Analysis: India does worse than expected

India’s economy performed worse than expected in the fourth quarter of 2008.

India’s economy performed worse than expected in the fourth quarter of 2008.

Mark Williams, an international economist at Capital Economics, notes that India has been hit hard by the crisis. Its GDP grew by just 5.3% in the fourth quarter, the slowest pace since 2003 and well below the consensus forecast of 6.3%. Williams expects growth to be no higher than 4% this year, with risks on the downside.

Other forecasts have been too optimistic, he says – including the latest published consensus forecast for GDP growth of 5.7% in 2009 and the IMF’s forecast of 5.1%.

In the short term, Williams says that perspectives are even worse than in the last quarter of 2008. “With interest rates still falling, the economy struggling and concerns about government debt on the rise, more weakness is to come,” he says.

Private consumption also weakened during the quarter, he notes, with a surge in government spending only partially offsetting the slowing growth of private demand. He says: “While fresh stimulus plans have recently been announced, fiscal constraints mean that the fourth quarter’s 25% growth in real government spending will not be sustained.”

The data suggests that real export growth rose in the fourth quarter, but collapsing global demand is likely to undermine growth in the quarter ahead. According to initial government estimates, exports declined by 22% in dollar terms in January after a drop of 1% in December.

Meanwhile, with unemployment rising and stubbornly high market interest rates likely to weigh on investment, other drivers of demand are set to weaken.

With the uncertain outcome of April’s parliamentary elections and economists’ warnings that its economy has not yet hit the bottom, investing in India resembles a tightrope walk.

Technology, for example, was the best performing sector in January after being the worst performer in December, says Alex Tarver, the global emerging markets product specialist at HSBC Global Asset Management. Telecoms, healthcare and financials were among the worst performing sectors.

Tarver’s HSBC GIF India Equity fund is overweight in technology, materials, consumer discretionary, industrials and real estate. Financials, energy, consumer staples and telecoms are underweights.

He says that fourth quarter results indicate a slowdown in corporate performance, while the aggregate results of about 1,078 companies show that sales grew 12.6% year-on-year while net profits fell 18.5%.

Tarver highlights that stock prices of many companies reporting results rallied over the month, perhaps suggesting that poor results and earnings downgrades have been factored into prices.

Vinay Gairola, the manager of the Atlantis India Opportunities Fund, sees investment opportunities on a 18 to 24 months basis. His strategy, however, is different.

“I am very bullish on consumer durables, assets like infrastructure and pharmaceuticals, but equal-weighted on telecoms. I am also very bullish on domestic sectors such as logistics, agriculture and farm producing,” says Gairola.

Agriculture and farm producing are among the Indian government’s priority sectors. It strictly regulates the finance sector and orders that 40% of bank lending must go to priority sectors, says Williams.

“Large parts of loans still go to agriculture to support poorer parts of the society,” says Williams. “Another problem is that Indian banks have to keep large parts of their deposits with the central bank; the cash reserve ratio is very high.”

“A key problem is that Indian firms are finding it hard to get capital,” he adds. “They are reliant on overseas borrowing and equity issuance for almost a third of their funding. And they have been hammered by a sharp reversal of capital flows over the past year.”

With India’s large and open capital markets, it was once easy for businesses to find capital. “Lenders were happy to invest in India. But now [that we are in a global crisis] Indians have turn to the domestic sector.” Domestic lending has continued to grow, albeit at a slower pace.

Williams says: “Close to half of its growth came from a surge in real government spending. But with fiscal strains growing, it is now up to the central bank to take the lead in supporting the economy.”

The bulk of the fall in growth was accounted for by weakness in investment. This is because the credit squeeze and slowing demand took their toll on private sector capital spending.

The lack of fiscal alternatives means that the initiative for a policy response now lies firmly with the central bank. “We expect a 50bp [basis points] cut imminently, and a total of 200bps of cuts to take the repo rate to 3.5% by mid-2009,” says Williams.

In the long term, however, William’s outlook is “very positive because although India is still a poor country, structural issues that used to hold it back are now solved.”

Tarver agrees: “We expect continued strong growth in the Indian market, albeit slower than in previous years. We believe GDP growth will be higher than markets are expecting, and that significant monetary easing and fiscal stimulus packages will help India achieve this.”

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