India: Big Country, Big Problems
July 19, 2013, 11:00 A.M. ET
By Ben Levisohn - Barron's
That’s the takeaway from a new report from Nomura, who offer four reasons why the pain should continue for at least the next six to nine months.
Reason #1: India’s current account deficit
Even though India’s current account deficit should narrow, it will remain large and financing it will remain difficult because of concerns over US QE tapering, decade-low growth in India and slowing growth in emerging markets. We expect INR to depreciate further.
Reason #2: The Weak Currency
Financial stability concerns will take precedence, which will prompt the RBI to keep rates on hold, and, as announced recently, keep money market liquidity tight for some time. With limited FX reserves, further INR depreciation will delay interest rate cuts, and policy hikes cannot be ruled out. A weak currency will also raise imported inflation pressure and squeeze margins, as weak demand prevents manufacturers from passing on higher costs to consumers. Asset quality concerns can resurface.
Reason #3: Slower Growth
We are downgrading our GDP growth forecasts to 5.0% y-o-y in FY14 (from 5.6%) and to 5.8% in FY15 (from 6.7%) and believe that consensus forecasts are too optimistic. The global growth outlook remains uneven and domestic consumer demand is likely to slow due to the weak employment outlook and a pass-through of suppressed inflation. Despite faster investment project approvals by the government, we do not expect a recovery in the investment cycle, as the incremental reforms implemented thus far have not reached the critical mass to drive an upcycle; it is hard to envisage business expansion amid rising uncertainty over the political outlook and the weak global economic backdrop, and the two sectors that would likely drive a capex revival, infrastructure and construction, are already burdened by high leverage.
Reason #4: Politics
The political situation remains fluid. We believe some reforms may be announced over the next two months, but the window for reforms will close after September, as the election calendar becomes heavy, with five state elections to be held in December 2013/January 2014 and the general election by May 2014. Achieving the fiscal deficit target will be challenging this year without slicing spending again – a strategy that would lead to a further growth slowdown.
Indeed, the situation on the ground has gotten so frustrating that some international corporations have cut back on their planned investments in India. TheWall Street Journal reports:
A series of high-profile withdrawals of foreign investment across several industries this week have highlighted growing frustration with the Indian government over weak public policy as the economy slows.
…The decision by foreign investors to withdraw plans came the same week that the Indian government announced efforts to improve the economy by opening up telecom to 100% foreign ownership and easing overseas-investment rules for defense, energy and single-brand retail. The government was hoping that luring more foreign investment would stop the rupee’s slide to 59.71 to the dollar, a more than 30% decline since the end of 2007, and spur growth that fell to 5% in the quarter ended March 31, its slowest pace in a decade.