Government and industry can accelerate recovery

Morning did not show the day in 2011. India began the year on a cheerful note and ended it with pessimism all around. The economic hardships are a combination of homemade and imported problems

Morning did not show the day in 2011. India began the year on a cheerful note and ended it with pessimism all around. The economic hardships are a combination of homemade and imported problems. But there are signs now that the worst may be over and the economy will recover with strong growth in 2012. Our major domestic problem in 2011 was inflation, which started with agriculture and gradually spread to the rest of the economy; the external problem was the European crisis, which made investors risk-averse and shifted from stocks to dollars.

Inflation is now nearly 21 months old. Food inflation peaked at 20 per cent. This raised the cost of living which, in turn, pushed up wages and salaries. This, in addition to the increase in raw materials cost, pushed up industrial production costs and, consequently, prices. Naturally, profitability went down. In July-September, profitability was the lowest it has been in the last seven years.

Inflation invited action from the Reserve Bank of India.  The repo rate or the rate at which the bank lends to commercial bands, was raised 13 times in 18 months, from 4.75 to 8.5 per cent.  Commercial banks revised interest rates on credit and other long-term financial assets, which slowed down investment.

The European crisis which began with Greece on the brink of several debt defaults intensified from August. The uncertainty created by the European crisis laid FIIs to disinvest to the extent of Rs 4,400 crore in 2011, against a net investment of Rs 1,30,000 crore in the previous year.

With the sharp drop in FII investment, the supply of dollars in the currency market was reduced while the demand for dollars due to jump in crude oil prices increased. The result was that the rupee depreciated from 45-46 to the dollar in August to 52-53 now.

The stock market went into depression and the Sensex dropped from over 20,000 at the beginning of the year to around 16,000. The market, contrary to common perception, is not merely a place for trading stocks. It directly influences investment by the corporate sector. When the market is good, companies are able to float new issues; when the market is down, IPOs invariably fail. The fall in investment in industry was partly due to the higher rate of interest, which made borrowed capital expensive, and partly owing to the depressed stock market that made risk capital impossible.

The cumulative effect of the different trends was that industrial growth which was over 11 per cent last year at this time shrank 5 per cent in October 2011. GDP growth consequently dropped from 9 to 6.9 per cent.

Some opinion surveys say it will take another year for growth to pick up. That is not how I look at the issue. There are signs that the first phase of recovery has already started and, if measures are taken by the government and industry early enough, I believe recovery will be much faster.

Food inflation has dropped to 1 per cent; this should bring down the general rate of inflation. The monsoon has been normal and agricultural growth will be at least 3 per cent. Supply of vegetables has substantially increased, this  has brought prices down significantly.

The core industry sector grew by 6.8 per cent in November. It constitutes about a fifth of the industrial sector and is an indication that industrial production will increase in November against the drop in October.

The European crisis has eased. A permanent bailout fund will be created and fiscal consolidation ensured after a new treaty is endorsed by the EU. Besides, recent data indicates that the US economy is picking up. That should bring FIIs back. Moody’s has upgraded India’s rating, which will facilitate ECBs.

In the new environment, the recovery in India will start by itself but will be accelerated when government and corporations work together complementarily.

What should be our agenda for 2012?

• The RBI is most likely to reduce the interest rate starting from its review in January. What is necessary is 2 percentage points cut in the first quarter of 2012. The RBI has already taken steps to curb speculation in the currency market which has hardened the rupee to some extent or at least prevented further fall. Industry should respond positively to this interest reduction and implement some of the projects that were on hold.

• The government will revisit its proposal for FDI in retail. The earlier timing of the policy was not right. After the UP elections, the proposal can be viewed more constructively, possibly with some amendments. There are more reforms in the pipe line  that will make up the earlier stagnancy in reforms. Foreign direct investment will speed up.

• Reforms in policy and governance will create a new environment that will expedite decisions by ministries and stimulate the government and private investment. A number of companies are cash rich and will be the first to convert liquid assets into productive assets once demand picks up.   

• Infrastructure, particularly power, has been a serious constraint. Both the government and private sector have to invest extensively in infrastructure. A practical business plan should be worked out for this purpose. Coal supplies have been hit by stagnancy in production and there is acute shortage of coal. The environment policy should be looked at afresh and new coal mines developed to keep production in public and private sector expanding since imports will distort trade balance.  

• The next budget can be a trigger. Since the economy has slowed down, greater attention will be given to stimulating growth rather than holding down fiscal deficit which has inflated largely because of the slowdown of the industrial sector. Recognizing its responsibilities as a partner in growth, industry has to take a long-term view of business rather than get bogged down by short term issues.

It is my expectation that the business environment will improve, beginning April. A number of indices like inflation, core industrial growth, stock market, exchange rate, agricultural growth have improved. Besides, Europe factor should be positive, which will increase the inflow of foreign funds. New investment by the government and private sector will start a virtuous circle with more demand chasing more investment.

 Indian business seems to be ready to respond to the change to enable the economy get back to its normal cruising speed. In 2012-13, a growth of 8-8.5 per cent should be possible.

The author is Chairman, RP-Sanjiv Goenka Group

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