The key concerns dominating the Indian economic landscape over the last 12 months have been declining investments and high inflation. The situation will, however, improve towards the second half of the current year (fiscal 2011-12) and investments should start picking up in some consumption-led sectors. A fuller recovery of the investment momentum will, however, depend on strong policy action in areas such as power, roads and fertilizers. While inflation will surely decline as the impact of the policy measures work through the system, it will continue to be above the level of policymakers’ comfort. Private firms will face accentuated profitability pressures over the medium term.
Overall, after the strong rebound from the global crisis, the Indian economy has started showing signs of faltering in its quest for 9% gross domestic product (GDP) growth; GDP growth in the current year (fiscal 2011-12) will clearly be lower than 8.5%, the growth rate in the previous year.
Following the global financial crisis, many potentially large investment plans were shelved: consequently gross fixed capital formation (GFCF) growth plunged to near-zero levels between July 2008 and September 2009. Immediately after this, investments picked up at a rapid pace to post growth that was well above pre-crisis levels in the fourth quarter of 2009-10 and the first quarter of 2010-11. This spike in growth was over a weak base, and investment growth returned to normal after the base effect wore off. The uptick that lasted till June 2010 was followed by a phase where GFCF once again saw a steep decline. Investment growth dropped from 14.6% in the first half to 3.7% in the second half of 2010-11. By the last quarter of 2010-11 investment growth was near zero.
Underpinning the investment slowdown were a rising interest rate environment and policy concerns relating to issues such as land acquisition, environment clearances etc. Looking ahead, one can expect investment in consumption-led sectors such as durables, white goods and automobiles to begin picking up by the second half of 2011-12, since the consumption trend in these areas continues to be buoyant. Sectors with excess capacity such as cement, shipping and commercial real estate are unlikely to witness an investment turnaround until 2012. However, appropriate policy action can make all the difference for investments, particularly in infrastructure. In power, steps to address issues such as fuel availability/coal linkages, multiplicity of clearances, tackling losses of the state electricity boards will do much to boost investment decisions. Similarly in roads, environmental clearances and regulatory clarity in land acquisition could provide a boost to investments.
Inflation will moderate to about 7.5-8% in 2011-12, as the Reserve Bank of India’s (RBI) tightening measures since March 2010 transmit through the system. However, it will continue to remain at elevated levels. The biggest concern is food inflation: a comparison of inflation trends between FY96 to FY05 and between FY06 to FY11 reveals that food inflation has shown a structural upward shift and has nearly doubled from 5.3% to 10.3%. A combination of supply- and demand-side factors makes food inflation particularly intractable. On the supply side, there are issues such as size of land holdings, rise in frequency of weak monsoons and lack of investment in agriculture. The demand-side factors contributing to inflation include a rise in purchasing power and dietary habits. A sharp increase in minimum support prices of cereals has also inflated prices.
For Indian firms, profitability pressures are expected to increase because of the rising trend in interest rates and commodity prices and intensifying competition—a study by Crisil covering 20 sectors has forecasted that while revenue growth of companies in these sectors will be maintained at a healthy 18% in 2011-12, weighted average operating margins for these companies will shrink by close to 1%. This is already being reflected in the results announced over the last month. Profitability of firms in the cement, chemicals, construction, automobile and textile spinning industries are the most vulnerable to high-input prices. On the other hand, metals and oil and gas sectors will be among the few to witness margin expansion. Overall, the credit quality of private firms has peaked and any improvement in credit quality may be limited in the medium term.
GDP growth will slow this year reflecting the impact of higher interest rates, reduced wealth effect and the recent sharp slowdown in investment growth: forecasts for 2011-2012 range between 7.5% and 8.9%. My expectation on GDP growth is in the range of 7.7-8% for fiscal 2011-12. Supporting these growth levels are a number of strengths: continuing strong private consumption (which grew at 8.6% in 2010-11), the expectation of a normal monsoon and the reduction in current account deficit to around 2.5% in 2010-11 through a better-than-expected export performance. Overall, though, concerns dominate. Key concerns include the impact of rising interest rates on corporate performance and the volatility in short-term capital inflows. The global landscape is more troubled, with uncertainties relating to the Middle East and North Africa and oilsupply, sovereign debt problems in the euro zone, rising fiscal risks and weak housing markets in the US. If global risks precipitate, India will feel the impact.
Illustration by Shyamal Banerjee/Mint
Roopa Kudva is managing director and CEO of Crisil.
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