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Sunday, Apr 04, 2004

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To keep India shining

Krishnan Thiagarajan

The double-digit GDP growth of 10.4 per cent in the third quarter of 2003-04 has shown that India is the fastest growing economy in the world.

THE new fiscal dawned on an optimistic note for the Indian economy. The double-digit GDP growth of 10.4 per cent in the third quarter of 2003-04 has shown that India is the fastest growing economy in the world. This trend is even more encouraging as it follows two good quarters of 5.7 per cent and 8.4 per cent growth in the first and second quarter of 2003-04, respectively.

Clearly, a host of cyclical and structural factors have contributed to a broad-based economic recovery. Factors, such as good monsoons, low interest rates fuelling consumer demand, rising exports, better capacity utilisation by companies stemming from cost cutting and restructuring in the lean years, and an emerging global mindset, have combined to bring sheen to the economy.

Three consecutive quarters of strong GDP growth can no longer be dismissed as a flash in the pan. But, going forward, sustaining the growth of the economy and, in turn, the stock market will hinge on three variables:

Lead impact of monsoons

The rain gods were kind to the Indian economy in 2003-04. In the third quarter of 2003-04, the agricultural sector expanded by 16.9 per cent, after contracting by 9.8 per cent in the same quarter of the previous fiscal.

Following the 7.4 per cent growth in the second quarter of 2003-04, this was the second straight quarter of strong positive growth for the sector.

It may be recalled that the lead effect of a favourable monsoon (based on the good South West monsoon) had led to a sharp re-rating of stocks in several sectors between August and December 2003. The direct beneficiaries were sectors such as fertilisers and agrochemicals, and indirectly, automobiles and consumer goods.

Obviously, this year all heads will be turned up, looking at the skies; this will provide the early signals of a sustained GDP growth.

If the monsoon fails or is inadequate in terms of quantum and spatial distribution, there is a possibility of the stock prices reacting adversely to this development, and that too, well in advance of its actual impact on GDP growth.

Lag effect of commodity price spiral

Over the past month or so, the government has deferred the hike in petroleum prices and intervened in the fixation of steel prices to sustain the demand for products in the end-user industries such as engineering, automobiles and consumer durables. In turn, this will keep the operating profit margins of end-user companies steady in the coming April-June quarter.

For the time being, this can be easily dismissed as a feel good election gimmick. But the new party which comes to power at the Centre will face the unpleasant task of taking this commodity price "bull by the horns", if the firm price trends continue.

And for that matter, this commodity price spiral is not confined to steel or petrol alone, but to a whole host of commodities ranging from copper, aluminium, paper, petrochemicals and cement. Whenever these price hikes are effected, they may test the strength of the industrial and consumer goods companies to absorb the higher input costs and maintain growth in operating profits. If they fail, the lower operating profit margins may take a toll on stock prices in these sectors.

The economy appears to be strong enough to manage the impact of either the lead effect of monsoons or lag effect of a commodity price spiral. But if the two factors happen simultaneously, they can prove devastating for the economy and the stock market.

Cushion of capital investments

The biggest cushion for the economy will, however, be when the economy can seamlessly switch from a demand recovery to an investment led mode.

The combination of consumption-led demand and massive restructuring by companies of their balance sheets and business operations in the late-1990s have created conditions for fresh capacity creation. Moreover, the combination of low interest rate regime, attractive return on equity and healthy profit margins is poised to encourage capital investments on a large-scale across different sectors in the economy. The first signals of capacity creation and capital investments in different sectors are quite encouraging. The low interest rate regime and sharp pick-up in non-food credit growth are also pointers to this trend.

Going forward, the even-handed spread of investments across all sectors such as power, manufacturing, mining and construction and quality of investments by the right corporate groups will make a difference to economic growth.

The only dark cloud that can be foreseen is a rise in interest rates following a steep increase in loanable funds for capital investments across the economy.

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