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2011 vs 2008: Policy insights
India’s economy held up better than expected during the 2008 global
financial debacle and was also understandably more resilient than the
local equity market. The aggressive fiscal-monetary policy response was
important in cushioning the hit to the economy, which already had built-in
relative resilience due to its lower reliance on exports. The current global
turmoil is still evolving but the economic hit is expected to be less severe
than in 2008 as a repeat of the global USD liquidity freeze that broke the
back of world trade appears less likely. The key focus will be on the RBI,
which could take a breather in its monetary tightening if the recent decline
in global commodity prices is sustained. However, even in that scenario, it
is unlikely to repeat the super-aggressive easing of 2008. Also, it will be
cautious in indicating an early shift to monetary easing, which will come
only after it remains on hold for some months. In a world desperately
searching for growth, India’s relative resilience in growth can’t be ignored.
However, while lower commodity prices are positive for inflation, higher
global risk aversion can be negative for capital inflows.
There are three main channels via which the India economy will be affected by
the ongoing downshift in global growth and the related deflationary shock: (1)
economic growth; (2) prices of commodity prices, especially crude oil; and (3)
capital inflows. We analyze the differences between 2008 and the current
situation, and their implications for the policy outlook. The most important
impact will be from a sustained softening in crude oil prices, which will have a
positive effect on India’s pesky inflation, and thus offer scope for an eventual
shift in RBI’s policy
At the very outset, apart from the differences in the causes and the transmission
channels, the ongoing global turmoil has an advantage in that it can be
compared to the 2008 global financial crisis (GFC) for its impact and the
policy response. This useful hindsight was not available during the GFC and
was itself a source of uncertainty.
The severity of the Euro-zone sovereign mess is still evolving and the
magnitude of its potential impact on global liquidity remains unclear. However,
it will probably not be as severe and widespread as the post-Lehman global
liquidity freeze. This is mainly because a potential EUR funding crisis will be
much more limited in its implications for global trade and is thus unlikely to
break the back of global trade as was done by the USD funding crisis in 2008.
The impact of the USD funding crisis on trade was more severe because of the
importance of USD for global trade settlement.
Economic growth: Smaller hit this time
There are two important similarities between the conditions prevailing now in
India and those in 2008: (1) a moderation in growth; and (2) lower reliance on
exports. Headline GDP growth plunged from 9.6% YoY in 4Q07 to 5.8% in
4Q08 before recovering (Figure 2). Importantly, the deceleration in nonagriculture GDP was less pronounced: from 9.6% YoY to 8.2% over the same
period. However, it bottomed at 6.8% YoY in 1Q09, a quarter later than the
headline GDP growth. This time too economic growth has been moderating.
GDP growth slowed to 7.8% YoY in 1Q11 from 9.4% in 1Q10.
There are also crucial differences between the conditions now and those in
2008 that will cushion the impact on growth: (1) the investment cycle has
already been weaker than what it was in the run-up to the GFC; and (2) the
sudden reversal in foreign capital triggered a boom-bust cycle in 2008 but a
shock of similar intensity this time is unlikely; and (3) policymakers have
lowered their realisable trend growth expectation to around 8% from 8.5-9%
that was common in 2008.
India presents a unique combination of a largely domestic-driven economy that
has an active and open equity market for foreigners. Thus, the economy has
built-in shock absorbers to cushion the hit from, say, downshifts in global
growth. However, given the high correlation across equity markets, especially
during periods of high global risk aversion, any significant and lasting collapse
in capital inflows and/or in local equity prices can cause dislocation of the
economic cycle, as happened in 2008.
The most severe casualty of the post-GFC economic downturn was the private
investment cycle, which was one of the strongest in the region. As local and
foreign financing options disappeared due to the global liquidity squeeze,
domestic investment collapsed. The overall drop would have been even more
dramatic had it not been for the government’s push on building infrastructure.
On a fullyear basis, GDP growth decelerated to 6.8% in FY09 (8.2% for nonagriculture GDP), the year that captured the full impact of the GFC, after
averaging 9.5% (10.5% for non-agriculture GDP) annually in the prior three
years. The collapse in the local equity market also negatively affected the
growth dynamics. A combination of aggressive fiscal and monetary measures
and a recovery in financial markets globally positioned the economy for an
earlier and stronger-than-expected recovery in growth to 8% and 8.5% in FY10
and FY11, respectively.
An important aspect of the broader resilience in India’s growth during the GFC
that is being overlooked is the significant role played by the Sixth Pay
Commission payout in FY09. This had been decided well before the Lehman
bust. Still, it worked as a timely (though unintentional) counter-cyclical
measure. The impact of the first tranche of the payout was visible as early as
December 2008. This is best reflected in the sequential bottoming and the
subsequent recovery in car sales (Figure 4), despite the weak consumer and
business sentiment at that time. Interest rate cuts by the RBI and fiscal
measures helped, but the initial meaningful swing factor was the increase in
disposable income following the Pay Commission payout. Notably, the
recovery in car sales took off even before the recovery in Sensex, which did not
bottom until February 2009.
We expect GDP growth at a below-trend 7.5% in FY12 after averaging 8.3%
annually in the post-crisis recovery years of FY10 and FY11. Our current FY12
GDP forecast builds in couple of quarters of GDP growth in the 7-7.5% range.
The growth moderation, which is a key policy objective to check inflationary
pressures, is bound to become more broad-based, although aggregate
consumption will suffer less partly due to its structural drivers.
Importantly, the softening global demand will hurt India’s domestically-driven
economy relatively less compared to other Asian economies owing to India’s
lowest reliance on exports. Indeed, despite becoming more integrated with the
rest of the world in the last two decades, India’s export/GDP ratio of 21.5% is
the lowest in the region.
Still, with the US and the EU accounting for 31% of total goods exports,
India’s merchandise shipments are bound to be affected by the deceleration in
growth in these areas. Exports will also suffer a knock on impact from slower
Asian demand as global demand softens economic growth in the rest of Asia.
Finally, exports to the EU (20.2% of total exports) could also be hit by further
weakness in EUR. IT service exports, which are not captured in the monthly
trade data, will also come under pressure.
Admittedly, depending on the severity of the emerging global backdrop,
including the possibility of a double-dip recession in the US, there could be
around 0.5ppt downside risk to our growth forecast (the downside risk will be
higher for consensus expectations). Still, the hit to exports is unlikely to be as
severe as it was in the aftermath of GFC (Figure 5). This is because the USD
funding crisis that broke the back of global trade is less likely to play out this
time. The current GDP forecast trajectory will be reviewed following the AprilJune GDP report at the end of August.
Lower commodity prices: A plus, if the fall is sustained
A deflationary environment is typically bad for equities, but it is also a setting
where a country, such as India, with an inflation problem, can benefit initially
as global commodities cool off (Figure 6). Also, India does better when global
growth is subdued and global liquidity is easy but not excessive so as to
significantly push up commodity prices. However, it is often overlooked that to
the extent lower commodity prices are a function of heightened global risk
aversion, capital inflows could suffer as well.
In Triple-A India-Tracking the macro risks (30 March), we reiterated that
India’s inflationary pressures are a complex mix of demand- and supply-side
factors, cover food and non-food categories, and are structural and cyclical in
nature. It is often mistakenly assumed that inflation is driven only by cyclical
demand pressures that higher interest rates alone will be able to check. Fiscal
consolidation and reforms to reduce structural rigidities are also needed for a
sustained solution to the inflation problem.
Global commodity prices have a significant impact on India’s inflation as the
RBI prefers to focus on wholesale price index (WPI) instead of consumer price
index (CPI), which is the norm with every other central bank. Further, India’s
dependence on imported crude oil and the government’s paternalistic approach
for subsidising local fuel prices ensure that changes in the global commodities,
especially crude oil, have a significant impact on the macro setting. Below is
our indicative sensitivity analysis of a USD10/bbl annual decrease (increase) in
the price of crude oil on four key economic channels (actual outcomes can vary
owing to several moving parts):
q GDP growth will probably be higher (lower) by 0.3-0.5ppt.
q Headline WPI inflation will likely fall (rise) by 1.5-2ppt.
q Fiscal deficit (% of GDP) will narrow (widen) by around 0.2ppt.
q CA deficit will fall (rise) by USD9.5bn, or around 0.5ppt of GDP.
To the extent global commodities prices, especially for crude oil, remain at the
current levels (Brent is down around 15% from its peak this year) or decline
further due to global growth scare, India’s WPI core inflation will be
favourably affected (Figure 7). This, if sustained, will offer scope for the RBI
to adopt a near-term wait-and-see approach in its monetary tightening (such a
move is not an easing) without lowering its anti-inflation rhetoric. Admittedly,
there are India-centric issues such “suppressed” inflation and the still-high food
inflation that need to be resolved. But the incremental impact of a sustained
decline in commodity prices cannot be ignored.
Roadmap to RBI’s September policy review
The following relevant markers (local data/global events) should be closely
tracked as they will influence the outcome of the RBI’s inter-quarter monetary
policy review on 16 September. Overall, the inflation indicators will still
favour further tightening, while the production (industrial output and GDP)
data and the worsening global outlook will favour a wait-and-see approach.
Obviously, Ben Bernanke’s upcoming speech in Jackson Hole, Wyoming will
be the joker in the pack. Any hint of further strong quantitative easing by
Bernanke could favourable affect risk appetite and commodity prices, and
hence will be bad for India’s inflation and interest rate outlook.
q 16 August - July WPI: Inflation will remain high around 9.5% YoY and
will be supportive for further tightening. However, bear in mind that it
refers to a period before the recent global turmoil.
q 26 August - Ben Bernanke’s speech at Jackson Hole, Wyoming: The
guidance about the remaining ammunition in the Fed’s arsenal and the
possible hints about further quantitative easing will be crucial for global
risk appetite and commodity prices. A renewed upturn in commodity prices
following the speech will increase the probability of a hike by the RBI in
September and also prolong the ongoing monetary tightening.
q 31 August - 2Q11 GDP: IP growth moderated to 6.8% YoY in 2Q11 from
7.9% in 1Q11, hinting that GDP growth in 2Q11 moderated further - as
expected - from 7.8% in 1Q11. We maintain our FY12 GDP growth forecast of
7.5% (RBI: 8%) but note that the worsening global demand could create
downside risk of around 0.5ppt on our forecast.
q 1 and 5 September - August PMI surveys for manufacturing and services:
The headline reading will ease further but remain above the neural 50 level,
indicating further moderation in the pace of activity.
q 12 September - July IP: Almost certainly to be lower than the aboveexpectation outcome of 8.8% YoY in June as the volatility in capital goods
segment will reverse course after an exceptional strong gain in June
q 14 September - August WPI: Inflation will still remain high but will come
off slightly as it will be positively affected by the decline in global
commodity prices.
q 16 September - RBI’s mid-quarter policy review: Rate action and
guidance will be a function of the above-mentioned markers but it will still
retain the hawkish stance. A formal lowering of its GDP growth forecast of
8% may not happen until the midyear review in October, but will probably
signal downside risk to its growth forecast.
Importantly, a pause – even if it is announced - on 16 September should not be
mistakenly assumed to indicate that the RBI is necessarily done with its tight
money policy. Barring a significant global crisis that also adversely impacts
domestic liquidity, the RBI will probably stay of hold for some time before
shifting to an easier stance. Even then, a repeat of the aggressive easing of
2008 is highly unlikely for the following reasons:
q Less severe hit this time: The current global challenges are still evolving
but the nature, severity and the channels of the anticipated hit may not be as
severe as the GFC in 2008.
q Lower trend economic growth: Policymakers have lowered their nearterm realisable trend growth expectations to around 8% from around 8.5-
9% in 2008.
q Higher inflation for longer: While lower commodity prices will have a
positive impact on inflation, the local tardy supply-side response will
ensure that domestically generated inflationary pressures, including those
on food, remain in place.
q Last aggressive easing and inflation: The RBI will be more mindful of
the inflationary impact of its aggressive easing following the GFC, and
hence be much more cautious in adopting an easing monetary stance.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
2011 vs 2008: Policy insights
India’s economy held up better than expected during the 2008 global
financial debacle and was also understandably more resilient than the
local equity market. The aggressive fiscal-monetary policy response was
important in cushioning the hit to the economy, which already had built-in
relative resilience due to its lower reliance on exports. The current global
turmoil is still evolving but the economic hit is expected to be less severe
than in 2008 as a repeat of the global USD liquidity freeze that broke the
back of world trade appears less likely. The key focus will be on the RBI,
which could take a breather in its monetary tightening if the recent decline
in global commodity prices is sustained. However, even in that scenario, it
is unlikely to repeat the super-aggressive easing of 2008. Also, it will be
cautious in indicating an early shift to monetary easing, which will come
only after it remains on hold for some months. In a world desperately
searching for growth, India’s relative resilience in growth can’t be ignored.
However, while lower commodity prices are positive for inflation, higher
global risk aversion can be negative for capital inflows.
There are three main channels via which the India economy will be affected by
the ongoing downshift in global growth and the related deflationary shock: (1)
economic growth; (2) prices of commodity prices, especially crude oil; and (3)
capital inflows. We analyze the differences between 2008 and the current
situation, and their implications for the policy outlook. The most important
impact will be from a sustained softening in crude oil prices, which will have a
positive effect on India’s pesky inflation, and thus offer scope for an eventual
shift in RBI’s policy
At the very outset, apart from the differences in the causes and the transmission
channels, the ongoing global turmoil has an advantage in that it can be
compared to the 2008 global financial crisis (GFC) for its impact and the
policy response. This useful hindsight was not available during the GFC and
was itself a source of uncertainty.
The severity of the Euro-zone sovereign mess is still evolving and the
magnitude of its potential impact on global liquidity remains unclear. However,
it will probably not be as severe and widespread as the post-Lehman global
liquidity freeze. This is mainly because a potential EUR funding crisis will be
much more limited in its implications for global trade and is thus unlikely to
break the back of global trade as was done by the USD funding crisis in 2008.
The impact of the USD funding crisis on trade was more severe because of the
importance of USD for global trade settlement.
Economic growth: Smaller hit this time
There are two important similarities between the conditions prevailing now in
India and those in 2008: (1) a moderation in growth; and (2) lower reliance on
exports. Headline GDP growth plunged from 9.6% YoY in 4Q07 to 5.8% in
4Q08 before recovering (Figure 2). Importantly, the deceleration in nonagriculture GDP was less pronounced: from 9.6% YoY to 8.2% over the same
period. However, it bottomed at 6.8% YoY in 1Q09, a quarter later than the
headline GDP growth. This time too economic growth has been moderating.
GDP growth slowed to 7.8% YoY in 1Q11 from 9.4% in 1Q10.
There are also crucial differences between the conditions now and those in
2008 that will cushion the impact on growth: (1) the investment cycle has
already been weaker than what it was in the run-up to the GFC; and (2) the
sudden reversal in foreign capital triggered a boom-bust cycle in 2008 but a
shock of similar intensity this time is unlikely; and (3) policymakers have
lowered their realisable trend growth expectation to around 8% from 8.5-9%
that was common in 2008.
India presents a unique combination of a largely domestic-driven economy that
has an active and open equity market for foreigners. Thus, the economy has
built-in shock absorbers to cushion the hit from, say, downshifts in global
growth. However, given the high correlation across equity markets, especially
during periods of high global risk aversion, any significant and lasting collapse
in capital inflows and/or in local equity prices can cause dislocation of the
economic cycle, as happened in 2008.
The most severe casualty of the post-GFC economic downturn was the private
investment cycle, which was one of the strongest in the region. As local and
foreign financing options disappeared due to the global liquidity squeeze,
domestic investment collapsed. The overall drop would have been even more
dramatic had it not been for the government’s push on building infrastructure.
On a fullyear basis, GDP growth decelerated to 6.8% in FY09 (8.2% for nonagriculture GDP), the year that captured the full impact of the GFC, after
averaging 9.5% (10.5% for non-agriculture GDP) annually in the prior three
years. The collapse in the local equity market also negatively affected the
growth dynamics. A combination of aggressive fiscal and monetary measures
and a recovery in financial markets globally positioned the economy for an
earlier and stronger-than-expected recovery in growth to 8% and 8.5% in FY10
and FY11, respectively.
An important aspect of the broader resilience in India’s growth during the GFC
that is being overlooked is the significant role played by the Sixth Pay
Commission payout in FY09. This had been decided well before the Lehman
bust. Still, it worked as a timely (though unintentional) counter-cyclical
measure. The impact of the first tranche of the payout was visible as early as
December 2008. This is best reflected in the sequential bottoming and the
subsequent recovery in car sales (Figure 4), despite the weak consumer and
business sentiment at that time. Interest rate cuts by the RBI and fiscal
measures helped, but the initial meaningful swing factor was the increase in
disposable income following the Pay Commission payout. Notably, the
recovery in car sales took off even before the recovery in Sensex, which did not
bottom until February 2009.
We expect GDP growth at a below-trend 7.5% in FY12 after averaging 8.3%
annually in the post-crisis recovery years of FY10 and FY11. Our current FY12
GDP forecast builds in couple of quarters of GDP growth in the 7-7.5% range.
The growth moderation, which is a key policy objective to check inflationary
pressures, is bound to become more broad-based, although aggregate
consumption will suffer less partly due to its structural drivers.
Importantly, the softening global demand will hurt India’s domestically-driven
economy relatively less compared to other Asian economies owing to India’s
lowest reliance on exports. Indeed, despite becoming more integrated with the
rest of the world in the last two decades, India’s export/GDP ratio of 21.5% is
the lowest in the region.
Still, with the US and the EU accounting for 31% of total goods exports,
India’s merchandise shipments are bound to be affected by the deceleration in
growth in these areas. Exports will also suffer a knock on impact from slower
Asian demand as global demand softens economic growth in the rest of Asia.
Finally, exports to the EU (20.2% of total exports) could also be hit by further
weakness in EUR. IT service exports, which are not captured in the monthly
trade data, will also come under pressure.
Admittedly, depending on the severity of the emerging global backdrop,
including the possibility of a double-dip recession in the US, there could be
around 0.5ppt downside risk to our growth forecast (the downside risk will be
higher for consensus expectations). Still, the hit to exports is unlikely to be as
severe as it was in the aftermath of GFC (Figure 5). This is because the USD
funding crisis that broke the back of global trade is less likely to play out this
time. The current GDP forecast trajectory will be reviewed following the AprilJune GDP report at the end of August.
Lower commodity prices: A plus, if the fall is sustained
A deflationary environment is typically bad for equities, but it is also a setting
where a country, such as India, with an inflation problem, can benefit initially
as global commodities cool off (Figure 6). Also, India does better when global
growth is subdued and global liquidity is easy but not excessive so as to
significantly push up commodity prices. However, it is often overlooked that to
the extent lower commodity prices are a function of heightened global risk
aversion, capital inflows could suffer as well.
In Triple-A India-Tracking the macro risks (30 March), we reiterated that
India’s inflationary pressures are a complex mix of demand- and supply-side
factors, cover food and non-food categories, and are structural and cyclical in
nature. It is often mistakenly assumed that inflation is driven only by cyclical
demand pressures that higher interest rates alone will be able to check. Fiscal
consolidation and reforms to reduce structural rigidities are also needed for a
sustained solution to the inflation problem.
Global commodity prices have a significant impact on India’s inflation as the
RBI prefers to focus on wholesale price index (WPI) instead of consumer price
index (CPI), which is the norm with every other central bank. Further, India’s
dependence on imported crude oil and the government’s paternalistic approach
for subsidising local fuel prices ensure that changes in the global commodities,
especially crude oil, have a significant impact on the macro setting. Below is
our indicative sensitivity analysis of a USD10/bbl annual decrease (increase) in
the price of crude oil on four key economic channels (actual outcomes can vary
owing to several moving parts):
q GDP growth will probably be higher (lower) by 0.3-0.5ppt.
q Headline WPI inflation will likely fall (rise) by 1.5-2ppt.
q Fiscal deficit (% of GDP) will narrow (widen) by around 0.2ppt.
q CA deficit will fall (rise) by USD9.5bn, or around 0.5ppt of GDP.
To the extent global commodities prices, especially for crude oil, remain at the
current levels (Brent is down around 15% from its peak this year) or decline
further due to global growth scare, India’s WPI core inflation will be
favourably affected (Figure 7). This, if sustained, will offer scope for the RBI
to adopt a near-term wait-and-see approach in its monetary tightening (such a
move is not an easing) without lowering its anti-inflation rhetoric. Admittedly,
there are India-centric issues such “suppressed” inflation and the still-high food
inflation that need to be resolved. But the incremental impact of a sustained
decline in commodity prices cannot be ignored.
Roadmap to RBI’s September policy review
The following relevant markers (local data/global events) should be closely
tracked as they will influence the outcome of the RBI’s inter-quarter monetary
policy review on 16 September. Overall, the inflation indicators will still
favour further tightening, while the production (industrial output and GDP)
data and the worsening global outlook will favour a wait-and-see approach.
Obviously, Ben Bernanke’s upcoming speech in Jackson Hole, Wyoming will
be the joker in the pack. Any hint of further strong quantitative easing by
Bernanke could favourable affect risk appetite and commodity prices, and
hence will be bad for India’s inflation and interest rate outlook.
q 16 August - July WPI: Inflation will remain high around 9.5% YoY and
will be supportive for further tightening. However, bear in mind that it
refers to a period before the recent global turmoil.
q 26 August - Ben Bernanke’s speech at Jackson Hole, Wyoming: The
guidance about the remaining ammunition in the Fed’s arsenal and the
possible hints about further quantitative easing will be crucial for global
risk appetite and commodity prices. A renewed upturn in commodity prices
following the speech will increase the probability of a hike by the RBI in
September and also prolong the ongoing monetary tightening.
q 31 August - 2Q11 GDP: IP growth moderated to 6.8% YoY in 2Q11 from
7.9% in 1Q11, hinting that GDP growth in 2Q11 moderated further - as
expected - from 7.8% in 1Q11. We maintain our FY12 GDP growth forecast of
7.5% (RBI: 8%) but note that the worsening global demand could create
downside risk of around 0.5ppt on our forecast.
q 1 and 5 September - August PMI surveys for manufacturing and services:
The headline reading will ease further but remain above the neural 50 level,
indicating further moderation in the pace of activity.
q 12 September - July IP: Almost certainly to be lower than the aboveexpectation outcome of 8.8% YoY in June as the volatility in capital goods
segment will reverse course after an exceptional strong gain in June
q 14 September - August WPI: Inflation will still remain high but will come
off slightly as it will be positively affected by the decline in global
commodity prices.
q 16 September - RBI’s mid-quarter policy review: Rate action and
guidance will be a function of the above-mentioned markers but it will still
retain the hawkish stance. A formal lowering of its GDP growth forecast of
8% may not happen until the midyear review in October, but will probably
signal downside risk to its growth forecast.
Importantly, a pause – even if it is announced - on 16 September should not be
mistakenly assumed to indicate that the RBI is necessarily done with its tight
money policy. Barring a significant global crisis that also adversely impacts
domestic liquidity, the RBI will probably stay of hold for some time before
shifting to an easier stance. Even then, a repeat of the aggressive easing of
2008 is highly unlikely for the following reasons:
q Less severe hit this time: The current global challenges are still evolving
but the nature, severity and the channels of the anticipated hit may not be as
severe as the GFC in 2008.
q Lower trend economic growth: Policymakers have lowered their nearterm realisable trend growth expectations to around 8% from around 8.5-
9% in 2008.
q Higher inflation for longer: While lower commodity prices will have a
positive impact on inflation, the local tardy supply-side response will
ensure that domestically generated inflationary pressures, including those
on food, remain in place.
q Last aggressive easing and inflation: The RBI will be more mindful of
the inflationary impact of its aggressive easing following the GFC, and
hence be much more cautious in adopting an easing monetary stance.
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