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Economic recovery? Aren't we being too optimistic?

By Abheek Barua
May 11, 2009 13:55 IST
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With the local stock-market seeming reluctant to shed its recent gains, the community of financial market analysts and economists are suddenly discovering signs of a recovery in the Indian economy. Some of them are not just content with calling a bottom.

A growing number of research reports that I come across seem to believe that the recovery can be quite sharp this year.

GDP and company earnings forecasts are being revised up with a vengeance. Let me give you an example of how mood in the investment research community has turned. A blue-chip British bank's researchers seemed confident as recently as March that headline GDP growth for India for 2009-10 would print at 4 per cent or less.

They seem just as sanguine last week when they raised its forecast by a good percentage point and a half.

I don't see myself as a card carrying be ar and am perfectly willing to accept the argument that the market has seen its worst and is likely to consolidate its gains going forward. What bothers me though is the premise is that the recent turn in the market is under-pinned by a steady and increasingly visible economic recovery. If indeed investors are returning to the market on this premise, they might be seriously disappointed in the near future.

For one, I am fundamentally uncomfortable with the perception of the economy as a somewhat user-friendly gadget with convenient 'on' and 'off' buttons. It cannot suddenly rev up simply because a bunch of money managers in Singapore, New York and Mumbai suddenly feel a little upbeat about investment prospects. If the experience of the late nineties and the first three years of this decade are anything by, the Indian economy has huge inertia and it usually takes a while to get out of its funk.

Economic indicators that I consider reliable (like bank credit) do not show any significant inflexion. Current accounts held by small and big businesses at banks that usually reflect the volume of business-related transactions up a turn in business transactions remain sluggish. There is very little evidence that investment activity is picking up either in the private sector or in infrastructure, save for a pipeline of planned equity issues investors over the next few months.

I must remind readers that a much heftier schedule of public offers had been planned in early 2008. Barely 10 per cent of it saw the light of day as the financial and economic crisis unfolded. The intention to raise money is not a sufficient condition for investment revival.

Money raised specifically for infrastructure is lying with the institutions that raised them. For instance, I am told, that the Rs 10,000 crore (Rs 100 billion) that the India Infrastructure Finance Corporation Limited (IIFCL) raised earlier this year is languishing in a bank account. Export growth is abysmally low and given conditions in the external market any major recovery seems somewhat unlikely.

There are some sectors like steel and automobiles that have seen some visible momentum over the past few months. I am not convinced that this will sustain. I am yet to hear a convincing explanation from either car makers or component producers for this up-tick in car sales.

The 'default' hypothesis is that increased government salaries have created a new pool of demand. The effects of these cash transfers are known to be temporary and I won't really be surprised if after a couple of months, auto sales turn down again.

In the case of steel and some other industrial inputs, the rise in production might just reflect a short term inventory adjustment and not fresh demand. Companies that adjusted their production schedules in the wake of a severe working capital crunch in the last quarter of 2008 had pared their inventories to a bare minimum.

Falling loan rates and easier access to capital have led them to increase production and hold more finished goods. This again could be a short term phenomenon.

I don't mean to be unduly pessimistic. The Indian economy is, as I mentioned, prone to inertia. Inertia works both ways-- while it is likely to thwart a quick recovery, it was also responsible for arresting the rate of decline in growth over the past few months.

A large share of domestic demand and a significant rural market for a swathe of products and services share set a floor to growth rates. Fiscal stimulus, particularly the 'default' stimulus that came from a pay hike also helped in steadying demand.

I have always believed (as have many others) that 5.5-6 per cent GDP growth really constitutes a bottom for India's growth rates. We are operating close to that level. That, given, our past record is dismal enough and constitutes a major slowdown. My guess is that we will take another year or perhaps more to get out of that growth band.

What is the brouhaha in the markets about then? My sense is that analysts who competed with each other in their pessimism about India's when the financial crisis peaked in October had failed to recognise that the Indian economy is far less nimble than others when it comes to either moving up or down.

Many of them simply applied the models that they used for other Asian economies that are far more export-driven and thus see wilder swings in growth on the back of business cycles. These analysts are now revising their forecasts to more sensible levels. That hardly constitutes a recovery

If financial markets are patient and forward looking enough to price in a longer term recover, our local markets could stay put in its current range and perhaps even gain some more. The international environment is clearly working in our favour.

While the world economy continues to contract, the rates of contraction seem to dwindle and investment managers are paying close heed to this nuance. Global risk appetite seems to be increasing and yield-seeking fund managers are dumping cash and return to emerging markets that have large local consumption bases. Indian market could continue to benefit if this persists.

If, however, investors need a steady dose of good news on economic fundamentals to sate their appetite, there could disappointment ahead.

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Abheek Barua
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