The global economic crisis has affected India in two ways—one indirect, where rebalancing of portfolios globally leads to people being less inclined to spending, and two, more directly, where businesses are affected either through revenues, costs or capital due to their relations with other businesses and economies.
It was in September that the India story had to be drastically reassessed—this was around the time the indirect conduit became very active. One must appreciate that the Indian markets commenced their levitation act against the backdrop of aggressive cuts in interest rates in the US. The US was not just cutting rates; it was determining the price of money globally. India, given its need for capital and its inherent currency linkages, could ill afford to run an interest rate policy that would be directionally different from that of the US.
This essentially meant that the money was easily available both domestically and in international markets and this cheap money fuelled huge expansion plans of Indian firms pushing our gross domestic product (GDP) growth rates closer towards double digits. The global credit bubble also fuelled exceptional returns in Indian stock markets. However, since September, when the tide turned, Indian markets have come crashing down. They are effectively down to 2005 levels.
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Interestingly, money flows from foreign institutional investors (FIIs) show a strong correlation to the stock market’s movements (graph 1). What is more interesting is the fact that the money pulled out by FIIs is comparable to the bonuses on Wall Street in any average year. The indirect conduit apparently seems extremely active—the bonuses of a few in the US can create havoc in an entire economy such as India.
Also See Drop in capitalization (2008-09)
I am reminded of the story that you may have heard. A man came to a village and announced to the villagers that he would buy cobras for Rs300 each. The villagers knew there were many cobras around the village and started catching them. The man bought thousands and as the cobra supply started to diminish, the villagers stopped their effort due to the increased cost of finding them. The man then announced that he would now buy cobras at Rs500 each. This encouraged the villagers to start catching cobras again. Soon the supply diminished further and people started going back to their old jobs. The man now announced that he would buy cobras at Rs2,000! However, since he had to go to the city on business, his assistant would buy on his behalf. Now that the man was out of sight, the assistant told the villagers, “Look at all these cobras in the big cage that the man has collected from you. I will sell them to you at Rs1,400 and when the man returns, you can sell them to him for Rs2,000 each.” The villagers lined up with all their savings and bought all the cobras. That was the last they saw of the man or his assistant.
Illustration: Jayachandran / Mint
Also Read earlier articles on the survey
On a more serious note, although the Indian markets are back to 2005-levels, the fundamentals of the Indian economy are better, if not just as good, than in 2005. Will Indian markets see a revival? The answer lies less in today’s strong fundamentals and more in the delivery of future performance. At today’s valuations, the embedded performance expectation is about 6% GDP growth—a so-called hurdle rate for the Indian economy. Can we do better? And how confident are we of meeting, or, ideally, exceeding this?
The survey reflects pessimism among Indian executives. Around 70% expect India not to meet this hurdle. Therefore, it is quite unlikely that our markets will show signs of substantial revival.
This is quite consistent with the finding that about 65% of executives expect things to continue in their present state for at least another year and the market to revive only after this period.
While this may manifest the pessimism at the overall level, the reassuring aspect is that it isn’t uniform—different businesses are likely to revive at different points in time. A distant look at a tray of black and white items suggests simply a continuum of grey. However, with closer observation, one can separate the black and the white. This is true of economic downturns as well—at a distance the entire economy seems to be more or less uniformly affected, but in reality some industries are hit harder than others, and some get out of the tunnel faster than others. For instance, in 2001, the IT industry bounced back in less than a year, while the telecom industry took at least a couple of years to revive—and the process was accentuated by a few bankruptcies as well.
Today, with a global downturn, the variations between sectors have been amplified depending on how and to what extent each industry is affected. While the Indian markets on an average have dropped by around 50%, there is a substantial difference across industries—while realty has dropped a whopping 92%, the fast-moving consumer goods (FMCG) industry is relatively better off with a drop of around 20% (graph 2).
In the next part of this series, we will take a look at how this is actually a function of two variables: a change in the fundamental characteristics of these businesses, and a change in expectations on their performance.
Sanjay Kulkarni is head of management consultant Stern Stewart’s Indian operations. Your comments are welcome at email@example.com
Graphics by Ahmed Raza Khan/Mint