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How to ride out the slowdown

Veena Venugopal, Outlook Money | August 06, 2008

February made me shiver
          
With every paper I'd deliver
Bad news on the doorstep;
           I couldn't take one more step...

Goes the song American Pie. In India, start with January and go up till July. The bad news is delivered at our doorstep every day. Oil prices are threatening economies around the world, inflation is almost at 12 per cent, we have a wobbly government at the Centre now, and the stockmarket is tumbling.

As more and more of you write in to us asking for specific strategies to cope with the changed dynamics of our economy and market, we attempt to answer some prime money concerns.

The story so far In order to evaluate how much worse things are likely to get and for how long, let us first look at how bad things are now. If you compare this year with the last, the state of the economy seems unrecognisable.

This time last year, we were worried about rupee appreciation, exporters felt under threat and sops were being extended to them. This year, so far, the rupee has already depreciated 8.2 per cent. Indications are that it will fall further in the coming weeks. The ratings company, Fitch Ratings, downgraded India's currency rating in the first week of July.

It said: "This is based on a considerable deterioration in the Central government's fiscal position in 2008-09, combined with a notable increase in government debt issuance to finance subsidies not captured in the Budget."

Even if we consider 2007 the year of aberration in the stockmarket as it grew 47 per cent in 12 months, what is imperative is the amount of confidence foreign institutional investors had in our growth. Between January and December 2007, Rs 71,487 crore was pumped in.

Cut to July 2008: FIIs have taken out Rs 27,112 crore (Rs 271.12 billion) since January. With the liquidity-led rally of the last few years hitting serious speed breakers, the broad market represented by the Nifty 50 is down 30 per cent in the last six months.

At the beginning of the year, all-knowing market experts set their target for the Sensex this year at 28,000. Now the worry is that it would dip down to four digits, under 10,000.

The clouds of gloom are not just over the world of stockmarket valuations. The Index of Industrial Production is now growing at 3.6 per cent, down from 14.8 per cent in March 2007. Inflation is barely shy of 12 per cent. The culprit for this is oil price, which touched $140 a barrel, double from $70 last year.

So what gave? How did this dramatic shift happen? Much of it was due to the US sub-prime crisis. As the US Federal Reserve was on a spree of cutting interest rates, home loans were given to people with little ability to pay them back.

This promoted cheap housing finance and the young started buying homes and the middle-aged started buying their second and third homes. Cheap money also flooded into India - into the stockmarket as FII inflows and into Indian companies through foreign direct investment.

The rupee strengthened, and exporters and IT companies were the only sufferers. But when housing prices peaked in the US, consumers started defaulting and the sub-prime crisis began to unfold. Banks and lending institutions were hit hard towards the end of 2007.

But, in India, we felt that we had our own resilience and our burgeoning middle classes would support growth. Inevitably, Western banks had to shrink the size of their loan books, and the flood of funds into India started ebbing. The first tranche of withdrawals in January, when share valuations were ridiculously high, spooked our investors.

The US Fed slashed interest rates further and doled out bailout packages. These funds went into commodities, especially crude oil. A barrel of oil soared from $91.82 to $139.81 in six months. This has had tremendous consequences on our economy. For one, we are paying more for petrol and inflation has also zoomed.

Interactive

The clouds of gloom are not just in the world of stockmarket valuations. The Index of Industrial Production is now rising at 3.6 per cent, down from 14.8 per cent in March 2007. So what gave? How did all the major indicators turn from green to amber?

1st Person: I thought till recently everything was going great. What happened suddenly?

2nd Person: Well, everything that goes up must come down. This is not a recession but only a slowdown.

1st Person: The stockmarket is down, inflation is up...how did such a reversal take place?

2nd Person: Among the many factors was the sub-prime crisis which hit lenders in the US...

1st Person: How is housing in America connected to oil prices and inflation?

2nd Person: The US Fed slashed interest rates and cheap money chased speculative deals in commodities

1st Person:...so crude oil and other prices soared. Is that why interest rates have been hiked?

2nd Person: Yes, high oil prices imply high inflation, which in turn means high interest rates

Our central bank tightened interest rates in order to suck liquidity out of the system and control inflation and rendered the home, auto and personal loans we took during the good times much more expensive.

The government faced a trust vote on July 22 and managed to hang on. Though some reform may breeze through now without any opposition from the Left, elections are only nine months away and any steps to rescue the economy from the slowdown are likely to be half-hearted.

And now?

These events, some foreseen, others unexpected, are behind the roadblocks on the much-touted India growth story. We don't hear 9 per cent anymore, instead words like slowdown have re-entered our vocabulary. What is next?

Party might not resume yet...

The government has been saved, for now. Inflation has not yet touched 12 per cent, and current news is that oil prices have come off their highs from the early part of this month. Does this mean that the party can resume? Will the state of the economy recover and would we continue to grow at the estimated 9 per cent rate? Chances are, it is going to take a while. The reasons?

  • The sub-prime crisis is still throwing out skeletons from the cupboards.
  • Oil prices holding up above $130 dollars a barrel.
  • Inflation continues in double digits-11.89 per cent. Interest rates still high.
  • Elections due in the next nine months, with accompanying maneouvres.
  • Tempered growth.

A few things are clear. For one, funds flow across the world will be slower. Almost a year after the term sub-prime was heard, sudden crises are still happening. Fannie Mae and Freddie Mac, two of the largest mortgage companies in the US, had to be rescued by the US Fed this July. Merrill Lynch has written off $4.89 billion as losses. With the stress in global financial markets, investment might dry up. This will be true for FIIs in the Indian stockmarket as well as FDI in Indian companies.

The rupee is expected to continue its slide. Inflation also is not likely to wind down in a hurry as 70 per cent of our requirement for petroleum and over 50 per cent of our demand for edible oil is met through imports. Crude prices have come off a little bit after the first fortnight of July, but any significant fall in prices is not expected very soon.

The government will try to hold on to price subsidies, but its fiscal position is deteriorating rapidly, and it will have to increase petroleum product prices again. This will drive another wave of inflation. And, of course, if we are staring at early elections, most calculations on policy initiatives simply fly out the window.

As a result of this, interest rates will have to be held up, which will make fresh investments less energetic. The growth process will inevitably become slow. This state of suspended animation is likely to play out over the next 2-3 years, before inflation and interest rates are tempered.

In this new scenario, how should you play your portfolio? Are there any investments you should take a relook at? Despite the volatility, is this a good time to buy stocks? If yes, what kind should you opt for? What should you do with your Ulip? Should you continue your SIP or sit on cash or invest it in a fixed deposit?


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