Rising risk aversion

Weakness in industrial growth to have ripple effect on the services sector.

Corporate India has a good reason to protest against the Reserve Bank of India’s repeated rate increases. While not much has been achieved on the price rise front, these increases have slowed down corporate India’s investment cycle dramatically. What is expected to hit the cycle even harder is the rising risk aversion. For a capital-starved economy like India, this is bad news.

Given that the cost of capital is relatively high in India, corporate India is heavily dependent on external capital, primarily in the form of portfolio flows. Following any major financial crisis, unlike an economic downturn, the level of risk aversion remains heightened for a prolonged period of time. And, this has become apparent since August, when foreign institutional investors have been selling risky assets like emerging market equities.

This is expected to have a direct impact on investment demand, which is expected to decelerate to 5.5 per cent in FY12 and to 4.5 per cent in FY13, says Ritika Mankar, economist at Ambit Capital. Mankar believes weakness in the US economy is likely to persist in FY13, which, in turn, is likely to mean a continued weakness for India’s capex cycle (which depends meaningfully on equity capital inflows). Consequently, Ambit expects moderation in economic activity to persist in FY13 and GDP to grow at 7.2 per cent year-on-year. This will impact portfolio flows even further, as eight per cent growth in the economy helps generate double-digit returns in equities. If growth dips below this level, returns become unattractive.

Ambit is not alone in forecasting slower growth. Nomura expects deceleration to continue in the second half of FY12. It says: “GDP growth eased to 7.7 per cent y-o-y in second quarter (April-June) from 7.8 per cent in the first. Leading indicators suggest it will moderate further in the second half, as high interest rates weigh on consumer demand and exports demand, weakened due to the slowdown in global growth.”

Weakness in the industrial and manufacturing sector will have a ripple effect on the services sector. However, the only positive is consumption, which has held on, even in times of crisis. India, China, Indonesia and Philippines saw no decline in private consumption or investment (in 2008-09), according to Standard Chartered Global Research.

Economists believe private consumption got a boost due to government spending and fiscal initiatives to create jobs. This time too, Mankar believes, government revenue expenditure is likely to support the community, social and personal services (CSPS) component of ‘services’, which is likely to experience high growth ahead of the scheduled general elections in CY14.