The Slowdown Scare

So,in all likelihood,the RBI will continue with its tightening stance. In its review mid-September,a 25-50 basis point increase in repo rate to 8.25-8.5 per cent doesnt seem implausible. With such pronounced hikes,a slowdown is inevitable,but what worries many in Corporate India is the possibility of a precipitous fall given the worsening domestic investor sentiments and hugely uncertain global environment. In other words,they fear that a persistent high inflation,rising cost of capital and a discernible policy drift at home,together with the possibility of a double-dip recession in the US and a looming European debt crisis,will derail the India growth story.

The volatility in Indias stock markets,despite repeated assurances by policy-makers including Finance Minister Pranab Mukherjee and SEBI chief U K Sinha,reflects the underlying tension of not just global institutional investors,but also domestic retail investors.

In a television interview,Indias biggest individual investor,Rakesh Jhunjhunwala,advised others not to indulge in bottom fishingtrying to buy stocks cheap given the 8 per cent fall in Nifty,the 50-stock benchmark index of the National Stock Exchange. Despite strong IIP Index of Industrial Production numbers,the Nifty dropped 65.35 points or 1.29 per cent to close at 5,072.95 on Friday. Many technical chartists say the Niftys next support level after it closes below 5,000 will come only at 4,700. This may or may not happen,but it does give a sense of despondency that has gripped India watchers.

INFLATION MATTERS MOST8230;

C Rangarajan,chairman,Prime Ministers Economic Advisory Council PMEAC and former RBI governor,said,Though international commodity prices are now softening,RBI will closely monitor the inflation data for the next four weeks before taking a call on monetary policy. Inflation is the major responsibility and RBI can only consider lowering rates if prices decline.

Jahangir Aziz,who was India Economist at JP Morgan and has now shifted to Washington DC,agreed and said,Just from the data flow thats coming out of Asia,it doesnt look as if the slowdown will be sufficient to bring down core inflation without further significant rate hikes. He also cautioned that if developed markets,especially the US,goes in for another round of substantial monetary easing,global commodity prices could once again start rising. Some in India had already started betting on a reversal of the rate hike cycle given the week-to-10-day-long softening of metal and crude oil prices.

Monsoons too have been playing truantthough rainfall has been 14 per cent above normal this past week,the India Meteorological Department has forecast below normal rains for the country during the second half August-September of the current south-west monsoon season. This could mean that food prices could continue to soar,giving little or no let up in food inflation and pushing the central bank into more rate hikes.

There may be some trade-off between growth and inflation when inflation is at 4-5 per cent,but there is no such trade-off when inflation is running in double digits. If rates arent tightened and inflation brought down quite quickly,I think well learn about the lack of this trade-off the hard way, Aziz said bluntly.

8230;SO DO RATE HIKES

For the corporate sector,a tighter monetary policy has put a virtual freeze on their expansion plans. At a time,when all available data indicate a clear slowdown in industrial and economic output,this is a matter of great concern since there could be a tipping point beyond which salvaging a downward spiral of growth could be an arduous task8230;It is imperative now that non-monetary measures are rapidly deployed to deal with supply-side issues,which continue to contribute to inflationary pressures, CII Director General Chandrajit Banerjee had pointed out after the RBIs surprise 50 basis point rate hike on July 26.

Already,higher lending rates have led to a decline in bank advances,once again reigniting the growth versus inflation debate. Recent RBI data reveals that credit growth declined to 18.5 per cent on an annual basis as on July 29,compared with 19.33 per cent a fortnight before.

Though industrial output did revive in Junemany say it may not sustainother indicators are pointing to a slowdown in the economy as high inflation and even higher interest rates eat into consumer appetites. Most of this rebound in IIP is because of capital goods. Except capital goods,there has actually been a slowdown,so sustainability of this trend is actually in question, said Sonal Verma,economist,at Nomura.

For instance,car sales fell to a three-year low in July and plunged 16 per cent. According to the HSBC Purchasing Managers Index,Indias factory output fell to a 20-month low to 53.6 in July. Leif Eskesen,chief economist for India amp; ASEAN at HSBC,said,The momentum in the manufacturing sector eased further in July as sequential growth in output and new orders slowed.

More worryingly,foreign fund raising plans of Indian companies could also be hit with the increased uncertainty in international financial markets after the US debt downgrade. Sudipto Mundle,Professor Emeritus at the National Institute of Public Finance and Policy and a member of the RBIs Technical Advisory Committee on Monetary Policy,believes that the downgrade could lead to a flight of capital much like 2008. FIIs will tend to move out to safer havens and will pull back funds from emerging markets, he said. This will dissuade the corporate sector from raising funds given the sluggish sentiments in the secondary markets.

THE POLICY DRIFT

Investor sentiment is getting further eroded by the governments own policy paralysis,which was also highlighted by industry leaders in a recent meeting with Pranab Mukherjee. Its also evident in the ongoing session of the Parliament,where controversy ridden UPA-II remains silent on key reforms and pending legislation.

A combination of factorsincluding persistently high inflation,higher cost of capital,cut in fiscal spending to GDP,weak global capital markets and slow pace of investmentwill cause a further slowdown in growth, investment bank Morgan Stanley said in a report last month,where it slashed Indias GDP forecast to 7.2 per cent from the earlier 7.7 per cent.

A concerned PMEAC has warned the government that its delay in carrying out urgent reforms could prove costly and hurt growth. The uncertainty arising from political developments has had a very negative impact on business confidence and investment outlook, it said in the Economic Outlook for 2011-12,where it slashed growth forecast to 8.2 per cent for the current fiscal from an earlier estimate of 9 per cent.

UNCERTAIN GLOBAL OUTLOOK

The contagion in the world economy has now made the government also accept that the economy may not fare as well as it had initially projected. The finance ministry is expected to revise its growth forecast after the first quarter GDP numbers are released on August 31. In an internal note last month,the ministry had cut its growth estimate to 8.6 per cent for the fiscal from the Budget expectation of 9 per cent.

More than the US credit downgrade,what will impact the Indian economy is the slow growth rate in the US. The US economy is expected to grow by just 1.8 per cent in the current fiscal,and this will have significant implications for India in terms of trade flows and credit flows, said Rangarajan.

Though exports have been doing well and grew at a record 82 per cent in July,they are expected to be hit by the crisis in the EU and US that together account for nearly 35 per cent of Indian exports. It is simply not sustainable. We should see immediately by August-September growth rates slipping, commerce secretary Rahul Khullar warned after the July trade data was released on Thursday.

Across much of the developed economies,all signs are pointing to a slowdown,if not a full-blown recession. The Eurozone is deeply in debtGreece,Ireland and Portugalhave already been bailed out by the IMF; while Spain and Italy too may need to be rescued. While the recent rioting in the UK could further worsen matters,the French economy spluttered to a halt with zero growth in the second quarter.

The US,with a 1.1 trillion budget deficit,plans to put in place severe spending cuts,fuelling worries that it would further impact the already teetering growth. The US grew a mere 0.4 per cent in the first quarter of 2011 and 1.3 per cent in the second quarter. Unemployment continues to remain above 8 per cent for the 30th consecutive month in Junethe longest since the Great Depression. Consumer confidence is at a record low and manufacturing has grown at its slowest pace in two years in July.

The gloom and doom in the world could,however,have one silver lining for India,which could become a more attractive destination for capital flows. There is a line of thought that what is bad for the developed markets is good for the emerging markets8230;Once the dust settles down,investors will seek out the stronger balance sheet,higher growth,and higher inflationary environment of the emerging market world, Aziz said.

For this to happen,Mukherjee cannot just depend on his luck. He needs to stop being defensive about the policy drift,acknowledge it and then move at double speed to restore confidence in the domestic economythe only antidote to global uncertainties.