Why India is worse off today than in 2006

Why India is worse off today than in 2006

Mumbai: India’s benchmark stock index, the Bombay Stock Exchange’s Sensex, fell below 10,000 Friday, a level it hasn’t seen since 20 June 2006, finally catching up to macro-economic indicators that point to a rather stark conclusion: the country, and by extension, its people, are worse off now than they were 28 months ago.

The same 28 months that saw the Sensex cross the 21,000 mark had also witnessed other dramatic changes in factors affecting India’s economy and its standing as an investment for foreign companies and investors.

The prevailing sentiment in June 2006 was greed. In October 2008 it is fear supported in part by worsening economic data.

The Sensex closed at 9,975.35 on Friday. The rupee at Rs48.89. And, on Thursday, the government announced that inflation, as measured by a rise in wholesale prices was 11.44%.

Also See Worse off (Graphic)

In June 2006, inflation was 5.21%. And the rupee was trading at Rs46.06 to the dollar. The currency would go on a twisting ride that would see it touch Rs39 to the greenback in 2007 before threatening to touch Rs50 in recent weeks. The rupee has lost more than 19% this year, the most since 1991 when an acute balance-of-payments crisis forced the nation to pawn its gold with the International Monetary Fund to pay for imports.

And the country’s industrial growth has slid from 9.6% in June 2006 to 4.9% now.

In 2006, not too many people in India were familiar with the term subprime mortgage, or housing loans extended to people with poor credit history that were bundled into complex securities and sold, and which eventually resulted in the collapse of several US investment banks and the ongoing credit crisis across the world.

But, while politicians and bulls caught flatfooted would like to point to the US, not all of India’s ailments can be blamed on the US-led markets meltdown alone.

For instance, the country’s fiscal deficit now is Rs116,890 crore sharply above the June 2006 level of Rs77,740 crore.

Also See How the Sensex stock fared (Graphic)

Meanwhile, key economic reforms, many requiring parliamentary approval, have languished as the ruling United Progressive Alliance government lurched from one political crisis to another, the latest being a trust vote that it won on 22 July for the India-US nuclear deal.

Now, with five states going to the polls in the next two months and Lok Sabha elections scheduled to happen sometime in the first half of 2009, analysts agree that the next few months are unlikely to see a change in pace of policy making.

Despite inflation being where it is—and higher in recent months—some economists blame the Reserve Bank of India’s (RBI) tight monetary policy. As inflation soared on the back of growth and a global boom in commodity markets with the consequent increase in prices, the central bank had, until now, sought to control it.

“We are in the soup we are in because of hawkish monetary policy," claims Surjit Bhalla, managing director, Oxus Research and Investments, a New Delhi-based economic research, asset management and advisory firm.

It took the Sensex 19 months from June 2006 to touch its lifetime high of 21,206.77 on the back of a seemingly unending flow of foreign institutional investors (FIIs) enamoured with the so-called India story. But the global credit crisis, an unprecedented liquidity crunch and looming recession in the world’s biggest economy have seen the index plunge to the current level in just nine months.

In the process, Indian stocks may have just become more affordable to some willing to ignore decelerating earnings and a weakening economy. The price earnings (PE) multiple of the Sensex’s 30 constituent stocks was 17.78 in June 2006. This has fallen to 12.52 now. This PE indicator is the price of a stock expressed as a multiple of the earnings per share.

But, the India story has worn thin too in this period, although the country is still much better off than several others.

While still respectable, especially by current global standards and recessionary talk, the growth of India’s gross domestic product (GDP) is down to 7.9% now from 9.6% in June 2006. and several economists predict it will go down further.

“In the worst case scenario, we should see 6-7% GDP growth over the next three years. While other economies are sliding into recession, we are only talking of a slowdown in growth," said Anoop Bhaskar, head of equity at UTI Asset Management Ltd.

The rupee touched a six-year low on Friday and would have fallen further but for the RBI’s continuing sale of dollars in the market to meet the demand of importers. RBI’s aggressive dollar sale is evident from the fact that India’s foreign exchange reserves fell by record $9.9 billion (Rs48,213 crore) to $265 billion in the week ended October 10.

India’s foreign exchange reserves in June 2006 were much lower—around $156 billion—and quickly rose to cross $320 billion in May. Since then, the pile has been coming down in the absence of fresh inflow of dollars and RBI’s dollar sale. FIIs have pulled out $11.2 billion from Indian markets this year after pumping in $17.36 billion in 2007.

RBI’s policy rate too was lower in June 2006 than what it is now. Similarly, banks’ reserve requirement or the money that commercial banks need to keep with the central bank was higher.

On both these counts, RBI is set to adopt a softer approach now as economic deceleration is fast emerging a bigger threat than inflation. The RBI has already cut banks’ cash reserve ratio and released Rs1 trillion into the financial system.

Still, liquidity alone may not he able to change the face of Indian stock market.

The equity opportunity in India was one of the most celebrated global themes till early this year but the country’s appeal now seems to have waned.

The global credit crunch has seen most global investors scrambling to raise cash from their equity portfolios and take them back them home. Worsening macroeconomic indicators are also contributing to this.

And the pain here isn’t over, say some investors, because the credit crisis has generated a huge appetite for and almost as big a scarcity of cash.

“When preference for cash weakens, only then will investors look at risky assets," said Narayan Ramachandran, chief executive officer of the India unit of US-investment bank Morgan Stanley. “India (till then) will be a reasonable middling emerging market country in terms of attractiveness."

The biggest short-term risk for Indian stock markets and other Asian markets is more capital outflows as risk aversion grows and portfolio funds continue to face redemptions, say analysts.

The risk of short-term capital outflow “is clear from the recent dramatic weakening of emerging market currencies in current account-deficit countries," said Christopher Wood, chief strategist at foreign brokerage CLSA Asia-Pacific Markets, in his Thursday report. Still, he wrote, “Asia and emerging markets will end up being the chief beneficiary of the current increasingly aggressive global monetary easing in terms of where the liquidity flows in the next liquidity cycle."

Brokers and foreign fund managers in India, however, don’t expect to see any of that money soon. They say the sell-off by FIIs will continue for at least another three months. “It’s going to be another couple of quarters, may be three quarters, before FIIs turn net buyers in the market," said Ramachandran.

Meanwhile, local institutional investors are taking a longer-term view. “People should focus on what will happen in five to 10 years, equities will outperform holding cash," said UTI’s Bhaskar.

Still, India’s economy is fundamentally strong say some economists, pointing to strong foreign direct investments inflows, which hit $14.6 billion in the five months to August compared to $6.5 billion in the year-ago period.

“We expect interest rates to come down early next year and the growth to return to 8% by 2010," said D.K. Joshi, principal economist at rating agency Crisil Ltd.

All eyes are now on RBI which meets next week for a mid-year review. After greed and fear, comes hope.


Ashwin Ramarathinam of Mint and Anoop Agrawal of Bloomberg contributed to this story.