Busts wipe out the excesses of the previous boom. They push down lending, pare inventories and lower interest rates, setting the stage for the next cyclical upturn. This time, though, the conditions at the beginning of the recovery seem to be very different.
Compare, for example, the current recovery to the previous one. After the dot-com bust and the drought in 2002-03, the Indian economy started recovering in the second quarter of 2003-04, when gross domestic product (GDP) growth shot up to 9% from 5.4% in the preceding quarter. That was truly a V-shaped recovery. The Sensex too started its long climb upwards from June 2003, moving up from 3,176 points on 1 June 2003 to 5,838 by the end of December, a rise of 84%.
This time the rise in the equity markets has been spectacular, but many macro indicators at that time were at very different levels. During the last downturn, GDP growth plunged to a low of 1.7% in the third quarter of 2002-03, because of a terrible drought and agricultural production falling by a huge 12.1% in that quarter. Thereafter, GDP growth quickened to 3.7% in Q4 of 2002-03, to 5.4% in Q1 of 2003-04 and then to 9% in Q2. This time, the lowest GDP growth has been 5.8% in Q3 and Q4 of FY09, while growth has improved to 6.1% in Q1 of FY10. Manufacturing growth was far stronger during the last downturn than in the current one, with services remaining relatively buoyant in both. The big difference, the one that kept GDP growth high during the worst phase of the current slowdown, lay in government spending.
Graphics: Sandeep Bhatnagar / Mint
Next, take the level of interest rates in the bond market. The 10-year government bond yield at the end of June 2003 was between 5.6% and 5.8%. At present, the 10-year yield is nearly 7.5%. Interestingly, yields were lower then despite inflation being higher. The Wholesale Price Index (WPI) was at 5.7% at the end of May 2003, unlike today’s negative inflation rates. But long bond yields were low in 2003 because inflation expectations were low—by June 2004, WPI inflation was at 5.6%, slightly lower than a year ago. This time, though, the inflation rate is expected to go up very sharply. What this indicates is that real interest rates are higher now than they were at the beginning of the last recovery. Also, the maximum bank deposit rates in 2003-04 were around 5.5%, much lower than today.
Money supply growth (M3) at the end of May 2003 was a tepid 11.5% year-on-year (y-o-y), going up to 13.8% by the end of December 2003 and to 14.8% by the end of June 2004. Contrast that with current y-o-y M3 growth of 20%.
Banks are also going into this recovery with high credit-deposit ratios. At the end of May 2003, when the recovery started to gather steam, scheduled banks’ credit-deposit ratio was 55% and this remained low for quite some time, moving up to 56.25% by the end of June 2004. This time, banks’ credit-deposit ratio is already at 69%. That’s because credit growth is higher. Y-o-y growth in bank credit was a very low 11.5% at the end of May 2003, moving up to 14.8% a year later. In contrast, y-o-y growth of bank credit at present is already around 15%. The high credit-deposit ratio means that when credit picks up, banks will have to hike lending rates.
In short, this time around, the conditions for economic recovery are nowhere as good as they were around the middle of 2003. But because of the easy money policy, liquidity is much higher, which is good for asset prices.
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