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India's economy after the bloodbath

It is remarkable that despite OECD's forecast of a slowdown in global trade and investment, India continue to grow at over 7 per cent. The IMF has also predicted a slower global economic growth which now seems probable when there are alarming factors in the global arena especially in the Chinese economy.

China's housing bubble that finally burst led Chinese small investors to make quick bucks in the stock market which kept on rising. But because of weak fundamentals, the rise could not be sustained and China had to devalue the Yuan by 4 per cent. This was followed by the Chinese stock market crash that affected many countries in the world and the Rupee slid by 3 per cent as a reaction. The depreciation of the rupee may help boost our sluggish exports( declining by 10.3 per cent in July) but the fact that China is slowing down and US economic recovery is not strong enough ( though US growth rate picked up in the last quarter) will not be good for India's exports. Even the EU is not growing fast. India's industrial growth at 3.8 per cent ( June) has also been sluggish . Hence job creation will be slow.

But Yuan's devaluation will now affect its own product prices because it imports a lot of component and parts from neighbouring countries in the ASEAN. It may now import fewer components as well as raw materials and thus China is slowly spreading its own malaise in its neighbourhood.

The recent global stock market crash was also due to China's stock market meltdown when the Shanghai Composite index fell by 8.8 per cent. Devaluation in China, the Greece's next bailout package and the resignation of Prime Minister Alexis Tsipras on account of his acceptance of the new austerity package, China's huge debt ( 262 per cent of GDP) and the Tianjin disaster where 100 people died, all led to a crisis of confidence.

Many analysts think that China's devaluation was also aimed at reducing capital outflows because for some time now, sensing a slowdown in manufacturing growth, there was an outflow of capital. On the whole it shows that Chinese investors who borrowed money to invest, were dumping stocks so as not to get hurt further.

Indian stock market also tumbled by 6 per cent , 1624 points, but has recovered a little since 'Black Monday'. Though the stock market fell mainly due to external factors, it was also due to massive exit of FIIs. They withdrew around Rs. 16,250 crore in just 7 trading sessions in August. They sold perhaps due to lack of confidence in India's ability to weather the crisis. With lower rupee, there will be a problem of attracting more FIIs because of uncertainty and volatility in the rupee's value.

On the agricultural front due to monsoon deficit of around 11 per cent, there will be slower agricultural growth which has been low at 0.2 per cent (2014-15) due to low returns to investment in the face of small increases in Minimum Support prices. Moody's has revised India's GDP growth projection downward by 0.5 per cent.

The domestic investment in the country has to pick up from its stagnant state to counter all the current economic problems but the RBI Governor seems adamant to reduce interest rates further even though China has already reduced its interest rate three times ( now at 2.3 per cent) to stimulate its economy. Governor Raghuram Rajan seems to think that inflation can still be a threat though both the WPI and CPI have fallen sharply. Many infrastructure projects are on hold because of high interest rate of 7.25 per cent.

The other big problem in India is that many of the crucial reform bills have got stuck in the Parliament and are awaiting approval. The Land Acquisition bill is the most important one that needs clearance. The NDA government's amendment has not been acceptable to the Congress because it has five categories of land that are exempt from the critical 'consent' clause. The problems of compensation and the requirement of 80 per cent consent from landowners and affected families, will have to be resolved by a consensus between the two political parties as millions of small farmers' lives are involved.

By creating a more enabling business environment like reducing red tape and having an exit law in place, more foreign investment can be expected and indeed PM Modi's foreign tours have been successful in attracting FDI (it has increased by 48 per cent between April and July 2015) but the implementation of projects is awaited. There has to be consensus on all the reforms proposed by the NDA government.

Urgent action is needed in the area of banking and the NPAs are at a danger level of 5.75 per cent of gross assets. Loan recovery seems weak especially from big borrowers who happen to be some of the biggest industrialists. Banks have to be fortified against possible financial market turmoil which can hit again from the West or the East. There is need for a massive recapitalization of the public sector banks to comply with the Basel III norms.

The rupee may not depreciate more against the dollar because India has huge dollar reserves( $355 billion). On the other hand the reason behind the dollar's strength is due to investors' belief in US recovery gaining strength and US becoming a safe haven. They also believe in the possibility of an interest rate hike following a stronger US recovery which will attract FIIs back to the US. But with Chinese goods getting cheaper and US imports increasing, the interest rate issue could be postponed (till the next job data comes out) to give an impetus to US industry.

The sharp fall in oil prices is another factor contributing to the bearishness of the stock markets. Oil prices at near $40 a barrel was unthinkable even a year ago. All commodity prices are spiralling down except gold. People will probably buy more gold as a hedge against the future as Indians have always done! Our challenge and opportunity now is to raise the competitiveness of our products.

Jayshree Sengupta
8 September 2015
(The writer is a Senior Fellow at Observer Research Foundation, Delhi)

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