The Hindu : Is this spring or Indian summer?

Online edition of India's National Newspaper
Tuesday, Dec 23, 2003

Business

Business

Is this spring or Indian summer?

By Prem Shankar Jha

As the year ends, there is almost a surfeit of good news in the Indian economy. Last Friday, India's foreign exchange reserves crossed the $100-billion mark. This is sufficient to finance imports for 19 months. More satisfactory is the composition of the reserves that are now seven times India's short term debt and debt servicing requirements.

The BSE Sensex ended the week at 5541. The market capitalisation of stocks traded on all Indian stock exchanges has crossed Rs. 1225,000 crores ($260 billion). After years of seeing their wealth shrink before their eyes as their shares slumped ever lower in value, more than 20 million shareholders are beginning to feel distinctly well off again. This has bred a sense of well being, bordering on euphoria, in the urban middle-class that the country has not known since the mid-1990s.

The primary share market has at last revived. In sharp contrast to the situation in the past three years when there would be very few IPOs (initial public offering) and even the private placement of shares and rights issues to existing shareholders had begun to fail, IPOs are slated to take place almost every fortnight during 2004. In all analysts expect that Rs. 22,000 crores worth of shares will be issued in the coming 12 months. This will translate into 4-5 times that amount of new investment in the coming two years. This spurt in the primary market is also qualitatively better than the spurt that took place in 1993 to 1995, because, thanks to a considerable tightening of the rules by the Securities and Exchange Board of India, the sale of what could be classed as junk bonds has largely ended.

Projections for the `real' economy are equally good for next year. By mid-January, the surge in rural spending power from the sale of the autumn harvest will hit the market. Virtually every segment of industry is bracing itself for an increase in demand. Thus, for example, the sales growth of FMCG (fast moving consumer goods) is expected to rise from 3-4 per cent to 7-8 per cent, of cement from 4.4 to 6.5 per cent, of motorcycles from 12 to 20 per cent and so on. This demand pull will push up the rate of industrial growth from the present 5. 9 per cent to 7 per cent or more in the next six months.

If the private investment that is now being planned kicks in at that point, Indian industry could go back into a mild boom that could last for the next three years if not longer. Were that to happen the GDP could grow at a sustained average rate of more than 6 per cent for the next three years or more. That would be a return to the situation that had existed between 1992-93 and 1996-97.

Despite all this there is fragility about the Indian economic revival. The rise of share prices in the secondary markets has occurred more because of a sharp drop in interest rates on bank deposits than because of a genuine revival of demand and earning prospects in the product market.

Over the last five years the interest rate on bank deposits has virtually halved. With inflation also having risen by two percentage points to more than 5 per cent, the net return on bank deposits is now close to zero. As most Indians still habitually keep their savings in banks, there is a touch of desperation in this move to a stock market that has let them down repeatedly in the past decade.

The $28 billion increase in foreign exchange reserves this year also differs from the $22 billion increase last year in one important particular: At least half of the increase last year was of genuine, that is, not borrowed, funds. These consisted of balance of payments surpluses and the revaluation of reserves held in non-dollar securities. This year the overwhelming portion of the rise in reserves has consisted of foreign institutional investment and deposits by non-resident Indians in Indian accounts, both of which can leave the country at very short notice. The FII portfolio investment is clearly aimed at making a killing on the rising share market. The `killing' becomes doubly safe at least in the short run because in the act of bringing in the money the investors are also making the rupee appreciate. The motive behind the rise in NRI deposits is also to take advantage of the appreciation of the rupee, for inflows have continued even after the Reserve Bank of India virtually eliminated the difference between Indian and foreign rates.

However, the appreciation of the rupee has begun to play havoc with India's exports. These have risen by only 8 per cent in April to October against an increase in non-oil imports of 27 per cent. Largely as a result of this India's balance of payments has become negative after two years of surpluses. If this trend is not reversed it will set the stage for a sudden sharp reversal of foreign exchange flows in the not too distant future. That could result in a devaluation that would also kill the incipient industrial recovery.

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Is this spring or Indian summer?