India will be first in Asia to rebound

India’s domestically driven economy will be among the first in Asia to rebound, in mid-2009, but the run-up to that will be a “white knuckle ride” during which it will be vulnerable to the ‘liquidity destruction’ induced by the global credit crunch, according to CLSA Asia-Pacific Markets economists.“India is currently in the midst of a cyclical downturn, which is being led by the consumer sector but is broad-based,” observes economist Sharmila Whelan. That downturn will run its full course without any early relief, but India will be Asia’s early mover in terms of moving into the next business cycle because unlike the other economies, it is not export-driven. “We believe the worst will be over by mid-2009.”While that’s the good news, it’s not all rosy. “The bad news,” says head of economic research Eric Fishwick, “is that until that recovery starts, India will prove surprisingly vulnerable to continued credit crunch and risk-aversion because it runs a current account deficit and needs to continually attract savings.” India, he adds, also has a weak fiscal position and fiscal implementation problems; it also has a “relatively overextended domestic credit cycle”. Lending has run ahead of GDP for five consecutive years, so there is likely to be more “balance-sheet strain” there than anywhere else.In Whelan’s estimation, inflation is unlikely to peak soon or start coming down rapidly. “I expect inflation to peak in the fourth quarter of this year; it will still be running at 12% at the end of this year, and at about 8.5% at the end of the fiscal year.” Beyond that, she expects it to come off steadily, with help from declining global commodity prices, to about 5.6% next fiscal.This also means that interest rates won’t fall off quickly. “I’m looking for the first rate cut in the second quarter of next year, and I won’t be surprised to see another rate rise in the interim.”Although the RBI had been aggressively raising interest rates since 2004 to combat inflation, it was actually “behind the curve,” says Whelan. “All of last year, the RBI was struggling to mop up excess liquidity, and money supply (M3) accelerated.” The problem, was that the RBI was overwhelmed by capital inflows.Had it not been for the money inflows in 2006-07, however, the Indian economy would have rolled over 18 months earlier than it did, agues Fishwick. Going forward, “I’m particularly worried about the Indian rupee, which will remain under pressure, and test Rs 49/dollar.” That’s because the RBI’s balance balance-sheet has grown at 25-26% y-o-y, which points to “a very loose monetary stances” - notwithstanding all those rate hikes. India’s economic rebound, when it does happen, will be investment-led, and consumption growth effect will kick in after a lag, says Whelan. “The initial recovery from a trough starts when profit margins and profit growth recovers. At this stage, companies start investing retained earnings to upgrade existing capacity.” Indian corporate, she adds, are well-positioned to finance investments. In the second stage of the investment-led cycle, “what you need to see is the return of risk appetite.” A more bullish outlook will lead companies to leverage up.” An additional factor that will inspire the Indian recovery is the government’s $500 billion infrastructure spending plan. Even factoring in delays and other hurdles, this spending will reinforce the investment cycle, reckons Whelan. She is projecting 7.3% GDP growth for FY 2008 and 6.5% next year.

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