Growth in industrial production for the month of September came in at a pitiful 1.9%. Guess what industrial growth was in September 2008, when Lehman Brothers collapsed? A very healthy 10.9%. It went down to 3.9% in October 2008 and was in negative territory by December of that year. The question is: Given the current weakness in growth, is it possible that the Indian economy could see a replay of 2008-09, when real gross domestic product (GDP) growth went down to 6.8%?
In fact, the risks are higher today than they were at the time of the Lehman collapse. Take the global situation. The risk in Europe of a disorderly default is graver than the impact of a Lehman collapse for the simple reason that this time around there are several nations involved and many politicians, often with conflicting domestic priorities. Coping with the crisis is, therefore, a much tougher task, even though Europe’s leaders do seem to have finally decided to take their heads out of the sand. The sums involved in bailing out the affected sovereign nations are also likely to be much larger. And most importantly, governments no longer have the fiscal fire-power to step into the breach, as their debt-to-GDP ratios have increased hugely.
India’s domestic situation, too, is worse than in 2008. A recent piece in this paper’s Mark to Market column said that the year-on-year (y-o-y) fall in net corporate profits for the September 2011 quarter has been even worse than during the September 2008 and December 2008 quarters. It’s not just the manufacturing sector that’s getting hurt—service sector Purchasing Managers’ indices in recent months have pointed to a contraction. Moreover, in 2008 the Indian corporate sector had benefited from several years of prosperity that had led to low net debt to equity levels and high returns on equity. This time around, company balance sheets are not as robust. Consider, for instance, the bad loans of State Bank of India, the country’s largest lender: its gross non-performing assets (NPAs) at the end of September were 4.2% of advances and net NPAs 2%; at the end of December 2008, gross NPAs were 2.6%, while net NPAs were 1.36%.
Nor is the government in a position to bail anybody out. The gross fiscal deficit this year is expected to be around 5%, not giving much leeway for increasing government expenditure to offset the slowdown. In contrast, the central government’s gross fiscal deficit was a low 2.55% in 2007-08, so the government was able to stimulate the economy, resulting in a deficit of 6% in 2008-09.
At the macro level, there are many similarities. Real GDP at factor cost grew 7.7% in the first quarter of 2011-12 and is expected to grow around 7.5% in the second quarter. In 2008-09, GDP grew at 7.9% in the first quarter and 7.7% in the second quarter. It was during the second half of 2008-09 that economic growth slowed considerably. That might not happen to the same extent this time if there’s no meltdown in Europe, but the risk exists.
Inflation was very high in 2008-09 too and the Reserve Bank of India’s repo rate was at 9% in July 2008—it was only in October 2008 that it was bought down to 8%. That’s lower than the current repo rate of 8.5%. The yield on the 10-year government bond was at 7.5% in October 2008—it’s now hovering around 9%. Bank deposit rates were lower than they are today. Interestingly, y-o-y growth in bank credit was as high as 28.5% at the end of October 2008, compared with a growth of 17.9% at the end of October 2011. This suggests that underlying demand was much stronger then.
The Sensex ended September 2008 at 12,860, but went down dramatically during the following months. If we take valuations, though, then the trailing price-earnings (P-E) multiple for the Sensex was around 17 in September 2008 and fell to a low 11.9 in December that year. Currently, the Sensex trailing P-E is a bit below 18.
The rupee is today weaker than what it was in 2008. In November that year, it averaged around 48.8 to the dollar. Currently, it’s above 50.
The sharp recovery from the lows of 2008-09 was the effect of a fiscal and monetary boost, combined with the hopes of reform after the election victory of the United Progressive Alliance-II and the resumption of large-scale capital inflows. These positive factors have now faded. Inflation is seen as structural and sticky. Confidence in the abilities of the government has been eroded. Portfolio inflows have dried up. Business confidence has plunged, easily seen from the dismal state of investment. Exports are slowing. Given this situation, the economy will be at considerable risk in the event of an external shock.
Of course, Europe’s leaders would be extremely stupid to allow a collapse of the euro zone. I am, perhaps naively, willing to give them the benefit of the doubt and allow that they will probably try and restore confidence. But the chances of a quick fix are slim and the most likely solution will be a muddling through. If that happens, the slowdown in growth in Europe will be prolonged. And in India, too, there won’t be a V-shaped recovery this time. Gaurav Kapur, senior economist with Royal Bank of Scotland in Mumbai, summed it up succinctly: “I wouldn’t be surprised if growth dips below 7% in 2012-13.”