Mumbai: The fiscal year that ends today will be remembered as the year the Indian bubble collapsed. The global credit bubble had been pricked in the preceding year and Indian equities were well off their highs, but the consensus at the beginning of the fiscal year was that the Indian economy would not be affected too badly. And the ghost of decoupling—the belief that the Indian economy and markets were insulated from those of the US and Europe—hadn’t been well and truly buried.
There were reasons for the optimism: Gross domestic product (GDP) growth in the fourth quarter of 2007-08 was 8.9% and the ABN Amro Purchasing Managers’ Index for manufacturing was at a seasonally adjusted 57.5 in April 2008, which indicated robust expansion. Globally, while the collapse of Bear Stearns Companies Inc. had sent ripples of fear through the markets, the fallout had been contained. In fact, the concern in India at the time was about the economy growing too rapidly for its own good and there were heated discussions on whether the economy was overheating and stoking inflation as a consequence. The fact that the Reserve Bank of India (RBI) continued to raise interest rates till July 2008 clearly shows what kind of concerns about the economy the regulators had at the time. The equity market rallied in May, with the Bombay Stock Exchange’s benchmark index, the Sensex, reaching a high of 17,735 in that month.
Big fall: The Lehman Brothers headquarters in New York. Daniel Acker / Bloomberg
It didn’t take long for the optimism to evaporate. Equity market indices fell slowly and steadily. The stars of 2007— real estate stocks, leading capital goods firms—fell the most. The weakening rupee exposed the holes in corporate balance sheets and earnings estimates started to get revised downward. Nevertheless, the sense still persisted that the Indian economy would get off relatively lightly, a hope buffered by the 7.6% growth in GDP for the September quarter.
The credit crunch in the last quarter of 2008, however, put paid to that hope. Lehman Brothers Holdings Inc. fell with a crash heard around the world. Global credit markets seized up and Indian banks with overseas exposures were not spared. Near-panic conditions prevailed as liquidity evaporated and overnight money market rates soared. The currency plunged and worries about companies’ exposure to foreign loans and derivatives raised their head.
Bank credit growth faltered and turned briefly negative. Industrial production started to shrink. Export growth fell off a cliff and the GDP growth plummeted to 5.3% in the December quarter. Obviously, the Sensex plunged to new lows in October, at its nadir losing 64% from the peak reached in January 2008.
Thankfully, the extraordinary circumstances during the quarter drew an equally unprecedented response from the government and RBI, with the former pushing through a strong dose of fiscal stimulus while the monetary authorities flooded the market with liquidity and slashed interest rates.
As we look back at the end of the year, what, as they say, are the key takeaways? The first is that much of the rise in asset prices, including equity and real estate prices, was on account of the extraordinarily benign liquidity conditions as a result of cheap funding options and the inflows of foreign funds. It wasn’t, despite the strenuous efforts of equity analysts, justified by the “fundamentals”. One reason why India has been hit by the crisis despite most of its demand emanating from the domestic sector, is because of the depth of the country’s financial integration with the rest of the world. At the same time, it’s worth noting that the country’s banking system has remained relatively unaffected by the credit crisis and the economy is doing much better than that of most other countries.
At the end of the fiscal year, there are some green shoots of recovery.
Bank lending has been positive since the beginning of February. Cement despatches have picked up, as have auto and steel sales; rural India has proved to be remarkably resilient and some of the government stimuli seem to have kicked in. But worries remain about the strength of domestic demand, with investment demand declining, and about the government’s massive borrowing programme, which has already led to higher interest rates in the debt markets. A big question mark remains over the health of banks in the West and the fragility of the Western economies. And there’s a lot of uncertainty over the outcome of the general election. Small wonder, the equity market continues to be very skittish.