Twice shy

Once bitten by the global meltdown, India has to hedge its growth story

Is history repeating? Various multilateral and Indian agencies are once again forecasting mouthwatering economic expansion for the country in the current year. This sounds familiar. Rewind to a couple of years ago, when India was expected to notch above 8% growth for the next few years despite the first signs of credit crisis in the US markets. Then, as now, growth projections were based on domestic consumption. The theory of decoupling was being bandied about. There was buzz about imminent capital controls to slow the foreign exchange inflow to cap inflation and interest rates. A few months down the line, there was a dramatic reversal in the situation. The concern was to insulate the Indian economy from the drying up of liquidity in global markets. The Indian government followed the US and China in announcing a fiscal stimulus package including cut in excise duties to pump up demand. The central bank loosened money supply. This had the desired impact. The markets bottomed out and doubled their value from their lows in the last fiscal as foreign funds started coming back on prospects of India repairing the imbalance in its expenditure and revenue following funds mopped up from the domestic market by a clutch of PSUs, successful auction of third-generation spectrum and broadband and wireless access , and hike in fuel prices. Growth is back on track, particularly since the second half of the previous fiscal. Manufacturing output in the first few month of the current year too is rising. Tax revenue is buoyant, eliminating the need to completely withdraw tax breaks. The markets have broken out from the 17,000 levels. Do these signals signify that the worst is over for India? What has changed that India can afford to ignore the still raging storm in the developed economies?

The IMF has imposed austerity measures in Greece to bail it out of its sovereign debt default crisis. Outlook of the euro zone is still cloudy. Japan’s growth remains flat. The slow recovery in the US is neither accompanied by spurt in jobs nor investment by the corporate sector, raising fear of deflation as the US Federal Reserve has no more scope to lower interest rates. China is under pressure to let its currency appreciate and is putting cap on money supply, which will slow its and, consequently, global growth. If not recession in west, India’s inflation partly contributed by food grain demand-supply imbalance and partly by foreign capital inflow, has the potency to effect a slowdown as the central bank makes credit costly. Yet, there is increasing decibel levels about decoupling on one hand and how global Indian markets are becoming. Cross-border mergers and acquisitions and fund raising imply repercussions on the bottom line of the parent and the home country beyond depreciation in contract value. So will things be different this time? The Indian economy can remain immune from withdrawal of foreign portfolio investors if the global economy once again dips into the last leg of recession if it can ensure that capital expenditure plans including capital market forays of a host of companies in the private and public sectors are not derailed and companies dependent on export revenue are not hurt. This would probably call for another round of fiscal and monetary stimulus and, thus, would be a setback to current efforts of nursing the country’s finances to sound health.

Hopefully lessons have been learnt from dealing with the past crisis. The first is that textbook prescriptions for economic health may not always work. There should be no hurry to rollback the fiscal stimulus neither to tighten money supply till the US and the euro zone economy are decisively out of danger. To have higher interest rates even as other countries are offering money at rock bottom rates will turn India into a speculators’ market. What about inflation? The current spell of inflation is spurred by shortage of food grains and rising consumption. A normal monsoon this season is expected to tame food grain prices. High interest rates will no doubt douse consumption but will also impede efforts to expand capacity to meet demand. Recent resources mopping efforts through PSU divestment and spectrum sell-offs as well as movement towards freeing fuel prices from control should ease government pressure on the bond market, contributing to keeping rates mild. Also, volatile markets should not deter it from going ahead with PSU divestments even if this is at throwaway prices. It could do this in bits, whetting the appetite of investors. This would set the markets on fire, benefiting even the private sector. What the recent global meltdown has done is to recognize the role of governments in making and breaking markets. If there were conventional responses to the past crisis, the future may call for out-of-the-box solutions. For instance, governments using the derivatives market to shape up events to meet ends. It is now recognized that the futures markets contributed to crude oil shooting past the US$ 140 a barrel mark and collapsing to US$ 33 a few months later. During periods of uncertain outlook, stable currency and commodity prices can provide comfort. With commodity prices rising but yet to reach the pre 2008 levels, this is the ripe time to undertake hedges. China is following the tradition route of buying up mines and oil exploration rights. Opec says it is comfortable with the current US $75 a barrel level. So why not tie up supply for the next few years at this level through the commodity futures market? Funds for undertaking this exercise can be raised by floating a sovereign Betting on India’s Growth (BIG) fund (with apologies to Anil Ambani), opened exclusively for foreign institutional investors. If the central bank can intervene through various tools at its disposal to guide the rupee to keep the import bill manageable and at the same time not hurt exporters, surely it is time for the Central government to lead by example by staying on top of the commodity cycle by writing contracts to calibrate prices. The bottom line is to ensure that events do not overwhelm us.