initiatives forthcoming and the fiscal situation continues to worsen India could see itself facing an external liquidity crisis akin, early 1990s. And this time it would be even more difficult to dig ourselves out of the external payment mess:

  • Primarily because of the overhang of maturing external debt, our forex reserves of $300bn may not be sufficientto help us tide over an external shock.
  • India’s corporate sector is likely to be the worst affected where a combination of depreciated rupee and a bear market is adding to the stress of corporate houses with foreign currency borrowings, whether FCCBs or ECBs.
  • New investment proposals in 2011 are at a 5-year low, falling 45% to Rs 10.46lakh crore from Rs18.88lakh crore a year earlier. While private sector investment proposals declined 48% y-o-y, investment by the government, struggling to meet fiscal deficit target, declined by 40%.

Even if the external payment crisis were to be avoided, lower investment levels could lead to a long drawn-out crisis of sub-seven percent growth, well below the 12th Plan’s goal of nine percent, in process triggering a series of unpleasant social, economic and political cycles.

  • The absence of meaningful policies to substantially increase job opportunities for un-skilled and semi-skilled labour could convert the so-called demographic dividend into a demographic nightmare, of unemployment and social unrest.

Drifting into a 6% growth trajectory, the country now seems to be losing confidence. With

  • combined fiscal deficit at an unsustainably high 8% plus of GDP,
  • headline inflation close to 7.5%,
  • foreign trade (goods) deficit over 10% of GDP,
  • current account deficit approaching 4% of GDP,
  • external commercial debt at record high,
  • skittish capital inflows and an uncertain and weak global economic situation, the macroeconomic signals for India are already flashing red.

This time around

  • RBI has less leverage on its monetary policy to resolve a crisis situation.
  • As for the fiscal policy, we do not have the cushions that were available in 2009 and 2010, essentially confidence of the government in its competence of economic management symbolized by sustained fast growth.

Whatever could go wrong, went wrong in 2011. Can India now look forward to a rapid growth path going forward. What needs to be done?

  • With the government’s reform credibility and fiscal management reputation severely challenged, it will be quite some time before we can get back to the heady days of 9% plus growth trajectory.

The Markets

The real difference between a bull and bear case in 2012 seems to be the government.  Will it come out of its policy inertia and take decisions that will enthuse investors or give in to internal and coalition constraints and cater to the populist agenda to win votes. Only time will tell and the UP elections could be the defining moment for this government.

  • From a valuation perspective markets are trading below their long-term averages both on a trailing and forward basis and provide an attractive risk-reward benefit.
  • The marked slowdown in the Indian growth story has led to earnings forecast cut by 11% since last year. The FY12 expected EPS has been cut from 1263 in December 2010 to 1130 in December 2011.

From a domestic perspective, governance and policy inertia seems to be the only impediment to investor sentiments, where even the rate cuts by RBI would not be enough to start a capital expenditure cycle, as policy constraints will continue to hamper investments.

From a global perspective, debt issues in the euro-area continue to keep investors on the edge and are a key risk to financial markets across the globe. Where any possibility of a disorderly outcome could cause financial markets to freeze.

Tough call for investors to make under these circumstances.

  • However, if you believe in the ability of the euro-zone members to resolve their debt problem and hope on a policy revival on the domestic front (though not backed by any evidence on the ground so far), hope that something has just to happen and that the long-term future of India will not be sabotaged by petty vote-bank politics, then current valuations provide an attractive entry point for investors.
  • Else, the market may provide more attractive a window of opportunity going forward, irrespective of the valuation that currently prevail.
Data & Information reference: Business Standard editions from 10-15 January 2012
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