India's 2009 General Election Delivers A Surprise Outcome

Guest Post by Manuel Alvarez-Rivera, Electoral Resources On The Internet

Contrary to exit poll findings and widespread expectations of a closely fought race, India's ruling Congress Party - formally the Indian National Congress - and its allies won a clear victory in the general election held in April and May of this year, emerging well ahead of the right-wing, Hindu nationalist Bharatiya Janata Party (BJP). In all, the Congress-led United Progressive Alliance (UPA) won 261 of 543 seats in the Lok Sabha - the lower house of India's bicameral Parliament - and came within eleven seats of an absolute parliamentary majority, while the BJP-headed National Democratic Alliance (NDA) secured only 157 and the Third Front - composed of leftist and regional parties - captured 80 seats. Meanwhile, the new Fourth Front also fared poorly, obtaining just 27 seats, while the remaining 18 seats went to other parties.

The Election Commission of India has 2009 parliamentary election results available here.

Members of the Lok Sabha are elected in single-member constituencies by the first-past-the-post system used in parliamentary elections in the U.K., India's erstwhile colonial ruler. However, unlike in Britain, no single party has won an overall parliamentary majority in a general election in India since 1984, when Congress - which at the time had ruled India for all but three years since the attainment of independence in 1947 - won a record landslide victory, following the assassination of then-Prime Minister Indira Gandhi; since 1989, Congress has been in and out of office, while BJP has emerged as a formidable rival to the Congress Party. In the meantime, India, which previously had a multi-party system with one dominant party - namely Congress - developed a highly fractious party system characterized by a proliferation of regional parties, which stands in stark contrast with the two-party (or at least two-party dominant) systems of other countries with first-past-the-post electoral systems, such as the U.K., the U.S. and (to a lesser degree) Canada.

Nonetheless, the outcome of this year's election, in which Congress won 206 seats (up from 145 in 2004) constitutes the best showing of any party since 1991, when a wave of sympathy following the assassination of then-Congress leader Rajiv Gandhi (Indira's son) in the middle of a general election allowed the party to capture 232 seats in the Lok Sabha. Conversely, BJP had its worst result since 1991, although the party remains by far the second largest in India.

The election was also a major defeat for the Third Front: the Communist Party of India (Marxist; CPM) suffered a crushing defeat in its traditional stronghold of West Bengal, while the Bahujan Samaj Party (BSP) of Mayawati Kumari, the Chief Minister of Uttar Pradesh - India's most populous state - failed to make an impact outside its home base. Moreover, Congress made a major comeback in Uttar Pradesh, capturing 21 of the state's 80 Lok Sabha seats, up from just nine in 2004 and one more than the twenty won by BSP, which seeks to represent the lower-caste Dalits, previously known as the "untouchables;" Congress' gains in Uttar Pradesh came largely at the expense of the Samajwadi Party (SP) - the Fourth Front's largest party - which lost twelve of its thirty-five seats in the northern state.

The UPA has held power since 2004, when Congress narrowly prevailed over BJP, which had been in office since 1999. After Congress Party president Sonia Gandhi - the Italian-born widow of Rajiv Gandhi - declined an offer to become India's head of government, Manmohan Singh formed a minority coalition government with outside support from leftist parties. Singh had previously served as finance minister in the 1991-96 Congress Party government of P.V. Narasimha Rao, implementing a number of measures that liberalized India's economy (until then tightly controlled by the state) and paved the way for its subsequent rapid growth. Despite the global economic crisis, India has the world's second-fastest growing economy; however, widespread poverty remains a major problem.

Although UPA remains just short of an absolute majority in the Lok Sabha, it is expected that Congress and its allies will remain in office, in light of their unexpectedly strong election showing.

Is The Indian Economy Heading For Its Finest Hour?

"For what it’s worth, a key conclusion from the IMF’s new World Economic Outlook is that recessions caused by financial crisis typically end with export booms, with the trade balance improving,on average, by more than 3 percent of GDP. I find this a disturbing result: we’re now suffering from a global financial crisis, which means that the usual driver of recovery will only be available if we can find another planet to export to."
Paul Krugman

With results still coming in, projections show the United Progressive Alliance is likely to win about 250 seats, making it a shoo-in to form the next government and provide continuity, a stable administration and progress on key economic and corporate reforms.
Wall Street Journal, May 16 2009

Prime Minister Manmohan Singh’s electoral victory, the biggest any Indian politician has scored in two decades, may loosen political shackles that have restrained the country’s economic growth as it struggles to free half a billion people from poverty.....Political stability will make India a more attractive investment destination as Singh, 76, seeks the funds to stimulate Asia’s third largest economy.
Bloomberg, May 18 2009

Many are called, but few are chosen, as the saying goes. But could it just be that this time around, and on a one-off, never to be repeated basis, India might find itself right there in the midst of things, with a 50-50 opportunity to add its name to that select and noble band, the chosen few. After all, someone has to lead the next global charge? The majority of the developed economies are either bogged down in the substantial quantities of debt that they desperately need to pay off, or weighted down by those elderly populations who are weakening consumption growth and leading to export dependence (Germany, Japan...). And as Krugman humorously points out, someone will have to add the extra demand which will allow global trade to start to grow again, so why should India not supply a significant part of this new demand, after all we are more likely to find consumers in India than we are on Mars.


In fact, I may not be the only person around who believes this, since India's Sensitive stock index, or Sensex, surged 2,099.21 points to 14,272.63 first thing this (Monday) morning, posting a record 17 percent gain in a brief period of trading following the news of the election outcome, before the surge prompted exchanges to halt trading at 9:55 am, Mumbai time. Markets closed initially for 2 hours but the decision was then extended to include the rest of the trading day, the first time ever that this has happened to the Sensex. The stock index had previously climbed 23 percent so far this year while the Nifty Index was up by 24 percent. climbed 47 percent In fact since hitting "bottom" and closing at a three-year low on March 9, the Sensex had already risen by 47 percent while the rupee was up 4.4 percent in the same period.

The rupee also powered up again toady, and jumped the most in two decades while bonds also rose. The reason for the surge is not a feeling of deep-seated admiration for the Singh government itself, but rather a sense of optimisim that it will give India the continuity and stability it needs to grasp the challenge before it with both hands.



The rupee strengthened 3.1 percent, the most for a single day since March 1986, and closed at 47.92 per dollar at 5 p.m. in Mumbai. That took its gains this month to 4.5 percent, the best among the 10 most-active Asian currencies outside Japan. This contrasts sharply with today's performance by currencies in the more export dependent economies, with the Korean won falling 0.2 percent, Malaysia’s ringgit dropping 0.7 percent to 3.5750, and the Singapore dollar weakening by 0.2 percent. The reason for today's general fall was negative investor sentiment towards riskier assets following the Eurostat report last Friday that the EU economies contracted the most in at least 13 years in Q1.



From "Hindu Growth" To A Global Powerhouse

But why so much enthusiasm now? Certainly India's post independence growth record has been notoriously uneven, with growth rates up to the 1980s low and extremely volatile. But then, in the 1980s and 1990s things started to change, economic reform began to get off the ground, tentatively at first, and more substantially later, while Inda's demographic profile started to improve, as the country faced the prospect of a steadily growing, healthier and better educated workforce. Post 2000 growth really started to take off - and has averaged around 7 percent since then. In 2007 the Indian economy maintained an impressive 9 per cent growth rate, despite the arrival of the sub-prime crisis (although not a few were talking of overheating, and "bubbles"), only then to drop back to a 7.3 percent rate in 2008, with the IMF are currently forecasting growth of 4.5 percent in 2009.



Evidence of the recent slowdown in the Indian economy is now - like the ubiquitous IT technician - everywhere, but this, it should be stressed, is a "slowdown" and not an outright crisis of the kind we are seeing in many other countries. GDP growth slowed in Q4 2008 to 5.3 percent (from 7.6 percent in Q3), a serious development, but not an outright disaster.

Industrial output also fell year on year by about 1 percent during the first three months of 2009, which compared to the 8.7 percent rise in the first quarter of 2008 was disturbing, eespecially since this is the first time we have seen a quarterly contraction in many years. Money supply has remained rather more constant, and M3 growth to mid February 2009 was an annual 19.9 percent as compared to 21.6 percent growth last year, so the rate of increase has only eased marginally. And in the meantime the annual rate of wholesale price inflation has fallen back strongly, hitting an estimated 0.48 percent at the start of May. But then, since money supply growth hasn't slackened that much, there has evidently been a significant weakening in internal demand (alongside the obvious fall in commodity prices).

A number of fiscal stimulus packages have been put in place, and as a result the fiscal deficit from April 2008 to January 2009 was 174.3 per cent above that for the corresponding period a year earlier. The revenue deficit was up by 278 percent higher, indicating very strong pressures on the fiscal deficit and a significant departure from the The Fiscal Responsibility and Budget Management Act (FRBM). This surge in the fiscal deficit has been widely criticised, and Standard and Poor's reduced India’s rating outlook to negative from stable in February, citing the danger that “continued loose fiscal policy would result in a downgrade” in the country’s credit rating. In the meantime it affirmed India’s BBB- long-term credit rating, the lowest investment grade level.

But there are reasons for optimism. As Duvvuri Subbarao (Governor of the Reserve Bank of India) argued in a speech - ‘India, Managing the Impact of the Global Financial Crisis’ - delivered to the Conference of Indian Industries on 26 March this year, the Indian economy has been spared the worst of the blast from the present crisis for two reasons. The Indian economy is still not sufficiently "open" to take a direct hit - only 15 percent of the Indian economy is export oriented - and Indian banks and financial corporations were relatively free of contamination from "toxic" instruments.

Why Should We Expect A Ressurgence In Indian Growth?

In order to understand what may happen next, perhaps the most import thing to grasp is what it was that just happened. In some ways a quick look at look at the Reuters/Jeffries CRB commodities index (see chart below) says it all. The chart - which shows the evolution of this index from the mid 1990s to date - immediately makes a number of important details about what has been going on incredibly clear. In the first place we can see how, after long languising idly around some sort of mean, a secular rise in commodity prices starts up around 2002 and last for around four years, eventually flattening out from between 2006 to mid 2007. After this there was a further strong surge forward in the autumn of 2007 which lead to a sharp spike upwards. Basically, you could say (with the benefit of hindsight) that this period from August 2007 to July 2008 was the "overheating" period, as the growth crisis in the developed economies which followed the initial wave of "financial turbulence" in the US lead to massive inflows of funds into the BRIC and other emerging economies. This produced a sharp spike in commodity price inflation, and monetary tightening in one emerging economy after another. A desperate attempt to avoid the inevitable correction in the global economy which would follow the sub-prime "blow out" was "forcing" growth in the emerging economies at a rate they could not withstand (given global resource constraints), and the thing inevitably had to burst. Commodities peaked in July 2008, but the correction in the real economy only set in following the aftermath of the collapse of Lehman Brothers in October.

The Reuters Jeffries index hit an all-time series high of 473.518 on 2 July 2008, but was still stuck in the low 200s as we entered May 2009.

So the real point I want to make about India's current growth slowdown is that it does not have "made in Delhi" written all over it, it is not the result of any inherent problem with the Indian economy as such. It is rather the local reflection of much more general problems at the global level, whereby the Indian economy was first accelerated and then half crashed. And this is precisely why I personally think the recent (and highly controversial) US bank stress tests were so important, not because of their significance from a US banking point ofview (which is what all the fuss was about), but because of the reassurance they can give market participants that we are not going to see another financial explosion in the United States (as opposed to a protracted recession, and slow recovery). Uncle Ben is thus underwriting the recovery in emergent economies like India and Brazil by offering the reassurance that investors need that there will not be another violent bout of instability. What India and Brazil now most need is for Ben Benanke to commit to mainaining US interest rates near zero for a sustained period of time, so that people can practice "carry" with a certain degree of confidence that things won't unwind, then, I think, we are up, up and away. So, on behalf of everyone concerned, thank you Ben.

Here Come The Opportunities

India’s inflation rate stayed under one percent for a ninth consecutive week at the start of May, giving the central bank a much needed margin to keep the current record-low interest rates in place and offering the outlook of inflation free economic growth for some time to come. With so much slack in the global economy, a sudden surge in commodity prices like the one we saw in the autumn of 2008 is most unlikely, and so, as they say, while the cat is away the mice can well and truly play.

Wholesale prices rose a mere 0.48 percent year on year in the week to May 2 following a 0.70 percent increase in the previous week.

Not everyone is convinced the outlook is so benign, and Reserve Bank of India Governor Duvvuri Subbarao said only last week policy makers need to begin to think about when they will begin reversing their expansionary steps. The current RBI forecast is for inflation to climb back towards 4 percent by March 31 as the economy gradually revives. Some evidence to support Subbarao's fears can be garnered from the evolution of consumer prices paid by industrial workers, which rose 9.63 percent in February from a year earlier, after gaining 10.45 percent the previous month, according to government data. Consumer-price inflation for farm workers was 10.79 percent. India, in fact, has four consumer-price indices and as a result tends to rely on the wholesale price index as benchmark because since it is felt the consumer price indices don’t adequately capture the aggregate price. However, the disconnect between wholesale and consumer prices that we can see at this point can be more a reflection of the fall in commodity prices and the presence of excess capacity on the supply side, so the evolution of these indices needs to be carefully monitored.

The RBI has now slashed borrowing costs six times in the past seven months, with the reverse repurchase rate being cut by a quarter-point to 3.25 percent as recently as April 21.
This means the bank has now lowered the benchmark by 275 basis points since last October, while the repurchase rate has been reduced by 425 basis points over the same period to its current 4.75 percent level.

As I say governor Subbarao is rightly cautious about reducing interest rates further as Indian consumer price gains remain high, suggesting that local demand hasn’t been completely dented even as the rest of the world remains mired in a recession. Cheaper loans are helping stoke consumer spending. “The fiscal and monetary stimulus measures initiated coupled with lower commodity prices could cushion the downturn in the growth momentum” over 2009 to 2010, the central bank said recently. “Notwithstanding the contraction of global demand, growth prospects in India continue to remain favorable compared to most countries.”

And between now and September, the central bank is set to inject another 1.2 trillion rupees ($23.8 billion) into the banking system by purchasing government bonds via auctions and buying back market stabilization bonds, which were sold in the past four years to drain money from the economy. The injection is estimated to be the equivalent of a 3 percentage point reduction in the cash reserve ratio, according to the Reserve Bank.

Subbarao’s optimism is also based on forecasts for this year’s monsoon rains - which look set to be normal. If this expectation is confirmed it will help sustain the unprecedented 4.3 percent average annual farm production growth recorded since 2005, boosting incomes for the three-fifths of India’s 1.2 billion people who depend on agriculture for their livelihood while keeping price inflation modest to feed to consumption of India's urban workforce.

Sibbarao is also aware that India is much less vulnerable to the global economic slump than most of its neighbors since exports only constitute about a quarter of the economy, as compared with around a half for developing Asia as a whole. So India is less open, and while in general terms this would not be an advantage, during the current slump in world trade it is an evident plus.

Industrial Output Falls Sharply In Q1 2009

India’s industrial production fell the most in 16 years in March as the worst global recession since World War II hit demand for the country’s exports. Output at factories, utilities and mines declined 2.3 percent from a year earlier after a revised 0.7 percent drop in February. Production was dragged down in March by an 8.2 percent drop in capital-goods output (which does not bode well for short term investment), with all other categories showing improvement from February. Consumer durables production jumped 8.3 percent from a year earlier, the biggest increase in six months.

In fact the (non seasonally corrected) output index was up in March over February, and substantially up from the lows registered in the last quarter of 2008. This impression is confirmed by the purchasing managers index, which in April gave the highest reading for the Indian headline manufacturing PMI in seven months. In fact the output index registered 53.3, a level above the 50 critical one separating growth from contraction. In fact the index has now steadily risen after hitting a trough of 44.4 in December.

Just as encouraging, the new orders index rose to 54.9 from 49.5 in March. The return to growth was primarily driven by an improvement in domestic demand, according to the accompanying report. "Although the rise in new business came principally from the home market, there was also some, albeit slight, improvement in foreign demand for Indian manufactures," ABN Amro Bank said in the official release.

Also worthy of note is the fact that along with the expansion Indian manufacturers noted renewed input price inflationary pressures. A combination of increased prices for some commodities and unfavourable exchange rates led to a moderate rise in input costs during April. This is the first time that input price inflation has been recorded in India's manufacturing sector since October last year. However continuing competitive pressures meant that manufacturers did not pass on their cost pressures on to customers, and factory gate prices were cut for the sixth straight month. However, the latest drop in average prices was the weakest in the current period of falling output prices.

Employment levels across India’s manufacturing economy were little-changed during April with increased production requirements leading to recruitment on the one hand, while cost-cutting pressures produced job losses on the other.

"The April PMI gives a very clear indication that business conditions in the manufacturing sector have improved significantly after a period of sharp contraction and gradual stabilisation. The headline PMI at 53.3 has signaled expansion in activity for the first time since October 2008. Moreover, the April reading is the strongest since October 2008," according to Gaurav Kapur, Senior Economist, India, with ABN Amro. "Survey data suggests that production was ramped up during April in order to cater to a pick-up demand and to build inventories. The output index printed at 55.7 for April compared to 49.3 in March, as new incoming business expanded during the month. The domestic orientation of the improvement in demand is clearly visible from the new orders index rising well above 50, even though external demand also improved modestly. New orders index printed at 54.9 as against 49.5 in March. This is critical as it suggests that domestic demand conditions are now strong and supportive for growth in the sector,"

Car sales and the production of cement, electricity and refined petroleum are also showing signs of recovery. India’s passenger car sales increased 4.2 percent in April from a year earlier, after a 1 percent gain in March. Cement production jumped 10.1 percent in March and electricity output rose 5.9 percent from a year ago, according to government data. But exports still remain weak, with shipments declining 33 percent in March from a year earlier, the biggest fall since at least April 1995.Goods exports dropped 33 percent from a year earlier to $11.5 billion last month, the government said in New Delhi today. That was the biggest fall since at least April 1995. Exports slid 21.7 percent in February.

Exports Fall, But Without Heavy "Export Dependency" Exposure


India’s exports, which account for about 15 percent of the economy, have been falling back recently, although they were still up by 3.4 percent (to $168.7 billion) in the fiscal year ended March 31. They did however fall well short of an initial $200 billion target set by the government before the September collapse of Lehman Brothers accelerated the world financial and economic slump. The government now expect exports to total $170 billion in the year that started April 1. The decline in exports is likely to continue until at least September, according to India’s Trade Secretary Gopal K. Pillai, while falling overseas sales may cost India about 10 million jobs, according to estimates from the Federation of Indian Export Organisations.

Imports were also down in March - by an annual 34 percent - and as a result the trade deficit narrowed to $4.04 billion from $6.3 billion in March 2008. Oil imports plunged 58 percent to $3.8 billion, while non-oil imports dropped 19 percent to $11.75 billion.

However, Subbarao argues, the Indian economy has globalized rapidly during the past few years. In terms of openness to international trade the ratio of exports plus imports to GDP increased from by more than 50 per cent in the 10 years from 1997–98 to 2007–08 (from 21.2 per cent of GDP to 34.7 per cent of GDP). Furthermore, the growth of financial integration has been even more rapid. During the same 10 year period (1997–98 to 2007–08) the ratio of total external transactions (gross current account flows plus gross capital account flows to GDP) increased by more than 100 per cent from 46.8 per cent in 1997–98 to 117.4 per cent in 2007–08. Furthermore, corporate borrowing from external sources has also increased significantly. In 2007–08, for example, India received capital inflows to the extent of 9 per cent of GDP as against a current account deficit of 1.5 per cent of GDP.

Twin Deficits?

India has been facing the so-called twin deficit problem for some time now, and the poor fiscal record, together with the continuing high deficit is the main reason why international credit rating agencies have brought the country’s debt close to junk status. The fiscal problem is not an easy one - apart from running a general government fiscal deficit of a estimated 9.9 percent of GDP, the debt to GDP ratio is stubbornly stuck round the 80% level - far, far too high.

Meanwhile, capital flows have continued to be vibrant despite the huge withdrawal of money from the stock market by foreign financial institutions, or FIIs. As a result, while India's foreign exchange reserves fell initially during the crisis, they have since stabilised, and are even now begining to show signs of increasing again (see chart below). At the start of this week India's Securities and Exchange Board of India reported that foreigners bought a net $828 million of local equities on May 13, the most since February 2008. Indeed they report that overseas funds have already bought a net $1.8 billion in Indian equities so far this month, well below the heady levels of 2007, but still a significant turnaround.

Equally interesting is the change in the composition of the capital flows. FIIs withdrew an estimated $15.02 billion in 2008-09, according to Reserve Bank of India data. The scale and velocity of the withdrawal in the second half of last year certainly put significant pressure on India's money and foreign exchange markets - and short-term interest rates surged over 20% while the rupee tumbled to an all-time low of 52 against the dollar. But other types of capital inflows remained relatively strong, especially foreign direct investment, or FDI. Overseas Indians, too, sent a lot more money back home, due to the uncertainties created by the turbulence in the the developed economies and the higher interest rates on offer in India.

Taken together, the measures put in place since mid-September 2008 have ensured that the Indian financial markets continue to function in an orderly manner. The cumulative amount of primary liquidity potentially available to the financial system through these measures is about Rs.390,000 crore (78 billion dollars) or 7 per cent of GDP. This sizeable easing has ensured a comfortable liquidity position starting mid-November 2008 as evidenced by a number of indicators such as the weighted average call money rate, the overnight money market rate and the yield on the 10-year benchmark government security. Commercial banks have responded to policy rate cuts by the Reserve Bank of India by reducing their benchmark prime lending rates. Bank credit has expanded too, but slower than last year. The RBI’s rough calculations show that, on balance, the overall flow of resources to the commercial sector is less than what it was last year indicating that even though bank credit has expanded, it has not fully offset the decline in non-bank flow of resources to the commercial sector.

Of course, the present level of fiscal deficit is easy enough to justify, given the need to put a platform under the economy, and a number of stimulus packages have been announced by the Indian Government in response to the global financial crisis.

Just one such measure - the decision of India's Sixth Pay Commission (which was not a stimulus measure as such, but rather the outcome of the routine policy process, and possibly highly political in view of the impending elections) was widely criticised, although the implementation in the short term may in fact have been timely.

The Commission recommended across the board increases in salary for central government employees, to be followed in due course by comparable salary increases for state government employees. The payment was to be made in two installments, 40 percent (an estimated Rs. 1.57 trillion or roughly $31.4 billion) during 2008–09, with the remaining 60 percent coming due in 2009–10. The decision is, I say, deeply controversial, given the size of the deficit and accumulated government debt, but under the circumstances may well have served to place some sort of platform under domestic demand during times of global financial crisis.

The stimulus packages per se have also come in two installments, The first one, announced in December 2008, was largely fiscal in its intent, and included additional expenditure of Rs.3 trillion ($60 billion) over four months, a cut of 4 percent in value-added tax, as well as a 2 percent export credit for labour intensive sectors and other export incentive schemes.

The second stimulus package - announced in January 2009 - was, in contrast, mainly montary and directed towards credit easing. Among the more important measures an SPV was created to provide liquidity support for investment grade paper to specific Non Banking Finance Companies (NBFCs). The scale of liquidity potentially available was Rs.25,000 crores/$50 billion. Public Sector Banks were to provide a line of credit to NBFCs specifically for purchase of commercial vehicles. Credit targets of Public Sector Banks were revised upward to reflect the needs of the economy. Further the guarantee cover provided under the Credit Guarantee Scheme for loans to micro and small enterprises was increased from Rs 5 million to Rs 10 million with a guarantee cover of 50 per cent. In order to enhance flow of credit to micro enterprises, the government also decided to increase the guarantee cover available under the Credit Guarantee Fund Trust to 85 per cent for credit facilities of up to Rs 0.5 million. This measure should, in principle, benefit around 84 per cent of the total accounts accorded guarantee cover.

The India Infrastructure Finance Company (IIFCL) was also authorized to raise Rs 10,000 crores ($20 billion) through tax free bonds by 31 March 2009 for refinancing bank lending of longer maturity to eligible infrastructure bid-based PPP projects. This would enable the funding of mainly highway and port projects to the value of about Rs 25,000crore ($50 billion). In addition, in order to provide funding for additional projects worth about Rs 75,000 crore ($150 billion), the IIFCL is now able to access an additional Rs 30,000 crores ($60 billion) via tax free bonds once the current year's allocation of funds has been used up.

This surge in the fiscal deficit has been widely criticised, and Standard and Poor's reduced India’s rating outlook to negative from stable in February, citing the possibility that “continued loose fiscal policy would result in a downgrade” in the country’s credit rating. In the meantime it affirmed India’s BBB- long-term credit rating, the lowest investment grade level. S&P estimated that India’s national budget deficit, including off-budget items such as oil and fertilizer bonds and state government deficits, may increase to 11.4 percent in the year ending March 31 from 5.7 percent in the previous year.

Only last week Fitch Ratings also reiterated that India needs to cut its budget deficit to avoid having its credit rating lowered. “India faces considerable challenges in balancing the need for short-term stimulus measures to counter the economic downturn and the necessity of re-establishing a sustainable medium-term path for the country’s public finances,” according to the agency statement.

Fitch, which gives India a BBB- rating, its lowest investment grade, is worried that the new government may step up spending to soften the blow from slowing economic growth. If they do the ratings agency fears this will widen the general budget deficit to more than 10 percent of gross domestic product for the second year in a row in 2009-10.

And these ratings matter, since they influence investor decisions as to whether or not to hold rupee denominated assets. It should be noted however, that the ratings agencies generally have responded well to the latest election result. Both S&P and Moody’s Investors Service, were both emphasising yesterday just how the outcome gives India's government a chance to improve its fiscal situation.

The poll result gives the government more “political space” to sell stakes in state-run companies and improve revenue, according to Moody’s senior analyst Aninda Mitra, while S&P’s director of sovereign ratings Takahira Ogawa commented that the result means “there is a possibility for the government to implement various measures to reform for further expansion of the economy and for the fiscal consolidation.”


Current Account Blues?

As suggested throughout this post, the tailwinds behind the Indian economy are now incredibly favourable. A new government has just been elected which should provide stability to the country, and continuity in the realm of economic policy. The changing age structure of India’s population means that the proportion of the Indian population in the working age group (15–64 age bracket) is set to rise from 60.9 per cent in 2000 , to one which will surpass that if a developed economy like Japan by 2012, and continue to climb steadily to 66 per cent by 2030. But it isn't only quantity which is important here. Quality also matters. The nutritional status of India's population is improving rapidly, with calorie and other macro and micro nutrient deficiency on the decline. According to the 2001 Census, the literacy rate of India's population climbed from 51.54 percent in 1991 to 65.38 per cent in 2001. India will thus, in the years to come, find itself with a younger, healthier, better educated and thus more productive workforce than ever before.

At the same time, the massive slack which exists in the global economy means that Indian now has a more-or-less unique opportunity to accelerate the development process at non-inflationary growth rates well above those which would have been envisaged only two or three years ago. At the same time, as the age structure has shifted, and the weight of child dependence has reduced, India's savings rate has risen steadily from 23.4 per cent of GDP in 2000–01 to 35.4 per cent in 2007–08. During the same period investment rose from 24 per cent of GDP to 36.3 per cent of GDP, suggesting the need for a slight current account deficit to cover the gap between savings and investment.



And to return to where we started, on where the demand is going to come from to support the current global recovery. The IMF currently forecast a 2.5% of GDP current account deficit for Indian. Given the extent of investment that is needed in capital goods, technology and infrastructure this is a small, even benign, number, and at the end of the day will mean that Indian is once more playing its part in the community of nations, by adding a little extra net demand to the global pot.

India's Manufacturing Industry Continues To Expand in September

Just following up briefly on my last post, as anticipated by the PMI report India's industrial production growth bounced back again in September. Output at factories, utilities and mines rose 4.8 percent from a year earlier after a revised 1.4 percent gain in August, according to data from the Central Statistical Organization today (Wednesday).



India's factory output rose 4.9 percent in the six months to September from a year earlier, less than half the 9.5 percent pace recorded in 2007, according to today's report.

And the expansion in Indian manufacturing looks set to continue into October according to the latest ABN AMRO Bank purchasing managers' index (PMI) report. The index, which isbased on a survey of 500 companies, slumped to a seasonally adjusted 52.2 in October, its lowest since the survey began in April 2005 and sharply below September's 57.3. A reading above 50 signals expansion while a figure below 50 suggests contraction, and the manufacturing PMIs are interesting, since they do offer us a sort of "real time" snapshot of what is actually happening.

As Inflation Continues To Fall Back, Is The Indian Economy About To Take Off Again?

Indian inflation fell back again in the last week of October, as energy and commodity prices continued to fall, and the impact of the global financial turmoil and credit crunch ricocheted its way across one country after another. The IMF last week forecast annual growth for India of 6.3% in 2008 while India's manufacturing expansion, which continued to weaken, still held out against the global trend, according to the latest JPMorgan global manufacturing PMI.

So, as we enter November, and a number of Indian indicators start to improve, it is certainly worth asking ourselves, has India turned the corner? Will India lead the emerging markets charge during the next global expansion?

I am not, I am sure, alone in feeling that this is a distinct possibility, and, indeed, a similar view was expressed only last week by Sharmila Whelan, senior economist at CLSA Asia-Pacific Markets.

``We do expect the Indian business cycle to be the first to bottom in Asia. And, it should, in theory, be first to emerge,'' Sharmila Whelan, senior economist at CLSA, said ``The worst will be over by mid-2009 and by 2010 you should be able to see the next investment-led business cycle taking root.''

To the two reasons Wehlan offers us as an explanation for why we should expect India to do better than most (and, perhaps of particular nore here, better than China) - the fact that Indian trade constitutes only about 32.5% percent of gross domestic product (only about half the China figure - thus India is better protected from fluctuations in global trade) and the fact that India (unlike say Russia or Brazil) will be a large net beneficiary from falling commodity prices - I would add a third, India's very favourable demographic profile, which will mean that over the next decade India can continue to draw on the benefits of a young and rapidly growing labour force at just the time when 30 years of once child per family policy starts to bite really hard on the new labour market entrant cohorts in China (for example).

Inflation Screeches To A Halt

India's inflation held near a five- month low at the end of October, seemingly validating the central bank decision to reduce interest rates to bolster economic growth. Wholesale prices were up 10.72 percent in the week to Oct. 25 from a year earlier after gaining 10.68 percent in the previous week, according to the latest data from the commerce ministry.


Of equal importance is the fact that the weekly rate of inflation (week on week) recently turned negative, as energy and commodity prices drop back, and as a result the wholesale price index has now been dropping for eight consecutive weeks after peaking in the August 30 week.



One of the reasons inflation is weakening is of course the fact that Indian GDP growth has been slowing, and the current growth rate is clearly significantly below the 7.9 per cent rate registered in the second quarter (2008 calendar year) a rate which was already notably lower than the 8.8 per cent one reported for the January to March quarter. But with countries from the US to Germany, to Russia and maybe even China (who knows at this point) falling into or near to negative growth, then even a 7% rate looks decidedly healthy to me. What was it they were saying not so long ago about "Hindu growth"? Better a tortoise than a hare in some contexts, but then again, a 7% tortoise is certainly no mean one.




It is interesting to note in passing that the IMF - in revising their forecast down to 6.3% for 2008 - stated that they consider this level to be considerably below India's potential growth. For the time being, it seems, the old "overheating" debate has become a thing of the past. These days we all love India, now don't we?

Ironically, the current global situation is also making India's measured pace of economic reform look wiser than before. At a time when Western countries are frantically nationalising banking assets, the Indian government's reluctance to sell more than 49% in its state-owned banks—which control some 70% of banking assets—now seems reassuring. In addition, India has not yet introduced full capital-account convertibility, which protects its currency, while its careful control of foreign borrowings by domestic companies limits dependence on the global financial system. Regulators have also periodically introduced curbs to slow the formation of potential asset bubbles, such as higher provisioning and prudential requirements on real-estate lending.
The Economist

“For India we have marked our forecast down to 6.3% of 2009 calendar year. That is considerably below what we consider to be India’s potential growth,” IMF deputy director for Asia Pacific region, Kalpana Kochhar said. “There is a specific meaning to “potential” - it is the rate at which you can grow without causing inflation. And for India we estimate that to be 7.5% to 8%. Our forecast of 6.3% would put it quite a bit below the potential,”.

Obviously there are still varying forecasts, with the RBI and the central government being rather more optimistic than most, although India's central bank did reduce its growth forecast on October 24 down to 7.5 percent from 8 percent for the year to March 31. This prediction, if fulfilled, would mean the 2008/09 expansion would be the slowest in four years, but then in the midst of the largest global recession since the 1930s that doesn't sound so bad, now does it?


Interest Rates Coming Down and Monetary System Stabilising

The Reserve Bank of India cut its benchmark rate on Nov. 1 for the second time in two weeks, joining policymakers across Asia in lowering borrowing costs to shield their economies from the global financial crisis. For the first time since 1997, India's central bank on Nov. 1 deployed all three of its main tools to shore up growth after inter-bank lending rates climbed to as much as 21 percent. The move seems to have substantially improved liquidity in the financial system, and overnight call rates fell sharply.

The Reserve Bank of India lowered its benchmark repurchase rate to 7.5 percent from 8 percent. At the same time the central bank also reduced the cash reserve ratio to 5.5 percent from 6.5 percent, and and cut the amount of money lenders are required to keep in government bonds to 24 percent from 25 percent.



The RBI is also considering giving an additional 100 billion rupees ($2.1 billion) each as lines of credit to National Housing Bank and Small Industries Development Bank of India, according to Finance Minister Palaniappan Chidambaram speaking during last week. The idea here would be to increase cash flows for mortgages and for small companies.


Rupee Rises Slightly



The rupee climbed 3.8 percent last week to close at 47.66 a dollar at the 5 p.m. in Mumbai on Friday. The increase represents the biggest weekly gain since March 1996, making the rupee currently the best performer among Asia's 10 most-active currencies outside Japan.



In addition on the foreign currency front, the Japanese Yen is also dropping back slowly against USD, which means that yen "carry" may be slowly starting to recover. A surge in USD-Yen (and hence yen carry) would be another clear sign some key emerging markets we about to start moving, in my view. As we can see from the chart - unless we have more "turmoil" to cope with moving forward - October 24 seems like it represents some kind of turning point.




Stocks Start To Tick Up Again


The Bombay Stock Exchange Sensitive Index has also rebounded, and is up 17 percent since the bottom on Oct. 27. The index added 2.4 percent on Friday. The MSCI core index for India is also up 6.74% so far this month. After all that falling over the last twelve months, it is that little upturn since the start of November (see chart below) that we would like to see consolidate and continue. Of course, this may be yet another false start, and there may be another shoe to drop, but perhaps there are reasons for just a little more optimism at this point.




And the general MSCI Emerging Markets Index also looks as if it may well have turned.





Emerging Bonds Start To Rebound Too


Emerging market bonds have also started to recover, if we look at the JPMorgan EMBI+ chart, we can see what appears to be quite a robust "bounce back". Of course for some countries (Eastern Europe, Argentina etc) the worst is still not over, but India may well be relatively insulated from too much fall-out here.





Not Much Sign Of A Rebound In Commodities Yet

On the other hand, with growth in the OECD countries likely to be bordering on negative in 2009, and Russia and China both likely to have substantial slowdowns, there are not too many signs at this point of any recovery in commodities, if we look at the Reuters-Jefferies chart.




But since India is a large net commodities importer, this is hardly bad news. Oil prices were sedentary Friday following a large scale sell-off during the week, - and this despite a forecast from the International Energy Agency that put the price of crude at $200 per barrel by 2030. Light, sweet crude for December delivery rose 27 cents to settle at $61.04 a barrel on the New York Mercantile Exchange, although the contract had dropped below $60 in earlier overnight electronic trading for the first time 19 months. This is all now a far cry from June, when oil was trading at $147.

India's Foreign Exchange Reserves Continue to Fall

India's foreign exchange reserves declined again at the end of October - for the sixth consecutive week - and fell by $5.532 billion to reach $252.883 billion for the week ended October 31. India's reserves have fallen by more than $31 billion in the past one month alone, and are now well below their $318 billion April peak. But on the other had they are still substantial and not far different from what they were 12 months ago, following a very substantial rise over the previous nine months. So if they do not fall too much further, then it isn't evident that there is any real problem at this point.

Sustained dollar selling by the Reserve Bank of India in the forex markets, huge amounts of FII outflow from the domestic equity markets, and the revaluation of the reserves have been the main factors pressurising India's reserves, but all these factors are symptomatic of the general pressure which has come to bear on "higher risk" emerging market economies as a whole as the financial turmoil and associated uncertainty have raged in the United States and Europe, and there is little real evidence of "India specific" factors at work here, indeed Indian exceptionalism would rather be in the fact that - absent commodity export dependence - India's reserves have not been taking the same sort of pounding Russia and Brazil's have.




The Reserve Bank of India (RBI) also said on Friday that it will lend foreign exchange - via foreign excahnge swaps - to banks with overseas operations to help them meet their lending requirements, a move that many Indian banks had been asking for, and which should help ensure adequate funding for their foreign subsidiaries. Following the central bank’s announcement, banks will buy dollars from RBI at the reference rate plus three-month forward premium and will return dollars to RBI after three months, in case of three month swaps.

Additionally, the central bank has also extended a lifeline to banks for funding the swaps by allowing them to borrow through its regular liquidity adjustment facility (LAF). The LAF is the window through which it lends to or accepts money from banks, for the corresponding period at the prevailing policy rate.

Banks borrow through the LAF window by pledging government bonds. They are required to invest at least 24% of their lendable funds in government bonds; this portion of their deposits is called the statutory liquidity ratio, or SLR. In view of the tight liquidity conditions, RBI reduced the SLR by 1% to 24% on 1 November. RBI also said on Friday that if a bank did not hold enough government securities to pledge, it would consider relaxing the SLR requirement if the bank approached it.

The use of swaps helps banks obtain cheaper funds for buying dollars because they can now borrow from the central bank repo window at 7.5%. Previously banks needed to convert their rupee deposits - raised at a rather costlier 10.5-11% - into dollars.


India's Industry Resists The Global Slowdown


Despite the fact that India's industrial output plummeted to a 1.3% year on year rate in August, there are some signs that the situation may be improving. The first of these are the September performance indicators for the coal and cement sectors, the rise in which pushed up the growth in output in the core infrastructure industries to 5.1% in September. According to government data made public on Friday, coal production was up by 10.7% in September 2008 while cement production rose by 7.9%.



Core sector growth in August was just 2.3% - and the six core industries have a weight of 26.7% in the index of industrial production (IIP). On the other hand growth in electricity generation remained weakish - at 4.4% - in September. If compared with the growth rate in August this year, electricity generation was the worst performer among the six sectors, with an abysmal growth of 0.8% in August 2008. Of the six core industries (crude oil, petroleum refinery products, coal, electricity, cement and finished carbon steel), only coal and cement really registered strong growth rates in September 2008. So I guess we have to wait till mid-week now to see the complete September figures.

However, despite what may well turn out to be an improvement in September IP over the August number, it does looks very much as if activity at Indian factories fell to its lowest level in three and a half years in October as the global financial crisis and slowing export demand hit the country's manufacturing sector. The ABN AMRO Bank purchasing managers' index (PMI), based on a survey of 500 companies, slumped to a seasonally adjusted 52.2 in October, its lowest since the survey began in April 2005 and sharply below September's 57.3. A reading above 50 signals expansion while a figure below 50 suggests contraction, and the manufacturing PMIs are interesting, since they do offer us a sort of "real time" snapshot of what is actually happening.

"The outlook for the manufacturing sector appears to be bleaker in the backdrop of tough local and global economic conditions," said ABN AMRO Bank N.V. senior economist Gaurav Kapur.

So the point here would not be that Indian industry is in absolutely perfect condition (it is obvious that it isn't), but rather that, at a time when global manufacturing generally is taking a huge beating, Indian industry is hanging on in, by its fingernails, but it is hanging on in.

In comparison, the JPMorgan Global Manufacturing PMI posted 41.0, its lowest reading since data were first compiled in January 1998 and a level below the no-change mark of 50.0 for the fifth month in a row.

Output, total new orders and new export orders all contracted at the fastest rates in the survey history in October. With the exception of India, which again bucked the global trend, all of the national manufacturing surveys posted declines in output and new orders. The impact of the downshift in global market conditions also had a far-reaching effect on international trade volumes. Although new export orders fell at a slower rate than total new business, all of the national manufacturing sectors covered by the survey (including India) saw a reduction in new export orders.

"October manufacturing PMI data reinforce the stark retrenchment that the sector is currently facing, with production, total new business and new export orders all falling at record rates. The latest Output Index reading is consistent with a fall in global IP of almost 8%. The only positive from the surveys was a decline in input prices for the first time since August 2003."
David Hensley, Director of Global Economics Coordination at JPMorgan

Returning finally to India, perhaps somewhat significantly the export order index in the PMI survey contracted for the first time in the survey's history, coming in at 49.7 in October, compared with 53 in September. Manufacturers blamed poor global financial and economic conditions for the result. But this should not surprise us too much either, since India's exports grew at their slowest pace in 18 months in September. Overseas shipments, which constitute about 15 percent of the Indian economy, were up 10.4 percent (to $13.7 billion) from a year earlier, following a 27 percent gain in August. Imports also increased - by 43.3 percent to $24.4 billion, with the result that the trade deficit widened to $10.6 billion.

``The global financial and economic headwinds adversely affected foreign demand for Indian manufactured goods,'' said Gaurav Kapur, an economist at ABN Amro Bank in Mumbai. ``The growth of total incoming new work to the Indian manufacturing economy lost considerable momentum.''

So, in conclusion, I am not saying that everything in the Indian garden is simply perfect, rather I am simply pointing out that during times which are hard for everyone, India has some advantages to lean back on, and looks set to have a lot less serious downturn than many other emerging economies may experience. So to end, almost where I started, with CLSA'a Sharmla Whelan, I do expect the Indian business cycle to be the first to bottom in Asia, and I would most certainly agree that "it should, in theory, be first to emerge".