Tuesday, June 9, 2009

"Green shoots" in Indian economic landscape?

Are we justified in drawing any decisive conslusions from the "green shoots" in the economic landscape by way of the recent strength in the equity markets, revival of industrial growth as reflected in the improved figures for infrastructure and manufacturing, and even the stabilization of yields in the bond markets and returning vibrancy in the corporate bond market.

Of the three important components of industrial growth - infrastructure, manufacturing and trade - only the first appears to have recovered, thanks to the massive government spending on infrastructure.

While the second is showing signs of recovery, commerce looks set to remain weak for atleast the next two quarters. The Index of Industrial Production (IIP) for March 2009 is now nearly 14% above its low point (in October 2008) and just 2% away from its last year’s peak (in March 2008). While cement, power and consumer durables have rebounded nicely, others like automobiles have been slow to respond.

The latest CSO estimates puts growth for 2008-09 at an encouraging 6.7%. Encouragingly, construction, as bell weather for the broader economic strength, grew at 6.8%. In an indication that corporates have not halted expansion plans in any major way, investment as a proportion of GDP grew to 35.7% in 2008-09 from 32.9% the previous year.

On the negative side, the stimulus expenditures have pushed the fiscal deficit to Rs 3,30,114 crore in 2008-09, or 6.6% of GDP, higher than government’s target of Rs 3,26,515 crore, or 6% of GDP, according to figures released by the Controller General of Accounts (CGA). The government’s revenue stood at Rs 5,44,651 crore in 2008-09, 3.1% lower than the revised target of Rs 5,62,173 crore. Tax revenue at Rs 4,47,726 crore was 3.9% lower than the revised projection of Rs 4,65,970 crore. The concerns with the fiscal balance will remain one of the biggest challenges for the new government and the major obstacle in the restoration of financial market confidence and normalcy in the credit markets.

The hardening of yields on the benchmark ten year Treasury securities are an indicator of the market's concerns about a possible revision in the government borrowing target this year (gross borrowing target for the current financial year is estimated at Rs 3.62 lakh crore, of which about 29% has been raised in the first two months) to sustain the stimulus spending packages. The ten year YTM on the 10 year G-secs rose from 5.7% in late March to 6.55% last week. The declining "bid-to-cover" ratios at the weekly government borrowing auctions is a reflection of the waning interest in government securities. Though SLR is only 24%, the investment deposit ratio (IDR) for May was 86% indicating the excessively high investments in G-Secs.

Of greater concern is the continued sluggishness associated with credit off-take. The growth in bank credit in the current fiscal so far has been 15.9%, which is lower than the 25.3% growth recorded in the corresponding period last year. As Businessline writes, "Incremental credit deposit ratios widened to minus 30 per cent as against the previous fortnight’s level of minus 26 per cent, indicating low investment demand and high debt redemptions and surging deposits. Corporate demand for bank funds remained low. Instead top-rung corporates preferred direct access to the bond markets. Corporate bond trade volumes though dipped to Rs 400 crore per day last week, down from the previous week’s Rs 600 crore." Another sign of the liquidity over-hang is the high recourse (more than Rs 1 lakh Cr every day) to the reverse repurchase window of the RBI.

India VIX, which is a volatility index based on the Nifty 50 Index Option prices (from the best bid-ask prices of Nifty 50 Options contracts, a volatility figure (%) is calculated which indicates the expected market volatility over the next 30 calendar days), is ruling at a relatively high 40.55 on June 6 closing.

The buoyant equity markets are more a reflection of the end of the deleveraging from emerging economies and capital flight into these higher growth economies since April (at about $1 billion a week into India alone now), which has driven all major emerging market equity markets up by more than 50% (Sensex is up 50%, Russia 63%, China 57%, Brazil 60%, and Argentina 45% in 2009).

As the graphic below shows, the external sector will continue to remain a source of major concern, especially given the continuing contraction in global demand. The World Trade Organization estimates global trade to contract by 9% this year. Exports from the U.S. are down 30% and imports 34% in the first quarter of the year compared to the previous three months, Japan saw its exports plunge 45.5% y-o-y in March 2009, and exports from China and Brazil fell by 20% per cent in the first quarter. Given the extent of global recession and downturn in our major markets in US and Europe, it will be sometime before green shoots will appear in our trade front. The strengthening rupee (hurt exports) and rising oil prices (increase import values) will widen the deficit further.

News from the corporate front too is not encouraging. A study carried out by Financial Express, with a sample of 1,946 quoted companies, reveals that around 623 companies (32.1% of the sample) made losses during Jan-March 2009 quarter, an 18.2% increase in the number reported during the same period last year. In terms of value, the loss amount has increased steadily by 85.1% to Rs 3,540 crore in Jan-Mar, 2009 from Rs 1,912 crore in the same quarter of the previos year.

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