It was as if someone flipped a switch at midnight, December 31, 2011. The flipping of that switch magically turned around all that was terrible about India’s economy into the zone of happy faces and markets headed north.
If you’d bought the 30-share Sensex on December 30 and sold it 45 days later, you’d be 16% richer. Some stocks are up between 30% and 100% in the same time. The rupee, among the worst performing currencies in 2011, is strengthening against the dollar. Finance minister Pranab Mukherjee can finally afford a smile: inflation, which had raged at two-digit levels for nearly two years, is below 7%. Even better, the prices of food, which hit aam admi where it matters most, have actually dropped as vegetable prices cooled rapidly. No wonder, analysts Sujan Hajra and Gautam Singh at brokerage Anand Rathi expect the Reserve Bank of India (RBI), which had hiked interest rates through the last 18 months to rein in inflation, now expect the central bank to cut rates in another six months.
A cut in interest rates will drive down borrowing costs for mortgage holders and businesses, lower the effective cost of car loans and allow banks to lend more freely. A rate cut can boost growth, which has sagged from 9% levels to below 7% now. At HDFC Bank, a team of economists headed by Abheek Barua expects the RBI to cut rates in April, after finance minister Pranab Mukherjee presents his Budget in March 16 and makes his policy goals clear. Economist Pronab Sen, a member of the Planning Commission, doesn’t expect the RBI to ease up on interest rates so fast, “I’d look for at least two more months of declines in manufacturing prices before cutting interest rates.” Sen is keeping a wary eye out on the prices of manufactured goods. Indeed, the three biggest contributors to inflation over the last two years have been oil, metals and minerals and chemicals. The prices of these have soared, even during a global recession, driven by speculation in global commodity markets.
Ruchir Sharma, who moves large amounts of money in and out of emerging markets for Morgan Stanley, recently said that the biggest threat to global growth was the high prices of commodities. These drive up the prices of manufactured goods, stoking inflation and smothering growth around the world. The RBI hasn’t let its guard down on inflation. It conducts regular surveys of households to gauge their expectations about inflation. Its latest survey found that over 75% of households expect inflation to be above 9.5% levels one year down the line.
Another thing that could drive up prices is a vast tsunami of cash blowing in from the West. To prop up its economy, the US and European nations have already printed large amounts of money. European central banks have promised to print even more cash. A lot of those dollars and euros will wash up in high-growth emerging markets like India and inflate prices as they get converted into rupees. But just how much excess cash is out there?
“I’d reckon that after Europe starts pumping in money, the total excess liquidity worldwide will be $5 trillion,” says Sen. That’s 5 followed by 12 zeros, or roughly five times the size of India’s entire economy.
While economists worry about what this money can do to inflation, marketmen can’t wait to see it pouring in. A big infusion of overseas money is almost certain to lift India’s equity markets and could trigger another bull run. However, for foreign investors to get truly excited about India, policymakers will have to show that they’re back at work.
An official in the office of prime minister Manmohan Singh is upbeat about the prospects of revival, “We’re trying to sort out bottlenecks in sectors like power, coal, infrastructure and so on. The prime minister often chairs as many as four meetings a day.” Many analysts expect India’s fiscal deficit, the gap between what the government spends and what it gets in revenue, to balloon to 6% of its economy, much more than the 4.6% number that Mukherjee had budgeted for last year.
But it might not be so dire, says Sen, “I’d reckon that the actual deficit would be close to 5% of GDP.” But as he sets out to balance his books finance minister Mukherjee’s biggest worry could be the fiscal mess in three states: Punjab, Kerala and Bengal. Punjab’s deficit is expected to worsen to nearly 4% of the state economy, from less than 3.5% two years ago. Its farm economy has peaked out and industry is sputtering. Its government says sops for nearby Himachal and Uttarakhand have lured its industry away.
But the Akali-BJP regime sacked its own finance minister when he dared ask for reforms. Kerala might also need a bailout, though its deficit is lower than Punjab’s, at around 3.5% of the state economy. Bengal’s fiscal mess, a legacy of 34 years of Left rule, is gigantic: during the election campaign last summer, a figure of Rs 200,000 crore was touted as its total debt. But nobody knows whether the number is correct. For decades, the Left’s MIT-educated finance minister, Asim Dasgupta, managed to miraculously balance budgets despite plummeting revenues and soaring spending. Even today, official numbers project Bengal’s deficit falling to 2.5% of the state economy this fiscal, from 3.4% levels two years ago. Bengal’s rookie finance minister Amit Mitra traveled to Delhi recently to pitch for a bailout package to fellow Bengali Mukherjee. His demands, which topped Rs 80,000 crore, included a Rs 66,000 crore handout to repay debt and interest over three years.
Such large handouts might not gel with Mukherjee’s plans as he tries to shrink the deficit and prop up growth. Expect a sensible Budget, not a Santa Claus one. Expect a surge in the markets and plan for higher inflation as well, as growth seeps back into the economy.
