It’s alive!

After a year wracked by a global economic downturn, nervous investors and drought, the Great Indian Growth Story is stirring back to life. Manas Chakravarty looks at the monster’s return in 2010.

One question that will be answered in 2010 is: were the markets right and the pundits wrong? The majority of economists and experts, as well as institutions like the International Monetary Fund (IMF), have been repeating ad nauseam that recovery from the global financial crisis is likely to be slow and prolonged. The IMF predicts global gross domestic product (GDP) to grow by 3.1 per cent in 2010 after contracting by 1 per cent in 2009. (In 2006 and 2007 before the crisis hit, global growth was over 5 per cent.) For India, which had growth rates of over 9 per cent between 2005 and 2007, the IMF has forecast a growth of 5.4 per cent in 2009, 6.4 per cent in 2010 and between 7 and 8 per cent right up to 2013.

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Equity markets, however, have pooh-poohed such pessimism. The Morgan Stanley Country Index for the United States, a measure of the performance of US stocks, has gained 28 per cent in 2009 at the time of writing. The BSE Sensex has done much better, gaining around 81 per cent in 2009.

Clearly, the markets are looking at a V-shaped recovery. Does this mean that the downturn touted as the biggest since the Great Depression is over? Wasn’t this huge crisis caused by too much liquidity. So how could it be cured by pumping in even more amounts of money by central banks? Was all that talk about global imbalances, excessive borrowing and lax regulation just a lot of hot air and is it back to business as usual? 2010 will tell us whether the economists or the markets are right.

W curve: Asymmetry is the new symmetry
For India, though, the recovery in the economy, too, has been V-shaped. The trouble is, much of the growth is due to the push provided to the economy by the government, through the money provided by implementing the recommendations of the Sixth
Pay Commission, by the farm loan waivers and through excise cuts.

All these measures have boosted demand. Low interest rates by the Reserve Bank of India (RBI) have also helped. The question is: will growth remain robust once the impact of the government stimulus wears off and when interest rates start to rise? The RBI is already worried about higher inflation and the odds are that it will soon raise interest rates.
If we strip out government consumption expenditure from the GDP numbers, GDP growth in the September 2009 quarter was actually lower than what it was in the June quarter. Does it mean that, looking ahead, growth is likely to be more moderate? That is very probable. During the last downturn after the dotcom bust, the growth rate in manufacturing fell to dismal levels in 2001-02, improved substantially in 2002-03, decelerated in 2003-04 and then roared back at full speed in 2004-05.

Going with the capital inflows
If we follow the same trajectory, recovery will stall a bit before picking up strength again — a W rather than a V, but a lop-sided W with a much shorter second leg of the downturn. Growth may flag as interest rates rise and the government stimulus is withdrawn, but it’s likely to be a road bump on the road to full recovery.

The markets have soared because central banks have pumped in huge amounts of money. With growth remaining tepid and monetary policy loose, the excess liquidity has spilled over into asset prices. Also, the very low interest rates in America have led to a collapse of the dollar, with money flowing out of the US into non-dollar assets such as emerging market equities.

Monetary policy is expected to remain loose in the developed world for much of 2010, which will mean that the inflows to emerging markets should remain strong, although some of the excess liquidity could come down as growth picks up. The rupee should strengthen as the inflows continue.

A large part of the inflows could be mopped up by companies by way of initial public offers or private placements. That will strengthen corporate balance sheets and encourage investment. Analysts are predicting earnings per share to grow by more than 20 per cent in 2010-11. But valuations are stretched and any disappointment on earnings could lead to a sell-off.

Oh, the questions, the questions!
2010 will also tell us whether economies like India can decouple from the West. If they can, that will confirm the much-talked-about shift of economic power from the West to the East.

But many uncertainties remain. Will the US consumer revive?

Will East Asia be able to ditch its export-led model?

Will the big international banks get back on their feet? Will the US suffer the same deflationary fate as Japan?

That nerves have still not been fully soothed is seen from the recent rally in gold, which is viewed by investors as a safe haven during times of trouble.

And finally, 2010 will also provide clues to the biggest question of them all: while the policies that have been used by governments and central banks in the West to support their economies have helped avert a calamity, will they create another and bigger bubble, one that will sooner or later result in a spectacular bust?

Manas Chakravarty is Consulting Editor, Mint