INDIAN ECONOMY CRASHES!!!

Soon after I went out and bought two huge bars of chocolate to avoid depression due to global developments, the bad news from the real, as opposed to the monetary, sector hit my screen. August IIP at 1.3%. Just a month ago, we were bragging about our robust macroeconomic fundamentals, our $700 billion worth of investments in the pipeline and our strong corporate performances. Export figures were still growing, FDI was flowing in at over $10 billion in the first quarter, and tax revenues continued to be higher than expectations. So what happened suddenly?



In August, the world economy had not yet collapsed, investment banks were still around, and there was no sign of a $700 billion bailout requirement. Moreover, the Indian holiday season, synonymous with the Indian buying spree, was just round the corner. And yet manufacturing growth fell (we will not even go into the electricity sector and the mining sector, in which nothing much is going to happen until there is some sign of government action). The CSO happily says that as many as seven out of seventeen industries showed positive growth - this just means that ten industries declined.



Obviously, companies, and more importantly, those legions of self-employed persons in the SME and unorganised sectors, were not taken in by declarations of macroeconomic soundness. These people knew better than the rest of us seat-of-the-pants economists and investors that there was a major convulsion just down the road. They knew that the high interest rates would continue to impact demand, and they knew that the best option was to hunker down, stop borrowing, and keep their fingers crossed. And this was well before the credit markets shrivelled up and died.



The good news is that all commodity prices are down by huge percentages unimaginable just a short summer earlier, when oil prices were predicted to hit $200 per barrel. Strangely, RBI has allowed the rupee to plunge drastically, thereby reversing all price gains. Inflation therefore persists at the 12% level. With some $282 billion in foreign exchange in hand, why is the rupee sliding to its lowest levels ever? All these years, we have been proudly touting the ballooning FX reserves as our insurance against current account deficits. Last year, RBI sent the rupee to dizzying heights, drawing the ire of exporters.



While the CRR reduction was essential (although Indian banks so far have been insisting that they are well-capitalised and have enough liquidity), the far greater need is to slash interest rates by 200 basis points, control the runaway rupee downfall, and make enough liquidity available. After a long time, RBI is taking the cue from what other central banks are doing, but it may be too late.

At least FM has made himself visible after a prolonged absence. Although he may look slightly ridiculous talking about sound macroeconomic fundamentals, his presence reassures us that the government is on the job. The economic valleys of India will neither be so deep, nor its extent as long, as the recession in other parts of the world. This year should be the trough, but recovery can be ours from next year onwards, provided interest rates are cut enough to revive the economy. The government so far has desisted from strong policy action on any front, and that is all that is required of it going forward.

For the rest of the world, though, the prognosis is not quite as healthy. All of us seat-of-the-pants economists and investors with fancy models have a simple option - go out and buy more chocolate.