Saturday, March 29, 2008

Revisiting the India story

Indian stock markets have corrected by more than 15% YTD
in sympathy with the global equity markets, as market
participants expected the US deceleration to also negatively
impact Indian corporates. As a result, we are re-examining the
India growth story and its growth prospects in light of slowing
external demand and also the equity market outlook. In the
following section, we conclude that while economic
fundamentals are partially decoupled from the external events,
the stock markets might not decouple in the short term.

Can India sustain its growth rate?
India's economy has shown another year of remarkable
strength, with GDP growing at around 9% in FY 03/2008.
Since growth seems to be slowing down everywhere else, the
only question is whether it will last. As global growth slows, the
external impetus for the Indian economy will decline but, as we
explain below, the exposure of the Indian economy to global
trade and thus the downside risks to growth in this regard are
still fairly limited.

Low share of global trade
What was once regarded as the inefficiency of the
manufacturing sector and failure of India's economic policies
has become a winning point in current conditions. While we
are not suggesting that India's low exposure to world trade is
India's strength, it does appear to be a blessing in disguise in
the current scenario. In terms of world trade, the role of the
Indian economy is still only negligible. Figure 1 shows the
share of various economies in total world trade. China has
managed to increase its share substantially in recent years,
especially after WTO accession in 2001. But India is lagging
behind, especially in terms of manufacturing goods. Rigid labor
laws for larger firms, which apply to the manufacturing sector
but not to the services sector, have prevented many firms from
increasing in size and attaining crucial economies of scale,
representing just one area where increased liberalization and
more flexibility would lead to stronger growth rates. At roughly
25%, the share of exports (including services) in GDP is
significantly lower than the circa 55% share for the rest of
Asia ex-Japan. Hence, the risk of India’s growth slowing due
to an easing of external demand is comparatively lower than in
many other Asian countries.
What is more comforting is that, in terms of export markets,
India’s direct exposure to the USA is much lower than it is to
other regions. Data on the destination of exported goods, as
indicated in Figure 2, show that the US accounts for only 15%
of total goods exports, whereas the robust economies of Asia,
the Middle East, Africa and Latin America account for
approximately 60% of total goods exports. Similar to the rest
of Asia, China has gained significant importance for India as
an export destination, and as domestic demand in China
strengthens even more rapidly, its share of total exports is
expected to increase.

Domestic demand was and is likely to remain the
decisive growth driver
The Indian economy is consumer-driven. The importance of
domestic consumption is highlighted by the fact that total final
consumer expenditure (i.e. private plus government
consumption) accounts for approximately 67% of India's GDP.
Put simply, this means that for goods and services produced in
India, Indian consumers represent a larger market than the
world market. However, while the sector has been reeling
under the pressure of high interest rates (see Figure 3) due to
monetary tightening by the central bank, Indian consumers are
still a key driver of India's economic growth. Given that the
recent budget proposals should start to yield results and revive
consumption, we believe they will enable India to offset the
slowing external demand to a certain extent.

Infrastructure spending has been the major growth driver of
the Indian economy, especially in the last few years. As
indicated in Figure 3, growth in real fixed investment has
accelerated from approximately 4% in 2001 to 16% today.
While the capex boom has continued over the last few years,
India’s infrastructure is still significantly bottlenecked.
Infrastructure investment – both public and private – should not
only provide the basis for sustained growth but also drive the
economy as it is being developed. The government’s planned
infrastructure spending is approximately USD 500 bn over the
next five years. The plans indicate that the lion's share is
destined to be spent on power generation (roughly USD 150
bn), followed by highways and the telecom sector. There is a
large gap between the amount of infrastructure spending
planned and the actual money available from public funds. We
believe private investors will increasingly play a larger role in
obtaining required funding, which is already demonstrated by
the rising number of public private partnerships (PPP).

Conclusion: Growth lower than last year but still good
A few factors, such as the currency appreciation and
somewhat slower external demand, represent headwinds in
the current cyclical context of India's growth story.
Nevertheless, given the importance of domestic drivers and
infrastructure spending for growth, we believe the economy is
likely to retain much of its strength. Despite the expected
slowdown in external demand, growth still seems likely to be
around 8%, or even slightly higher in FY 03/2009 and maybe
even stronger in the following year. The monsoons could be a
downside risk factor for the economy as a whole, since
agriculture depends on this source to provide sufficient water
and because a huge part of the population is still dependent
directly or indirectly on the agricultural sector. Apart from
monsoons, another risk could stem from the current account
deficit, especially with rising crude oil prices. India is running a
modest current account deficit of around USD 11 bn (in
contrast to China, which has a large current account surplus),
but the inflows of longer-term money (FDI) appear sufficient to
finance the deficit, and thus we do not regard this as a
structural negative


Everymatter said...

a nice article about Indian economy

MGK said...

Article is great, two more aspects which are worth pointing out. The PSU's(like BFSI sector etc.) will be spending a lot on technology upgrades which will be a plus, but over the previous one and half years or so the Indian corporates have went outright and bought over a lot of companies at not so reasonable prices which is a negative when the major economies are going into recession.