India: Economy well placed for revival in foreign investment by 2010

Saturday, October 04, 2008 | Posted by: Grant Thornton
Categories: | Tags: India, investment, economy, global, India Watch, South Asia Group, Alex Wright

Although India does not have direct exposure to the financial vehicles that caused the credit crunch, Duvvuri Subbarao, India’s new Central Bank Governor, warned that India and other large emerging economies would not be able to avoid the fallout from the crisis.

The global economy has suffered an unprecedented downturn in recent months as the fallout of the credit crunch has taken even the most robust Western economies victim.

Against a backdrop of chaotic European and US financial markets, this October has seen the nationalisation of some of the UK’s largest high street banks, the collapse of numerous financial institutions and huge losses on investments.

In the face of these global problems, India’s government, like many others, is facing serious concerns about how they will handle the crisis. Although India does not have direct exposure to the financial vehicles that caused the credit crunch, Duvvuri Subbarao, India’s new Central Bank Governor, warned at a meeting of the International Monetary Fund in Washington earlier this month, that India and other large emerging economies would not be able to avoid the fallout from the crisis.

Evidence of this has already been seen with the Bombay Stock Exchange’s benchmark Sensex index falling more than 15% in the first week of October, taking it below 11,000 points for the first time in over two years. Further falls in the index were seen as India’s rupee fell against the dollar, a self-perpetuating problem which was worsened as investors retreated in search of lower risk currencies, bringing the rupee to its lowest level in nearly six years.

In an attempt to encourage and maintain investment, India relaxed its foreign investment restrictions, which it had only introduced last year, allowing for greater cross-border investments in Indian shares. Despite these actions, data from the Economic Intelligence Unit forecasts a decline in Foreign Direct Investment (FDI) in 2009, but, on a more positive note, predicts that FDI will rise to record levels in 2010.

Following months of soaring Indian inflation rates, the Reserve Bank took action, increasing its interest rate three times during June and July, finally reaching a 7-year high of 9%. As a result, inflation eased to just under 12%, its lowest level in 13 weeks. The Reserve Bank of India also raised bank’s reserves requirements to cut demand and cool prices. The general consensus among economists seems to be that inflation will nevertheless remain in double digits for some months, as flooding in certain areas of India has led to a lower crop output, heightened by increased demand during festival season, which is likely to push food prices up.

Following the high levels of inflation and interest rates in the first half of the year, the Economic Intelligence Unit (EIU) now estimates that India’s wholesale price inflation will average 10.1% in 2008 with a fall to 7.3% in 2009. Another report from the EIU states that with higher borrowing and input costs and slower external demand growth, India’s economic prospects will be effected, with real GDP growth forecast to slow from 9% in 2007/08 to 7.3% in 2008/09. Albeit a decline, this still remains hugely attractive in comparison to the negative or pedestrian growth in the western world.

Although the economy has suffered considerably over the last few months and the growing budget deficit remains an issue, there are strong signs of continued growth and stability throughout India. The Sensex index increased 8% on the back of India’s Finance Minister, P Chidambaram, announcing that measures will soon be put in place which will help boost the confidence of investors.

Further signs of stability in India’s economy were clear to see earlier this month as Tata Consultancy Services, India’s largest outsourcing firm, confirmed their purchase of Citigroup’s Indian business processing outsourcing unit for US$505 million. This half billion dollar purchase emphasises the current potential for greater M&A activity as companies’ valuations fall during the financial downturn. Cash-rich companies, many of which are based in South Asia, are beginning to position themselves in a way to make the most out of this global realignment. It is also important to remind ourselves that the fundamental attractions of India such as a young growing middle class and relatively low levels of personal and corporate debt remain unchanged.

India has not escaped the financial turmoil which the rest of the world is currently facing, and will undoubtedly continue to be affected until the global economy stabilises. Despite the measures which have been put in place in India to manage the effects of the downturn and to maintain liquidity in the financial markets, India, like the rest of the world, will ultimately have to wait for the restoration of investor confidence before a return to growth can be expected. It cannot be predicted when this restoration will begin, but India, with its significant growth potential and cash-rich companies, should be well placed for a recovery when it does.

Alex Wright
Executive, South Asia Group Capital Markets
For Grant Thornton UK LLP