Sunil Jain: Reading the tea leaves

RATIONAL EXPECTATIONS

Seven or below? That’s the question most pose for GDP growth in 2009-10, having agreed on around 7.5 per cent for the current year. With the global financial market looking terrible and growth in the developed world also slipping, it’s not too difficult to see why so many are plumping for seven. With global growth down, exports of goods and services will taper off; with global demand slowing, so will the investments in new steel plants planned to service this demand; with liquidity drying up globally, credit will cost more and also hit investments in the country.

But just how bad things are and how much they will be affected by global events is the question that the Icrier-CMIE seminar on Preventing an Economic Downturn asked last week. Two of the many slides presented by Mahesh Vyas of CMIE (shown here), in a sense, summarise the problem. The official Index of Industrial Production (IIP) and Wholesale Price Index data would suggest India’s heading towards the classic stagflation, with inflation rising and growth (at least industrial growth) falling. You’d expect that data on sales of the very companies that make up this IIP would show the same trend. Yet, it doesn’t. CMIE takes a sample of 2,100 companies from March 2007 to May 2008 and looks at their sales in current rupees; it then deflates these to remove the impact of inflation and comes up with real sales — and lo and behold, industrial growth is actually picking up! Plot the Consumer Price Index for Industrial Workers and you find that while inflation’s up, it’s hardly frightening.

So which picture should we believe, the one on the left or the one on the right? Some weeks ago, when the capital goods index in the IIP was also showing a dip, most saw this evidence of the falling growth in investment — at that time, in this newspaper, Vyas pointed out that the sales or balance sheet data of the firms in the capital goods space were rising. Well, as if on cue, the latest IIP shows a smart increase in the capital goods sub-sector!

Vyas also shows, using balance sheet data, that the sales growth rate in the June quarter continues to rise; that while profits growth has slowed, this is marginal if you exclude refineries, which are bleeding thanks to stupid government policies; that new investments being announced continue to straddle new peaks and that order books of most capital goods manufacturers are full for the next two and a half years. All of which would suggest the economy can continue to grow at over 8 per cent for some more years.

Sure, the global crisis can affect much of this, through both the demand side as well as from the availability of finance point of view. But a few things are worth keeping in mind. For one, according to Vyas, less than a tenth of the investment projects announced are linked to the export market; the rest are for local needs of increased townships, electricity generation, roads and so on. Second, while increased interest rates and poor availability of funds are clearly an issue, it’s worth keeping in mind that Indian companies have a lot more cash than ever before, are less leveraged and aren’t stressed in terms of payments either. In other words, while higher interest rates will affect demand, from the companies’ point of view, it may not affect profits as much as is widely believed.

Two other data points are worth keeping in mind. The Indian Council for Research on International Economic Relations (Icrier) presentation showed, using the Hodrick and Prescott filters, the economy has been growing much faster than what should be expected, given infrastructure and other constrains — this is the logic behind the belief the economy is overheating. Second, Icrier argued, India’s real interest rates are pretty much aligned with those in developed economies. This got discussant Surjit Bhalla’s goat and he argued that he’d done the same exercise and found India’s actual GDP growth was not in excess of the potential in the last three years. He also argued that if the GDP deflator/CPI was used in place of WPI (as other countries do) to arrive at India’s real interest rates, you’d find India’s rates were far in excess of those shown by Icrier.

While Icrier chief Rajiv Kumar agreed to take these points on board the next time around, it’s important to know whether the new RBI Governor is seeing both sets of data. Seeing just one will seriously bias his policy actions in one direction; seeing both will force him to pause and look at things again.