India has grown, now what?

It will be too simplistic to forecast a negative trend when the trend is already negative. The fact is that when India was growing at a hectic pace there were no reports on the unsustainability of growth. In the same breath just because growth trends are negative does not suggest that growth cannot fall further. However one cannot stand back and say that one does not know where the economy is headed as that line of stance will yield no returns. Arguing on India’s growth in earlier years will also not yield any returns.

The headlines on India’s hectic pace of growth in the mid 2000-2010 decade and the subsequent fall in GDP growth is more pedantic than a practical course on what lies ahead for stakeholders of the country.

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Yes India’s growth in the mid 2003-08 period was partly driven by huge leveraged global liquidity and the subsequent fall in growth thereafter was due to the withdrawal of that liquidity. However the fact remains that India’s GDP has grown at a CAGR of 14% over the last eleven years from 2000-01 to 2011-12. In absolute terms nominal GDP has growth from Rs 21 lakh crore to Rs 89 lakh crore in the same period. The over four times increase in nominal GDP has generated wealth to the country though the distribution of wealth is questionable.

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The problems India face now are well documented. Domestic issues include rising fiscal deficit (5.9% of GDP in 2011-12 up 1.3% from initial estimates), rising subsidy bill (highest even recorded in 2011-12), rising inflation (averaged over 9% for 2011-12), falling economic growth (came off to 6.5% in 2011-12 from 8.4% in 2010-11), weakening Rupee (down over 20% against USD in 2011-12), falling equity markets (Sensex and Nifty down close to 10% in 2011-12) and rising bond yields (ten year bond yield up 150bps in 2011-12). Global issues include worries on sovereign debt of Eurozone countries with Spain joining the ranks of Greece, Portugal and Ireland requiring bailout, China hard landing with GDP growth forecast at 8% to 8.5% levels from high double digit levels seen in whole of 2000-10 decade and sluggish US economy with unemployment rates at 8.2% higher than long term averages of close to 6%.

In light of the issues facing the economy, what is the future direction of the economy? Will India’s GDP growth plunge to below 6% levels as forecast by some economists? If GDP growth is going to fall, what are the implication on deficits, inflation and asset prices?

Falling GDP growth leads to high deficits as the country collects lower taxes though subsidy bills remain sticky. Inflation may or may not fall on fall in growth as food and fuel prices coupled with pass through of hidden inflation in the form of subsidies could lead inflation higher. Asset prices will fall in the face of low growth and sticky inflation but having been in negative territory for four to five years can equity, currency and bond prices fall further?

The right way to look at the future direction of the economy is not to try and predict how much will the economy grow in the coming years. The way the economy is reacting to a negative situation is more important. In India’s case the economy is reacting positively to the current negative environment.

There is a sense of setting issues of governance, deficits and inflation right by the policy makers. Corporates are busy restructuring, consolidation and improving to survive and prosper. Investors have lost their greed and are now more realistic in their return assumptions.

The FM acting on reducing fiscal deficit, a Future group selling off businesses to reduce debt and an investor looking for healthy balance sheets and good corporate governance are all positive signs.

Be positive on the economy for future gains.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.