Why this slowdown is here to stay

Will it be a V, U or the dreaded W? In 2009, even as everyone was debating the likely shape of India’s economic recovery, it was already well underway. The economy then charted the V-shaped recovery that economists love to talk about.

But expecting a similar bounce-back from the ongoing slowdown would be unrealistic. For, there are many indicators to suggest that this slowdown is structurally much worse than the previous one.

Extricating the economy from it is also likely to prove much more difficult than it did in 2008-09. Here is why.

Stiff valuation

Consider India Inc first. In 2008-09, companies barely had time to feel the pinpricks of crisis before the revival began. The top 500 companies reported profit declines for just two quarters in the two-year period. Aggregate sales, the indicator of demand for goods and services, suffered very little.

As a result, India Inc closed 2008-09, a slowdown year, with a robust 20 per cent sales growth. This gave credence to the notion that India’s growth hiccups were temporary and that all would be well once interest rates fell.

But numbers today present a far more worrying picture. This time, sales for the top 500 companies have steadily lost momentum, winding down from 20 per cent growth four quarters ago to 7 per cent in the latest March quarter. Profits haven’t shown much traction for two consecutive years now, inching up by only 6 per cent between 2010-11 and now.

This long spell of disappointing earnings has raised serious doubts about whether the Indian market deserves the stiff price-earnings multiple of 18 that it enjoys today. With high valuations overlaying dodgy growth, will foreign investors look upon India as a mouth-watering buying opportunity?

The picture was very different in 2009. Not only were corporate fundamentals better, doomsday predictions had led to the market multiple languishing at 9 times. Investing in Indian stocks then seemed like a no-brainer.

Don’t forget. In India, a booming stock market has usually been a precursor to economic prosperity. Without a stock market revival, what will set the virtuous cycle of business confidence, risk-taking, investments and growth, into motion?

Losing steam

Then there is the poor composition of growth. India has closed 2012-13 with a sub 5 per cent GDP growth. On the face of it, this may seem only slightly worse than the 6.7 per cent it managed in the crisis year of 2008-09.

But delving into the composition of GDP shows that both services and industry have fared far worse this year than they did in 2008-09. In 2008-09, services clocked close to 10 per cent growth; in 2012-13 they expanded only 6.6 per cent.

The sluggishness in industrial output is there for all to see, with the growth this year at a decade-low. Given that it is industry and services that largely determine employment prospects and wage hikes, this doesn’t augur well for consumer confidence.

Even if consumers were to perk up and loosen their purse strings, there will be capacity constraints to contend with.

In the last four years, additions to manufacturing capacities, equipment and so on (gross fixed capital formation) have been snail-paced, growing at just 6 per cent a year. In contrast, the four years leading up to 2008-09 saw capacities expanding at 16 per cent a year.

It is natural to pause for breath after racing up a hill at 20 km an hour. But to be on the verge of collapse after a leisurely amble on the plains!

Steroids, in short supply

Rejuvenating the economy with a booster-shot of liquidity proved quite easy in 2009, too. As India entered the crisis, the economy was coming off three years of 9 per cent-plus growth.

This meant healthy State coffers, bolstered by tax revenues. The central fiscal deficit in 2007-08 stood at a comfortable 2.5 per cent (of GDP) and interest rates, after Y.V. Reddy’s ministrations, were ruling high.

When the slowdown struck, all this offered plenty of room for the government to unleash a tidal wave of stimulus measures - deep rate cuts, big public spending, lower excise duty and cheap loans to infrastructure. These moves undoubtedly helped kick-start the investment cycle, and revved up economic growth.

Today, the fiscal deficit is already sky-high (5.9 per cent of GDP), rates have already begun their descent and rating agencies are breathing down the government’s neck to curtail spending.

The prospect of a stimulus fed by easy money from the exchequer is thus extremely limited.

The infusion of capital needed to revive the economy thus needs to come from foreign investors. But here too, the road is rocky.

Unlike 2009, one cannot automatically assume that India will be the blue-eyed boy for global investors looking to deploy their capital today.

This is because, with several developed as well as emerging economies on a revival path, India’s sluggish growth marks it out as a laggard.

The IMF projects that world GDP growth will average 3.3 per cent in 2013 and 4 per cent in 2014, led mainly by a recovery in the US and a turnaround in the Euro Zone. India’s growth is likely to hover at 5.7 and 6.2 per cent, respectively. Isn’t this good enough?

It may not be, for two reasons. One, given the higher risk and currency volatility that comes with emerging market investments, foreign investors expect much higher returns from India than from their bets back home.

Two, with this growth, India will lag most of its Asian peers who will average a 7 per cent-plus growth.

Again, the contrast with 2009 is stark. Then, India, with its 6.9 per cent GDP growth, appeared to be a safe anchor in a turbulent world. It was still soundly trouncing other developing economies as well as developed ones, which were in the grip of recession.

Overall, therefore, the message is that one can’t expect a V-shaped recovery from this slowdown.

It would be better to brace for a U and hope that it doesn’t turn out to be an L.

COMMENT NOW