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BW Businessworld

India Has Shot Itself

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Many believe that the current downturn has taken the Indian economy to a new depth — one that was not reached even in 2008. As a result, 2012 is beginning with depressed sentiment as far as the economy goes. The US and Europe have also had their share of jitters. As we enter 2012, are things looking slightly better on the global front? Can India shake off its policy apathy and manage affairs better so that Indian businesses begin to invest again? Will FII flows come back and when? Do we continue to live with inflation as it is today or is there hope that it will fall to 5 per cent again sometime in the future? Abheek Barua, chief economist, HDFC spoke to BW's Anjuli Bhargava on these issues. Excerpts:

What's your prognosis for 2012 — both for the global economy and India?
The US could well be the big surprise. Despite deep pessimism building up for the past few months, the numbers coming in are encouraging. Retail sales are up, unemployment figures are down. Consumption is up. There's still a problem with housing, and of course, debt, which is a long-term structural issue. But from a cyclical point of view, there is a bounce up that will have profound implications for risk taking and capital flows.

Europe remains a problem. Again, I would be careful about painting too grim a picture there because things are beginning to happen. Many countries — be in Italy or Greece — are getting their act together. There may be a fundamental problem with the way they are structuring their recovery; they may be stressing too much on austerity and compression of  government spending, whereas the need of the hour is to spend more in some areas.

Europe affects us quite a bit because we borrow a lot from their banks. They stopped lending or have started winding up their exposures to India and that has hurt the rupee.

Will the US recovery help counter some of the negatives of Europe for India?
The US is trying to adopt an aggressive export-oriented strategy, so I am not sure it can provide enough of an
offset to Europe. It will have an impact in risk taking and inflows. Contrary to popular perception, we are closer to Europe in  economic linkages than to the US. In fact, EU happens to be our largest trading partner.





What about the rupee value?
The rupee will settle at about Rs 50-51; it has been oversold. I do not think we will see further depreciation, contrary to market predictions. When the rupee depreciates, usually, there is a dollar shortage in the market. It has not happened this time. Similarly, the rupee depreciation has not helped exports this time. But there has been a rapid import substitution for SMEs — there is evidence of that. This is good for the economy as it helps domestic production. So, the impact of the rupee depreciation will work more through import substitution rather than boosting exports.

How will things pan out for India in terms of FII inflows that have dried up?
If the US starts to show sustained signs of recovery, it will bring about a change in the risk appetite, and this could flow into emerging markets including India. Given our problems, we are likely to underperform. But we will still get some incremental flows. So, FII inflows may recover by sheer default; we may not have done much to deserve it. What happens to us may be more a result of what happens to the US and Europe than our own doing.

Why has the RBI gone on increasing interest rates despite it seeming to have no significant impact on inflation?
The RBI's stance is that if they had not hiked interest rates, inflation would be higher still — 12 to 13 per cent. Those critical of the hikes were those who believed that inflation was being caused more by a supply side shock. But I do partly buy the RBI's argument because if you look at core inflation, it had also started picking up and had risen to 8 per cent. Then from August-September, it started flattening out. That could be due to the rate hikes.

So, when do we see inflation reach 5 per cent?
We do not see inflation coming down to 5 per cent again. The RBI is indicating that the new normal level of inflation could be around 7 per cent by March. We are no longer aiming for 5 per cent. 
Just like the rate of growth, then?
Well, the RBI has said that there was overheating and we needed to cool down the economy, from, say
9 per cent to around 8 per cent. Now of course we have gone far below to 7 per cent, but that may be due to factors other than the rate hikes. Sentiment has played a major role.

Don't we tend to overreact? All of a sudden everyone says the heavens are falling and then we realise they are not...
Sentiment is a loose term. But we have seen many conflicts in projects, whether with the environment ministry or other regulatory bodies. Take for instances, land acquisition issues of Posco and Lavasa. This has seeped through to second-rung steel projects. Then, we have had problems with power projects. The policy paralysis made things worse. A lot of the big investments have been hit by regulatory and policy issues. Where it didn't have much impact earlier was brownfield expansions, auto-components and consumer durables. But many companies had an ECB line; so even if domestic cost of capital was high, blended cost was lower. That has changed over the past 2-3 months because of increased hedging cost and reduced money flow from Europe.

With the fiscal deficit numbers expected to be larger than anticipated, does one see a crowding out of private investment?
I don't think so. The deficit numbers will have more of an impact on investor sentiment than any kind of crowding out.

Are things in the Indian market as bad as in 2008?
Possibly worse. The government line has been: look at the US and Europe and see what can be done. But that's not true. We have shot ourselves in the foot by not doing a number of things. Flip-flopping on issues like retail FDI do not help. Not that we would see a flood of FDI come in, but it affects a bunch of other decisions and impacts sentiment. I now handle investor relations with a bunch of my colleagues in the bank. This is a real issue. Not only do they miss why certain policies are not being introduced, but also do not understand the mismanage-ment of whatever they are trying to push through. It is hard to understand who is advising the government.

Illustration by Anthony Lawrence

In general, the perception is that fiscal and policy management has been a bit wobbly. But so far, monetary management has been good. For the first time, we are seeing a wobbly RBI. One day they say we don't intervene in curren-cy markets and the next day, there are string-ent measures which put people off — not allowing you to cancel and rebook contracts.  So, we are seeing in a sense mismanagement of both fiscal and monetary policy.

Let me also point out a couple of positives. Within India, Gujarat, Maharashtra and even Tamil Nadu, the pessimism does not seem to be that strong. The rural story remains strong. From the bank's perspective too, not just in terms of providing crop loans, but a whole bunch of other financial services, there is a lot happening in the rural market. The entire composition of growth has changed. India, like in China till the mid 2000s, has kept the terms of trade for agriculture depressed and kept rural wages low. This has benefitted manufacturing but this has now changed.

At a macro level, what can change the grim prognosis of today?
Once we get an indication that interest rates have peaked and are starting to come off — although I believe that rates don't make such a difference — the sentiment will begin to turn around. A cut may happen as early as January.

Then, this import substitution — which I don't think we have given enough attention to — will play a role. We believe this is happening very rapidly. It is so far anecdotal: we see this through our treasury operations. But it will get captured by the time we get the November-December IIP. We will see a pick up in the intermediate and components of the IIP, which again is a good development.

(This story was published in Businessworld Issue Dated 09-01-2012)