India rolls on despite the challenges

IFR India 2008
9 min read
Emerging Markets

If the platitudes being bandied around about the Indian economy are any guide the country has truly arrived. India’s recent economic growth has truly been impressive and in many ways deserving of the accolades that bankers, economists and company executives have been showering it with. However, stern challenges remain if the Indian economy is to maintain its express growth rate.

The main reasons people are excited about the Indian economy are its size, its rapid growth and the fact that some sectors of its economy have become truly world class in pretty quick time.

Let us start with its size and fast economic growth rate. India is already the world’s fourth-largest economy when measured in purchasing power parity terms and Goldman Sachs in its recent “Brazil Russia India China (BRIC) Report” predicted India would become one of the world’s three largest economies in absolute terms by the 2032. And Goldman Sachs is not alone in its optimism. John Redwood, of the UK-based Economic Competitiveness Policy Group, said that “India is now truly a land of opportunity”.

ACNielsen’s Travyn Rhall attributes the excitement about the Indian economy to two core advantages: an increasing presence of multinationals and an upswing in IT exports. India’s success in the IT sector means that many international companies now believe that while India is a developing country, some sectors of its economy are already world class. Jack Welch, GE’s former chief executive officer, perhaps summed it up best with his noted comment that “India is a developed country as far as intellectual capital is concerned”.

As the Goldman Sachs report indicates, many investors track India’s performance against other giant emerging markets, the BRIC economies, and India is expected to outperform its BRIC rivals, in terms of GDP growth rate, from 2015 onwards. For the 2006–2007 fiscal year India was the second-fastest growing BRIC economy with a 9.4% economic growth rate, second only to China.

Stern challenges

This is all good news but there are plenty of challenges ahead. Inflation is by far the most immediate threat to the economy, as it is in many Asian economies. India’s WPI inflation rose to 12.63% in the week ending August 9, from 12.44% in the previous week, while estimates of core WPI inflation rose to 11.88% from 11.62%.

And while measures of output price inflation fell in late August to 10.06%, from 10.23%, for the first time in many months, input price inflation accelerated sharply to 14.88% from 14.53%, further widening the gap between input and output prices. Pressure on corporate profit margins continues to rise, but the slower pace of output price inflation suggests firms are either concerned about losing market share as demand weakens, or that they expect some of the recent softening in global commodity prices to ease input cost pressures over the coming year.

Output price hikes may be in the works, however. Reports from equity analysts and in the news media suggest that some companies – especially those in the electrical, tractor and cement sectors – are planning to hike (or have recently hiked) prices, due to cost pressures. However, signs of weakening demand have deterred producers catering to the consumer goods sector from raising prices any further. The government is also taking measures to cool down food price inflation by selling rice, wheat and sugar in the open market. Food prices are obviously a political issues as well as an economic one.

Analysts now expect WPI inflation to increase to 12.82% year-on-year from 12.63% in September, due to higher prices of food articles, rubber, sugar, paper products, oil seeds, textiles and rubber and plastic products.

WPI inflation is expected to peak in October or November at around 13.5%-14%, but to stay in double-digit territory until February 2009. Many analysts expect economic growth to slow to 7.3% in fiscal 2009 which, along with lower oil prices, should help lower inflation some time in the first half of next year.

India’s battle with inflation is part of a regional battle. Consumer price indices in Vietnam, Sri Lanka and Pakistan have risen 30% year-on-year, while inflation has been running in double digits in the Philippines, Indonesia. In China, Singapore, and Thailand headline consumer prices inflation has also been approaching double digits.

India’s other big challenge lies on the infrastructure front. India’s rapid and sustained economic growth is placing a heavy strain on the country’s creaking infrastructure, which has been badly underinvested in over the decades. Rapid economic growth has caused a huge increase the amount of goods that need to be transported and the country’s rail and shipping port infrastructure is not extensive enough or efficient enough if the country is to maintain it’s fast growth rates. Financing this infrastructure upgrade is one the greatest challenges and opportunities for bankers and financers in India. (See the next story in this report on the country’s ports.)

Bright future

Despite these challenge, bankers and analysts are bullish on India’s growth prospects for structural reasons. The national economy is taking off, GDP per capita is accelerating, investment and savings rates are rising simultaneously and the challenge of an ageing population that plagues many other economies lies well into the future. Analysts said that if India tackled its weak infrastructure, bureaucracy and inflexible labour market, it could very likely succeed in lifting its potential growth rate to well over 10% and sustain it into the medium term.

Growth across various broad sectors illustrates this potential. In the 2007-2008 fiscal year, the industrial sector expanded 10.8%, the services sector rose by 8.5%, while the agricultural sector grew by 4.5%.

India’s foreign exchange reserves are well in excess of its external and debt and because these reserves are increasing steadily, they offer solid security against a currency crisis or monetary instability.

Investor confidence in Indian companies is also strong, which has led to a surge in cross-border borrowing to fund in-bound acquisitions. (See this report’s story on the Indian syndicated loan market and M&A activity.)

Indian companies are also well-placed to take advantage of the opening up or globalisation of the Indian economy. Quality and a cost advantage are the two things that Indian companies have leveraged to market their products and services. The fast-growing services sector is now a major contributor to increased exports from India. Exports in April 2008 amounted to US$14.4bn, up a hefty 31.5% from a year earlier.

On the import front, perhaps unsurprisingly, hydrocarbons accounted for the single largest component of India’s capital stock imports which, in April 2008, amounted to US$24.2bn, up a chunky 36.6% from a year earlier.

And while the US sub-prime crisis has taken its toll on equity issuance, even after some of the sheen has been taken off the country’s has still been attracting significant amounts of investment. (See this report’s story of India’s equity markets.)

With improved price earnings ratios and returns on equity, India sits in the second position on AT Kearney’s 2007 Foreign Direct Investment Confidence Index. Foreign direct investment inflows expanded 56% in fiscal 2007-2008. In April alone this year there was US$3.749bn of foreign direct investment in India. This is more than most countries get in a year. Electronic equipment, manufacturing and telecom have been the main destinations for this investment.

Foreign investor interest is also high in India’s services sector. In 2007, AT Kearney ranked India as the world’s preferred destination for services sector foreign investments and the country ranked second in 2008 on AT Kearney’s Global Retail Development Index.

India’s vibrant capital markets have certainly helped. While the global correction in equity markets have seen stock investors take serious hits over the past year, the long-term story is still positive. The Sensex – the Bombay Stock Exchange index -- rose 20 times from the 1990s to when it reached the 20,000 mark in November 2007. India is now the major global destination for the inflow of US dollars. And the medium-term prognosis is also good because the recent stock market correction has prompted regulators to make stock exchange listings easier. The effects of these reforms will outlast this downward phase of the economic cycle.

Gordon Feller