By Harris Parvaze
While the Indian economy and policy reforms have taken a cautious stand with the 2019 Lok Sabha elections approaching, political parties are gearing up to strike at each other’s actions and ideologies. With every election come a fresh set of promises and with these promises come expectations. However, practical attainability, promises and expectations have seldom found equilibrium.
Economic cycles can never be done away with, which is why despite tireless efforts good times fade away. Downturns follow upturns like night follows day, hence we need to objectively look at cause and consequences to extrapolate the near future and attribute performance.
The 2008 recession was a game changing event, and it is critical that we are cautious when comparing the economies of two eras. Increase in technological efficiencies, decrease in population growth and prolonged loose monetary policies have raised the possibilities of considering the “new normal” and revising benchmarks.
After the recession, every major developed economy drastically decreased their short-term interest rates to counter the slowdown. The US Federal Reserve, for instance, decreased the federal funds rate and the effective rate decreased from ~5.25% in July 2007 to ~0.15% by end 2008. Other central banks followed suit by keeping the interest rates close to zero percent levels and any further supply was aided through quantitative easing. India, on the other hand, was suffering from high inflation, and has thus had one of the highest interest rates levels in the post-recession era. While the developed world recovered at an unprecedented slow rate barring the US, investors sourced cheap credit and found heaven in the emerging world. As a result, currency and the current account deficit (CAD) remained stable, which made it easier to service debt and import oil. The oil price slump made the party more interesting to hang around.
However, the longer the party, the longer the hangover.
Things changed after 2016, when the Fed saw solid print in the economy and somewhat benign geopolitical risk. They decided to make a policy shift and let the markets gradually price in the hiking cycle. At the start of 2016, the unemployment rate was at 5%, while business confidence was high, which is when it decided to enter the “hawkish” mood.
Post the change in monetary stance, decrease in spread of interest rates between the emerging and developed world, possible change in tax regimes and a strong economic outlook, investors started fleeing to safe haven economies. This along with a recovery in oil prices resulted in the depreciating rupee and worrying CAD levels, which is partly the reason of rupee being suppressed to an all-time low currently. The revocation of the Iran nuclear deal resulted in an increased anticipation of sanctions, and lower inventory levels in major oil producing countries indicate bullish oil signals. With oil being price inelastic for India, the question is this: what is going to be the impact on India’s deficit and what is the future of the rupee? More importantly, should we keep drawing satisfaction from unsustainable growth levels that are vulnerable to exogenous shocks?
Time will tell, but the near future looks uncertain, an economic trait which investors don’t fancy.
The RBI has little room for more accommodation, especially when it has started focusing on the hiking cycle and drawing some liquidity out of the system. Following its August monetary policy meet, the RBI went for back-to-back repo rate hikes, the first time since October 2013. But where will spending come from at a time when the economy is recovering from two major causes of a decrease in demand, demonetisation and the implementation of GST?
Banks are ultra-cautious in granting loans due to increased scrutiny by the government, and rightly so. The mounting stressed assets and recent frauds have left banks in an uncomfortable space, making funding infrastructure projects a challenging task and hence reduced spending. With increasing interest rates and the weaker rupee, it becomes more expensive for the government to raise funding domestically and abroad.
There is a silver lining, however. The tariff war between the US and China has been a nightmare for emerging markets in an already capital-fleeing environment. The Indian export market has a chance to win some market share at a time when the rupee is competitive. The increase in exports could provide some offsetting effects to higher import bills resulting from higher oil prices, and help stabilise the deficit.
The next government will take charge in a less than ideal economic environment and will have significant challenges to take the economy back into the stable zone, let alone a double-digit growth rate. Markets have priced in two more rate hikes by the Fed this year and the economic print in the developed world by the end of this year will be a major factor steering the Indian economy in 2019.
Harris Parvaze is a valuations and corporate finance professional.
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