Most economists believe the deceleration in growth we’re seeing at present is a mid-cycle slowdown. It’s supposed to be a temporary blip and growth will soon be back on track. Many analysts think growth will accelerate in the second half of the current year, which is why their end of the year targets for the Sensex are well above current market levels. They also have institutional backing—the World Bank, in its June 2011 edition of its Global Economic Prospects puts India’s GDP growth at 8.1% in calendar year 2011, followed by a rebound to 8.4% in 2012.
Does this mid-cycle slowdown have a precedent? It does, if we consider the recovery from the tech wreck in the early 2000s. Real GDP growth slowed to 3.8% in 2002-03 from a then respectable 5.8% in 2001-02. In 2003-04, however, as the economy recovered, GDP growth shot up to 8.5%. Thereafter, it braked in 2004-05 to 7.5% before going on to post 9% plus growth for the next three years.
This time, the recovery has followed a similar pattern. After a severe deceleration in real GDP growth to below 7% in 2008-09, the economy rebounded by 8% in 2009-10 and by 8.5% in 2010-11. This fiscal, growth is expected to slow considerably.
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The reason for the mid-cycle pause is rather simple. As the economy comes out of a slowdown, there’s a lot of pent-up demand for goods and services. When times are bad, families postpone buying non-essentials, defer taking holidays and tighten belts. When good times return, they make up for lost time, buying all the things they couldn’t afford to during the downturn. But when that initial rush of purchases is done, there’s a pause as activity goes back to more normal levels. It’s this pause that’s the mid-cycle slowdown.
The bulls are already looking beyond the pause to the economy getting its second wind. Their reasons: a topping off of inflation and interest rate hikes, and lower commodity prices. The World Bank had cited reconstruction efforts in Japan and a lift from lower oil prices as reasons that would drive a re-acceleration in growth in the second half of the current year.
But there are significant differences between the situation in 2005 and current reality. Take interest rates, for example. The RBI policy rate at that time was much lower than what it is today. Bank deposit rates for three-five year deposits ranged from 6.25%-7% in 2005-06. They are over 9% at the moment. The yield on 10-year government bonds was below 7% in 2005-06—it’s higher than 8% now. The gross fiscal deficit of the central government was below 4% in 2005-06 and it went down to 3.3% in 2006-07.
In contrast, a recent Deutsche Bank research note said the centre’s fiscal deficit could widen to 5.5% of GDP in 2011-12, as against the government’s estimate of 4.6%. And, at the end of June 2005, the credit-deposit ratio of the banks was 64.9%, compared with 74.5% now. More importantly, global economic prospects could scarcely be more dissimilar, compared with 2005.
That may be the reason why the International Monetary Fund (IMF), in its World Economic Outlook update in June, predicted that India’s GDP growth will slow to 7.8% in 2012 from 8.2% this year. And while IMF estimates that oil and commodity prices will fall a bit next year, the fact remains that they are currently far higher than where they were in 2005. In short, the point is that while this slowdown may well be a short one, it’s undeniable that conditions now are very different from the last time the economy came out ofa mid-cycle soft patch in 2005.
There could, in fact, be an alternative explanation. There were clear indications that the Indian economy was overheating in 2007, even before the global financial crisis happened. Ditto for the Chinese economy, which expanded by a mind-boggling 14.2% in real terms in 2007. These economies had already reached the top of their business cycles in 2007 and growth would anyway have slowed, even without the financial crisis. What the crisis did was to make governments administer a fiscal and monetary stimulus to these economies, in response to the liquidity crunch.
The recovery from the downturn was therefore partly the effect of this stimulus. Capital expenditure during the downturn in 2008-09, for example, although it went down a bit, was nowhere near the lows it had reached in 2002-03. It was the stimulus that led to a swift rebound from the slowdown in 2008-09.
Putting it differently, is it possible that the slowdown we’re seeing now is finally the end of the long boom of 2003-07, an end that was postponed so long by the stimulus? Such an interpretation would account for the high interest rates, high inflation, high credit-deposit ratios and high fiscal deficits that we’re seeing now, which are all the result of that booster dose administered by the government. If this interpretation is correct, the slowdown will be much longer than is at present being anticipated by the market.
Manas Chakravarty looks at trends and issues in the financial markets. Comment at email@example.com