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What will happen to the economy in 2009?

Rajesh Kumar, Outlook Money | January 05, 2009

The problems of financial markets have started affecting the real economy worldwide. Consensus estimates suggest that 2009 will be worse than 2008.

The World Bank in its report titled Global Economic Prospects 2009 has painted a grim picture for the next year. It says: "Growth prospects for both high-income and developing countries have deteriorated substantially, and a movement of global growth from 2.5 per cent in 2008 to 0.9 per cent in 2009 appears to be on the cards."

Outlook for India

The global economic slowdown will have significant impact on how our economy does. The World Bank expects India to grow at 5.7 per cent in 2009, followed by a bounce back to 7.7 per cent in 2010.

Accepting the fact that the Indian economy is slowing down rapidly, the government has offered two stimulus packages of more than Rs 52,000 crore (Rs 520 billion) along with the Reserve Bank of India [Get Quote] cutting rates.

Analysts, however, feel this may not be enough. "We expect these measures to have a positive impact, but only at the margin," says Nomura Financial Advisory And Securities (India) in its research note. The financial services firm also believes that the Indian economy's growth will slow down to 6.8 per cent year-on-year in FY09 (year ending March 2009) and even lower to 5.3 per cent in FY10.

Goldman Sachs, in a similar note, says the moves are positive, but may not materially alter the growth outlook for the Indian economy. Their expectation for GDP growth is 6.7 per cent in FY09 and 5.8 per cent in FY10.

Inflation and interest rate

Inflation is showing signs of softening and is expected to come down sharply. "We are looking at 2 per cent inflation by March, and, possibly, even a negative inflation by July, and expect the overall average inflation to be at 2-2.5 per cent," says Abheek Barua, chief economist, HDFC Bank [Get Quote].

This means inflation will no longer stop the central bank from cutting rates. We have seen rate cuts in the second half of 2008 and expect RBIto take the cuts much deeper in 2009.

Currency

The Indian rupee depreciated by about 20 per cent against the US dollar in 2008 due to a combination of factors. As the credit crisis deepened in the West, foreign money started leaving India shores, which resulted in the rupee falling.

Money from all across the world flowing into US Treasury bonds in search of safety resulted in the US dollar appreciating. As a result currencies across the world, including the Indian rupee, depreciated. The trend may continue for some more time.

Says Mumbai-based forex expert A.V. Rajwade: "The rupee will remain under pressure for next couple of months or so. If the global markets become normal in the second half of 2009, then there is some possibility of rupee appreciation." Falling exports may also intensify the problems for the rupee in 2009.

Bigger picture

The macroeconomic picture does not look celebratory for 2009.

India will need capital for growth while global capital will remain in short supply. Corporate India, which has led the investment boom from the front in the last four years, will also be shy of putting more capacities into place due to falling demand. Even those who want to proceed with their capex plans may find it difficult to raise money even from the domestic markets.

To avoid a serious slowdown in the economy, the government will have to increase its expenditure to stimulate demand. The government, however, was already on a spending spree and it does not seem to have enough resources needed to force an economic revival.

Therefore, the big question for 2009 is: can we afford the higher government spending that is required to stimulate demand and ignore the deficit for a year or two?

This is something being advocated by a section of economists, including Paul Krugman, Nobel Prize winner for Economics in 2008, for the US. Can we follow the same in India?

In normal circumstances, a policy like this can be counterproductive as government borrowing crowds out private investments and pushes up interest rates, but these are not normal times. The question remains wide open.

Road Ahead

  • Inflation to see a sharp fall; may reach 2-2.5 per cent.
  • Interest rate cuts to continue. Expect lower deposit and loan rates.
  • Rupee to remain under pressure in the first half of 2009.
  • Growth in GDP to be less than 7 per cent

Quick Fix

Why is India affected so much when our fundamentals are said to be strong?

Our fundamentals are strong, but cash flows and liquidity are borderless now. So, sentiments also slosh in and out of economies along with cash. Our GDP growth estimate for 2009 is 5-6 per cent. It is lower than what was expected earlier but it isn't so bad considering that Western economies are logging next to nothing or even going in the negative.

Can we expect the prices of food, vegetables and primary articles to come down?

Inflation has already come down from the high of 12.63 per cent to 6.84 per cent. This is expected to fall further in 2009. Prices of food, vegetables and primary articles should correspondingly decrease, unless there are severe supply shortages.


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