Thursday, January 22, 2009


Justin Menza

The global economic downturn has forced India to take steps to shore up its own economy. Last week, the Reserve Bank of India slashed interest rates by 100 basis points, while cutting the cash reserve ratio (the amount of deposits banks must have in cash) to 5% from 5.5%. These moves are in addition to two previously announced economic stimulus packages, and should aid the economy in the second half of the year.

Like most other emerging markets, India has not been immune to the economic recession and financial crisis gripping the world's developed economies. With the United States, Eurozone, and Japan already in recession, and credit markets remaining constrained for many borrowers, India is naturally feeling the impact. Although the financial system has not faced systemic pressures stemming from the financial crisis, the credit market turmoil has been felt in the form of tighter liquidity and in less access to overseas funding sources for domestic firms.

"The fundamentals of our economy continue to be strong," the central bank said in a statement. "Once the crisis is behind us, and calm and confidence are restored in the global markets, economic activity in India would recover sharply. But a period of painful adjustment is inevitable."

In addition to cutting interest rates and reserve requirements, the Indian central bank announced that foreign investment in corporate bonds will be lifted to $15 billion from a previous $6 billion in a bid to lure foreign capital inflows back into the economy. The central bank also removed the ceiling on interest rates corporate borrowers can pay for their overseas funding until June 30.

Complementing the monetary policy initiatives, the Indian government announced two economic stimulus packages, one in early December and the second in early January. The first $4 billion stimulus plan is aimed at bolstering domestic demand, and includes a cut in the sales tax. The second allocates $6 billion to regional infrastructure projects, and $4 billion to recapitalize state lenders, which continue to make up a large portion of the Indian financial system.

S&P Asia-Pacific chief economist Subir Gokarn notes that India should benefit from the monetary and fiscal stimuli, "which will greatly stimulate domestic demand." Gokarn is anticipating economic growth of 6.0% to 6.5% in 2009, after estimated growth of 7.0% to 7.5% in 2008, and 9% growth in 2007. For the most part, economic growth is likely to be more limited in the first half of 2009 than in the second half.

Gokarn also points out that a contraction in industrial production in October for the first time in 15 years, points to a slowdown in the next few quarters. Export growth also dropped sharply in October, falling 12.1% due to weakening external demand amid the global economic downturn.

Another issue hanging over India during the first half of 2009 is the looming parliamentary elections, which are to be held by May. The ruling party will be under pressure to deliver on its economic stimulus measures in order to remain in power in what is expected to be a tightly contested election. This could lead to additional fiscal spending, but also raises the prospects for higher deficits and increased public debt levels, which are already substantial.

"If the fiscal balance deteriorates significantly; risk perception could force long-term yields higher, undermining the impact on monetary easing," cautions economic research firm Global Insight analyst Claire Innes in a report.

These fiscal and monetary policy moves have had a positive impact on the domestic equity markets, with the MSCI India index up nearly 7.6% in U.S. dollar terms so far this year (through 1/5). In addition, S&P Equity Research International Strategist Alec Young believes India's low 2009 estimated PE to growth ratio of 0.9 is also helping fuel the outperformance. The MSCI India index recently traded at 11 times 2009 estimated earnings per share (EPS), while the consensus expects earnings to grow 12% this year. By contrast, the broader emerging markets universe is expected to post only low single digit EPS growth in 2009.

The Indian equity market was among the worst performers in developing Asia in 2008, with the MSCI India index down 65.1%, compared with a 54.1% drop for the MSCI Emerging Market Asia index.