One could argue that India’s normally strong animal spirits have been “beaten down” by corruption scandals and economic uncertainty, which may explain the flight of capital from India, he said. But at the same time, he noted, the amount of money Indian companies are spending to invest abroad has not grown relative to the amount of money foreign corporations are spending in India. That indicates that businesses, at least, aren’t running for the hills yet. With all the headwinds India faces, it may be difficult to be blue-sky optimistic about the country. But with an improved fiscal situation, favourable harvest weather, the possibility that a depreciating currency could boost exports and the fact that interest rates are unlikely to stunt growth as much as is widely expected, it would also be wrongheaded to write off India just yet….
It’s hard to be optimistic about India right now. Asia’s third-largest economy is growing at the slowest pace in a decade, the trade gap is widening, the rupee is plunging and the Government’s cost of borrowing is soaring as confidence evaporates and investors flee. The wave of negative news has fueled speculation that India could be hurtling toward another economic disaster, something in the magnitude of the 1991 balance-of-payments crisis when the Government, on the brink of default, shipped its entire gold reserves to Europe to secure an emergency loan from the International Monetary Fund. India’s economy is a lot bigger now, meaning that a repeat of that scenario would have a much greater impact on the world economy this time around. All this makes for scary reading, but is the situation really that bad? Perhaps not. Credit Suisse Head of Southeast Asia and India Economics Robert Prior-Wandesforde suggested in a report last month entitled, “India: Recovery Cancelled?” that the doom and gloom about India may be overdone and, contrary to the view of many market observers, he was cautiously optimistic about the country’s economic outlook. Prior-Wandesforde said the naysayers are “focusing too much on the here and now and too little on the fundamental drivers of activity,” which he says are “clearly more supportive” of economic growth in fiscal 2013-14 than they were in the previous year. “In some ways, the current situation reminds us of mid-2012, when virtually everyone had given up hope of ever seeing wholesale price inflation fall and the central bank cutting policy rates further,” Prior-Wandesforde said. Those gloomy expectations were proved wrong. The Reserve Bank of India has cut policy rates three times so far this year. Wholesale price inflation slowed at the end of last year to around 7.3 per cent in year-over-year terms and then began falling in March. By May, WPI had hit its lowest level in nearly four years at 4.7 per cent. “Sometimes, patience is indeed a virtue,” Prior-Wandesforde noted.
Prior-Wandesforde’s glass-half-full view does not mean the Credit Suisse economist is reading India’s bleak data through rose-tinted glasses. The bank has cut its fiscal 2013-14 average GDP growth forecast to 6 per cent from 6.5 per cent, and lowered its projection for the following year by half a percentage point to 7 per cent. But Credit Suisse remains at the top of the consensus range, and Prior-Wandesforde lists a number of reasons why the bank maintains a relatively optimistic outlook amid what seems like a slew of worrisome data.
For starters, even the remarkable drop in the value of the rupee against the dollar that has been roiling India in recent days may turn out to be a good thing if it can boost the country’s exports. The Indian currency has fallen more than 6 per cent against the greenback since the beginning of August. It isn’t the only emerging market currency taking a plunge – the Turkish lira, Indonesian rupiah and several other emerging market currencies have also fallen sharply, as markets have braced for the U.S. Federal Reserve to start tapering the monthly asset purchases that have kept interest rates low and sent investors to emerging economies. Even as Treasury yields rise and the dollar strengthens, India’s significant current account deficit and slowing domestic growth have made the rupee particularly vulnerable among emerging market currencies, Credit Suisse’s fixed income research team explained recently in a note entitled “Emerging Markets Under Pressure.” While the 15 per cent plunge in the value of the rupee against a basket of trade-weighted currencies since July 2011 has been blamed for increasing the cost of imports, thereby fueling the current account deficit, Prior-Wandesforde argued that the weak currency could yet have a silver lining for exporters by driving down the cost of Indian goods at a time when domestic demand in Western markets is recovering. That hasn’t happened yet, but it takes time for export levels to reflect currency shifts. In other words, “it is too early to give up hope of seeing exports recover,” Prior-Wandesforde argued.
Prior-Wandesforde acknowledged that one of the chief risks to the bank’s relatively sunny outlook is that Credit Suisse may have underestimated the risk of an external financing crisis. But that seems unlikely, he said, noting that India’s foreign exchange reserves of $252 Billion at the end of July “buy it valuable time” to get its financial house in order and avoid a full-blown crisis like the one seen in 1991. “India’s foreign exchange reserves represent the equivalent of five to six months of total imports and comfortably cover short-term external debt; in 1991 reserves fell to about three weeks worth of imports,” he said. Low interest rates had been a driving force behind Credit Suisse’s optimism about India’s growth potential, but the Reserve Bank of India also faces pressure to defend the currency. It started to do that in July by both setting a ceiling on how much banks can borrow from the central bank and charging more for short-term borrowing – effectively tightening the money supply and pushing up interbank borrowing rates, one-year commercial paper rates and the yields on 10-year Government bonds.
But after 10-year yields topped 9 per cent on Monday, up from around 8 per cent when the measures went into effect, the central bank announced that it would buy 80 Billion rupees ($1.2 Billion) in long-dated Government bonds to inject liquidity into financial markets, lower Government borrowing costs and shore up bank valuations that had been hard-hit by the currency slide. “The interest rate outlook could hardly be described as crystal clear,” Prior-Wandesforde said in the note, especially since the central bank will welcome a new governor in September. But citing a statistical analysis that probed how various rates impact the Indian economy, the Credit Suisse economist said that the economic impact from interest rates should be limited this year as long as the central bank doesn’t raise the repo rate and commercial lending rates do not rise.
India’s relatively healthy balance sheet is yet another cause for optimism. Officials face much less pressure to cut costs this year than last year, when the federal Government reduced spending by the equivalent of 1 per cent of GDP to curb its budget deficit and avert a sovereign credit downgrade. India’s Finance Ministry is well placed to meet this year’s fiscal deficit target of 4.8 percent – down from 4.9 per cent in the prior year — without having to implement further austerity measures. That should relieve some of the downward pressure on economic growth.
Then there is the weather. Early monsoon rains in southwestern India, a major breadbasket for the country, had boosted the size of planted crops by nearly 20 per cent year-on-year by the end of July. Notwithstanding the damage done to some crops by the above-average rainfall, the “omens for the autumn harvest are relatively favourable at this stage,” Prior-Wandesforde said. A bigger harvest could feed into higher GDP growth and ease inflation in a country where food accounts for 45 per cent of the consumer price basket. In Prior-Wandesforde’s view, the biggest risk to Credit Suisse’s assessment of the Indian economy may just be fear. One could argue that India’s normally strong animal spirits have been “beaten down” by corruption scandals and economic uncertainty, which may explain the flight of capital from India, he said. But at the same time, he noted, the amount of money Indian companies are spending to invest abroad has not grown relative to the amount of money foreign corporations are spending in India. That indicates that businesses, at least, aren’t running for the hills yet.
With all the headwinds India faces, it may be difficult to be blue-sky optimistic about the country. But with an improved fiscal situation, favourable harvest weather, the possibility that a depreciating currency could boost exports and the fact that interest rates are unlikely to stunt growth as much as is widely expected, it would also be wrongheaded to write off India just yet.
– The Financialist