Emerging Economy

Indicus Analytics
November, 2008

4 November 2008
Indian Economy Next Quarter

RBI slashes rates before and after the mid-term review, expect little else next few weeks

Pessimism continues to rule though Sensex finds some support at 9-10,000

Corporate sector cuts back new investments, hiring and marketing spends

Crude collapses but fuel price cut not likely

Govt. admits fiscal deficit target will not be met

All financial and macro-economic models have become dysfunctional

India : Kal, aaj aur kal

October, what a dramatic month! Markets crashed worldwide, taking currencies down with them and
creating what has been now been called a ‘financial tsunami’. The madness of the media rivalled the
madness in the markets as anchors squeezed out stories from the minute by minute ticker.

All of this was predicted few months back, and we were among those who did so as far back as November
2007 and repeated our concerns in Feb 2008. Indian policy makers however kept up with their pro-
inflationary fiscal policies of increased government expenditure on the one hand and liquidity tightening
monetary policies on the other. This is a familiar pattern and occurred in the 1990s as well - profligacy and
inflation followed by interest rate tightening and growth slowdown. This time it is of course much worse, with
the impact of the financial imbalances in the international economy.

This will result in a slowdown in Indian exports, and there will also be a slowdown in Indian investment
growth especially in the corporate sector. We do not however expect any recessionary tendencies to affect
India. Some sectors will no doubt be affected adversely, and the strong growth momentum will level a bit,
India will however sail out of these troubled times relatively smoothly.

Among areas of concern, to inflation is now added financial and macro-economic stability. Given the rapidly
changing situation, to its credit the government has approached this crisis in a mature manner. Increasing
liquidity and reducing interest rates, strengthening of some institutions that appeared to be weak, and
allowing markets to stabilize by themselves have significantly and positively impacted the long term
confidence in Indian markets. This augurs well for the future.

Since inflation drives politics and economic policy in India, we would need to keep a close watch on it for
some time ahead. On the one hand commodity prices have fallen dramatically, but so has the rupee,
thereby reducing its anti-inflationary impact. Combined with a high budget deficit and potential mismatch in
supply and demand of some food products (typically of the non-food grain variety), inflation will fall but not
dramatically. Economists in the government would find it hard to convince the administrators and politicians
to reduce interest rates further.

The PM and others have meanwhile supported ‘pump priming’ the economy through additional infrastructure
investments by the government. Though infrastructure investments are generally welcomed, this would not
be very helpful for the problem at hand. Since the money flows would only commence in a few years, when
the worst of the growth slowdown would anyway have been over. Meanwhile large scale government
borrowings would only reduce confidence in the intervening period.

There is only one way to strengthen confidence in India – good fiscal management, and strong market
based institutions. Improved monitoring, quality of regulation, and policy all need to be oriented to these,
temporary hiccups notwithstanding.

PS: Alan Greenspan admitted that the Fed’s ability to forecast the economy’s trajectory was an inexact
science, he said, ‘If we get it right 60% of the time, we are doing exceptionally well.’ True, 60-40 sounds a bit
better than 50-50.
Sumita Kale & Laveesh Bhandari
4th November 2008, Indicus Analytics
Dr. Sumita Kale is Chief Economist, and Laveesh Bhandari is Director, Indicus Analytics. They can
be contacted at sumita@indicus.net & laveesh@indicus.net

Economic Growth
IIP for August crashed at 1.27% growth, a mere 1.15% in
Indicus Forecast 2008-09 manufacturing. This is on a double digit base of last August,
GDP hence reflective of the slowdown.
Electricity generation which grew at a measly 0.77% in August
Agriculture
over last year, showed slightly better performance in
Manufacturing,Mining &Electricity September at 4.38%.
Services including Construction ABN-AMRO’s PMI survey showed the lowest index in October.
Month of Forecast : September 2008 Biggest fall is in the new orders index, which projects lower
output in the future.
Auto production grew at 12.7% in the first half of the year, higher than last year’s growth. Sales of
passenger vehicles grew by 7.53% while commercial vehicles grew at 3.79%.

Auto exports did very well, growing at 27.4% growth in April-September period over last year.

Cement production grew by 8.11% in September over last year, while despatches rose by 9.2%,
higher than the 4.1% increase seen last September.
In aviation, international passenger movement grew in August by 9.3% but domestic passengers
declined by 17.1%. International cargo movement grew by 5.8% while domestic cargo by air barely
grew at 0.1% in August.

Foreign tourist arrivals up by 10.4% in the first half of this year, compared to 14.2% growth last year.

Railway freight revenue rose by 18.9% in the period April-September while Net Tonne Kilometres
grew by 9.60%. Growth during the same period last year was 9.77% and 4.88% respectively.
10.07 million wireless subscribers were added in September, compared to 7.79 million last
September. Broadband subscriber base is now 4.9 million and tele-density in India stands at
30.64% at the end of September.
Read: Inflation control chokes growth
Inflation
 Provisional WPI inflation finally fell below the 11% mark, for the week ending 18th October, sooner than
we expected.

Final estimates for August inflation continue high revisions coming precariously close to 13%.

Inflation measured by the CPI for Agricultural labourers stood at 10.98% in September and 9.77% for
CPI IW. Last September these were 7.89% and 6.4% respectively, showing hardening in inflation for the
common man.
Commodities have crashed worldwide, a good sign for inflation pressures ahead. Crude fell 25% in
October, coming down to an average of $73 a barrel.
Agri commodities on the NCDEX have shown a decline since the peak in July.
However, with the sharp depreciation in the rupee, expect prices to rise in imported commodities like
pulses, where stagnation in production has kept imports high.

Read: January, inflation data to be released once a month

Interest Rates
With liquidity concerns hitting India, the RBI slashed the CRR by an unprecedented 150 basis points in
the span of a few days.
A cut before the policy review was followed by another slashing on a weekend, after the review, keeping
the markets on the tenterhooks for decisions.
CRR now stands at 6.0% and the repo rate cut to 7.5%, as growth and liquidity take on higher priority
than inflation currently.
Worldwide rates were cut - a coordinated move by the Fed, ECB, China, UK, Canada, Sweden,
Switzerland on October 7th and the Fed cut again on the month end. South Korea slashed by the most
ever, its first cut since 2001.
The US has gone down from 5.25% to 1% over 13 months, and more is expected. Bank of Japan
seems to be headed for a zero interest rate period again.
Meanwhile there are others scrambling to rescue their currencies and raising rates: Denmark did so
despite being in a recession, Hungary hiked by 300 basis points and South Africa, Romania seem to be
likely contenders in the rate hike zone.
Yield on the 10 year benchmark gilt dropped with the rate cuts and from the 9.4635 % high in July, is
now at 7.5512 at the end of October.
Read: Fed makes breathtaking changes, cut rates too
Transcript: Duvvuri Subbarao
Exchange Rates
Exports in the month of September rose 10.4% in dollar terms and 24.7% in rupee terms while imports
grew by 43.3% in dollar terms and 61.9% in rupee terms over last year.

Oil imports had risen by 57.1% while non-oil imports grew by 36.2% in dollar terms.

Trade deficit therefore was $ 49.14 billion in the period April-August, compared to $34.54 billion last
year. Trade deficit in the first half of this year stood at $ 59.77 billion, higher than $39.1 billion last year.
The dollar swung upwards in October, as the so –called flight to quality led to a scramble to buy dollars
– the biggest monthly gain in 17 years.
The pound fetched its lowest against the dollar since 2002, while the euro also took a battering.
The rupee fell through 50 to a dollar briefly, a fall of about 7% in one month as money flowed out of the
country, following the trend of stock market lows worldwide.
The sharp change in the global environment has led to the fall in the rupee, and other currencies. Led
by sentiment, rather than any fundamental change in the strength of the economy, estimating a level for
the rupee now has more uncertainty. While the RBI is expected to tame volatility, trends can reverse as
suddenly as they set in.

Read: 38 to the dollar in 5 years

Ring a ring o’ roses