The Hindu Business Line : “Fiscal stimulus may not fully offset headwinds from credit crunch”

Macro-indicators, more than ever before, now hold the key to how your investments will perform. In an interview with Business Line, Ms Sonal Varma, India Economist, Nomura Financial Advisory and Securities, offers her outlook on India’s key macro-economic indicators for the year head. Excerpts from the interview:

What is the quantum of rate cuts you expect in 2009? Are the benefits of softening interest rate trickling down?

We are pencilling in a 250-basis-point cut in the CRR to 3 per cent; a 150-bp cut in the repo rate to 5 per cent and a 100-bp cut in the reverse repo rate to 4 per cent, all by mid-2009.

We expect this aggressive policy response given the slump in economic growth; GDP growth could slow from 9 per cent in FY08 to 6.8 per cent Y-o-Y in FY09 and further to 5.3 per cent in FY10, due to sharply lower inflation rates in the coming months.

The effectiveness of these measures could be fairly limited in the short term.

Banks are either still raising funds at high rates and are reluctant to sharply lower their lending rates, or have tightened their lending standards, thereby diluting the monetary policy transmission mechanism.

Will there be a slowdown in corporate capex spending and investment spending by Government in the coming year?

Yes, we do expect a slowdown in corporate capex spending because financing of new investments is becoming less accessible and more costly. First, thinning profits are eating into corporate domestic savings.

Second, the global credit crunch has led to a marked decrease in external commercial borrowings and equity financing. Third, the cost of raising debt-finance domestically has risen substantially.

We estimate that the amount of financing available from all sources rose to 15.1 per cent of GDP in FY08, but we expect this ratio to fall to 12.3 per cent in FY09 and 12.0 per cent in FY10, thus deterring firms from undertaking any new investments. Since financing for some projects has already been secured, the drying up of financing is expected to have a larger impact on upcoming investment.

Are funding constraints the key reason for the slowdown in spending?

There are numerous drivers of this investment slowdown. Over the last six years, India’s investment-to-GDP ratio has surged from 23 per cent in FY02 to 36 per cent in FY07, with investment in the manufacturing sector accounting for 10 percentage points (pp) of this 13pp rise.

However, now that the manufacturing sector is struggling with dwindling sales, rising inventories and financing constraints, we expect firms to draw down inventories and slow their capex plans. On the positive side, the government’s investment in infrastructure sectors can receive a boost from the fiscal stimulus announced as part of the package to boost economic growth.

But this is unlikely to fully offset the headwinds from funding constraints.

Overall, we expect real growth in gross fixed capital expenditure to slow sharply, from 13.8 per cent Y-o-Y in FY08 to 8.5 per cent in FY09 and to 2.5 per cent in FY10,.

Do you expect the current account and fiscal deficit levels to improve given the decline seen in crude prices?

On the external front, the sharp fall in oil prices is a big positive for a commodity importer like India.

However, with the simultaneous drop in exports (particularly software shipments to the US) due to the global recession, and a projected drop in private remittances, especially from Gulf nations due to lower oil prices, the current account deficit could double to 3 per cent of GDP in FY09 (year ending March 2009) from 1.5 per cent in FY08.

Exports will likely continue to flag in H1 FY10, but with import demand set to tumble, we expect the current account deficit to narrow to 1.4 per cent of GDP in FY10.

On the fiscal front, lower commodity prices have reduced the oil subsidy burden, but we still expect a wider fiscal deficit in FY09, given the need to give additional fiscal stimulus to counter slowing economic growth, the risk of lower tax revenues, farm loan waiver and the Sixth Pay Commission hikes.

Overall, we expect the general government deficit (Centre and States’ on- and off-budget) fiscal deficit to widen to 7.7 per cent of GDP in FY09, before narrowing to 6.7 per cent in FY10 because of a lower subsidy bill.

How will this influence the rupee-dollar movement? What is your outlook for the rupee in 2009?

With risk aversion deterring investment in emerging markets, a large balance of payment (BoP) deficit of $39 billion expected in FY09 and with India’s growth slowing sharply, we expect the rupee to remain weak, at around Rs.50.5 a dollar by March 2009. However, as external BoP pressures ease next year due to lower commodity prices and as risk aversion wanes, we expect rupee to gradually appreciate to 45.9 by March 2010.

(This interview was taken before the announcement of the second stimulus package)

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