Effect of euro debt crisis on India - ROGER YEOMAN in:: Business Line,

Please Share:: India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��

There is little evidence to suggest any major economic slowdown in India, driven by trade or investment flows.

As I sit here in leafy Surrey, just outside London, gazing over my garden pond to the fields beyond, it would be easy to imagine that this rural milieu is a reflection of the universe at large. Alas, of course, this is not the case.

The UK and several other major Western economies are still wrestling with the aftermath of the 2008 credit crisis. Confidence remains desperately low, particularly within financial services, but also in public sectors, where much-needed spending limitations are contributing to current unemployment and spreading uncertainty regarding the future.

Pressure on household spending is causing havoc on the high street too and many major retail brands have shut their doors.

House prices, the bedrock of middle-class financial security, are stagnant at best and probably falling in real terms, in most places outside London's Grade A areas, which are propped up by foreign buyers. Many banks have been effectively nationalised and owe their continued existence to those hard-pressed taxpayers.

The reversal in asset prices and the ongoing constrictions in bank lending have contributed to an extremely low level of money supply growth.

To add insult to injury, the debt crisis, which has already engulfed the sovereign states of Ireland, Portugal and Greece now appears likely to affect other Eurozone economies in a significant way, starting with relative weaklings such as Spain and Italy and raising concerns of another wave of bank problems even before the 2008 issues are close to being overcome.

BUYING BACK GREEK BONDS

The stronger economic powers within Europe are struggling to reach an agreement on how to cauterise the Greek problem, but there are bound to be significant losses and the need for ongoing financial help in the form of some type of support mechanism, which allows Greece to continue to fund vital services at a fraction of the open market rate.

The German and French governments appear to have come together around the principle of buying back Greek bonds at a discount, a process which would probably cause an orderly, selective default. This could be good news in the short term for larger states such as Italy and Spain, which might be able to continue to borrow in bond markets at reasonable rates.

STAGFLATION?

However, let us step away from these albeit serious technical issues and consider the bigger picture. We have here a set of (erstwhile) leading economies which are suffering from a major debt hangover and which, despite extraordinarily low interest rates (UK 10-year bonds yield around 3 per cent, money market rates are hovering around 0.5 per cent), remain desperately short of demand.

At the same time, inflation remains uncomfortably high in many countries (nearly 5 per cent in the UK). Causes include currency movements, global food and energy shortages and supply disruptions, with speculative premiums stoking prices further. It feels like stagflation and it represents a terrible tax on living standards. To the extent that this could be described as demand-pull inflation, the incremental demand is coming not from mature Western economies, but from Brazil, Russia, India and China (BRIC) and other emerging economies.

Meanwhile, the US has its own much-debated debt problems to contend with. But the root causes are the same — too much overhanging debt and too little growth to service it. Let us now cast our eyes towards India. One would certainly not suggest that it is without its own problems — supply-chain dislocations, state and local government corruption concerns, a stock market down 10 per cent year-to-date, compared to a flat UK market and a buoyant 5-10 per cent return so far for the various US indices. Yet, in India, the problems are of a very different and arguably healthier hue.

CYCLICAL SLOWDOWN

GDP growth is slowing, but from a breakneck 9.3 per cent in last year's June quarter to just under 8 per cent now. Inflation stood at a worryingly high 9.74 per cent in the latest quarter and it would be no surprise to see continued rate increases slowing the economy further and bringing inflation to heel. In other words, we are dealing with a typical cyclical, managed slowdown in an economy where demand has outstripped supply in a number of areas.

What impact are we seeing from the Western economies' problems? India's foreign trade account is hovering around a negative $10 billion per month, but that is no worse than several years ago and it is hard to detect a deteriorating pattern.

Foreign direct investment flows are higher for April and May than for the same months last year, and they actually seem to have picked up. Foreign indirect investment flows do appear to have come down near term, which has clearly contributed to the recent stock market weakness. Yet this number set is highly volatile — flat in March, up by $3.7 billion in April, negative $1.7 billion in May. In short, there is little hard evidence to suggest any major economic slowdown, driven by trade or investment flows, although foreign portfolio investors appear to have taken some money off the table as a safety shot ahead of the widely predicted monetary tightening.

To conclude, in the face of a near perfect economic hurricane in the West, India seems to be barrelling along on a better trajectory. The linkages of the past, when such markets were seen as warrant plays on the more mature economies, appear to be weakening .

Perhaps at least some of Don Quixote's ‘hulking gigantic enemies' are just windmills after all.