Deepening global recession impacts India

The U.S. is likely to increase further spending on defence and on rebuilding the infrastructure that has been destroyed. This would ultimately create a positive sentiment in an already lethargic American economy, says Oommen A. Ninan.

New York Stock Exchange - APAS THE world holds its breath in anticipation of the retaliation by the U.S. Government to avenge the ``Attack On U.S.'' on September 11, the global economy continues to flounder finding itself in the midst of what is perhaps the worst recession that it has faced.

``From an economic perspective, the impact of the attacks will go beyond the loss of life and real estate, threatening dislocation and greatly heightened risk and uncertainty. The timing could hardly be worse given that fears of U.S. and global recession were already rife. Business, consumer and financial market confidence will be hit, depressing global activity. A presumed Middle Eastern connection is pushing up oil prices, which may push up headline inflation while adding to the squeeze on global activity by reducing the purchasing power of oil consumers. The ultimate scale and damage from the resulting conflict is impossible to judge at this stage,'' noted analysts of ING Barings.

The moot question is - once started, how long the U.S. retaliation will continue. Afghanistan - where the prime suspect of the attacks on U.S., Osama Bin Laden is hiding - presents a completely different paradigm for the U.S. and allied forces what with harsh conditions and an inhospitable terrain.

Reliance on U.S. economy

Since Indian markets are increasingly dependent on the U.S. economy and its markets, it is imperative to analyse the impact on US economy which is manifold. ``Consumer spending and confidence which was holding well thus far will receive a severe setback. The U.S. recovery is likely to be delayed,'' stated a report of Tata TD Waterhouse Securities. Other impacts are: Investor sentiment will take a beating and result in further declines in stock markets in the U.S.; money flows in the U.S. could experience a shift towards safer avenues, like, bonds, and away from equities; There could be redemption pressure from U.S. investors which may trigger withdrawal of monies from non-U.S. markets; The U.S. dollar could weaken against the other major currencies following the setback to its safe haven image.

U.S. rebuilding exercise

There is another school of thought that in the longer term, these sentiments may turn around. Possibly, the US is likely to increase further spending on defence and on rebuilding the infrastructure that has been destroyed. This would ultimately create a positive sentiment in an already lethargic U.S. economy and by increasing the infrastructure spending, it could attain higher economic growth. So if the U.S. economy picks up over time, it should have a positive knock-on effect on Indian economy. In fact the Second World War actually helped the U.S. economy to become a global economic superpower. Till then, Britain held sway both economically and politically.

Strain on India's BoP

Further analysing the impact on Indian economy, Tata TD Waterhouse stated that in the aftermath of latest events, investment decisions are likely to be delayed and FDI (foreign direct investment) and FII (foreign institutional investors) flows are seen being impacted. The U.S. is a major investor in both portfolio investments as well as FDI. Moreover, any price spiral in oil can lead to a serious problem on the Balance of Payment (BoP) front given the poor current trend in Indian exports in Financial year 2002. This coupled with the likely setback to capital flows could lead to pressure on Indian rupee. Global oil price increase can lead to an eventual hiking of local fuel prices and in the interim to an oil pool deficit. These will further put pressure on fiscal deficit and could lead to higher government borrowings and together with the ``now increased risk perception (uncertainties) and lower inflows can lead to firming up of interest rates.''

The U.S. government's decision to lift economic sanctions it imposed three years ago cheered the beleaguered Indian markets, although temporarily.

Unlike the export-driven economies - which will be the worst hit if U.S. attacks Afghanistan - India and China have inherent strengths as they are large economies with huge domestic markets. With tremendous resources at their disposal, they can continue to grow under any circumstances that the world is facing today. But both of them manage it differently.

Disinvestment fiasco

When the markets were at their peak, China entered the developed markets and sold their state-owned companies's shares to them and got valuable foreign exchange. India, however, missed the bus not once but several times. The classic case is of Videsh Sanchar Nigam Ltd (VSNL). The delay in the privatisation of VSNL raised doubts over Government's ability to meet its disinvestment target. Once its monopoly status goes, its share price is likely to crash and thus a delay in privatisation has already hit the prospects of VSNL.

Air India is another case in point. It also faced the same fate as Singapore Airlines pulled out from its bidding process. The forthcoming sales of CMC and other PSEs are also expected to be canceled as the world markets are at their nadir. A delay in disinvestment will result in further pressure on India's fiscal deficit.

Upon closer analysis the Indian economy does not present a very encouraging picture. ``With continuing demand recession, lower industrial growth, investment slow down and lower export prospects, it is expected that the Indian economy is unlikely to fare much better this fiscal vis-a-vis last fiscal. We believe that the Indian economy is unlikely to grow by more than 5.4 per cent during the current fiscal.

Ever since the fall of the stock markets around the globe, Indian authorities were mostly worried about how to prop up the stock markets. Expecting a positive reaction from the market participants the Government decided to increase the investment limit of foreign funds to the level of foreign direct investment set in various sectors by the Ministry of Industries and introduced ``Margin trading'' which could avail of bank funds for equities.

A free fall in rupee

Stock prices are falling not because of lack of sentiment boosting measures by the Government. The prices are falling because of several other factors which are affecting the global economy and other events. But the sad fact is that while the government has taken care to address issues concerning the capital market, scant attention has been paid to the economy and pivotal institutions.

Further, there is a lack of clarity on the part of Government in formulating policies which have far reaching effects on the economy. It seems the Government is not sure about the fact that a free fall in rupee will affect the sentiments of foreign funds.

Like all others these funds also believe that rupee is expected to fall further. A free fall of the rupee always unsettles the foreign investors as it will result in exchange loss for foreign funds.

The government, in fact should become a catalyst (instead of being a direct market participant) by creating strong institutions which can access global markets.

Global markets are now controlled by top U.S. equity and debt funds especially in portfolio investments. Countries like China and India should develop huge funds to take on these funds. China in fact, has already realised this and started working in this direction.

On the other hand, Indian authorities were destroying fund managing institutions like the Unit Trust of India (UTI) and government mishandling of the UTI fiasco further eroded any confidence of the investing community.

It is time for the Finance Minister to look at the economy.

The Government should kick-start the economy by spending more on rural and infrastructure sectors. However, the Government failed miserably in implementing its own ``ideas''.

Out of 500 specific recommendations made by the Prime Minister's Task Force connected to economy, only 20 have been implemented so far!

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