Economy update

February 2009

A downcast outlook – the new paradigm

Source: Economist Intelligence Unit; *EIU Forecast

2009 will be a year of recession and adjustments

The sheer scale of global wealth destruction and its resulting pressure on banks, companies and households continue to exert downward pressure on economic growth. While no one expected good news in these turbulent times, third quarter economic numbers are daunting, notably in the UK, Germany, Japan and China. This paints a gloomier picture than before. The UK, which earlier had a mild to moderate outlook is now projected to experience a sharp recession. Japan’s economy, which was relatively better off, has worsened and so has Germany’s. Emerging economies have not been spared. Led by China, which is expected to experience the sharpest slowdown since 1990, the outlook for these economies continues to darken.

The medium term outlook at the global level is subdued

With these developments, the medium term outlook at the global level is subdued. The Economist Intelligence Unit (EIU) expects the US – which is now reeling under 16 year high unemployment rates – to contract by 1.6% and the outlook for the Eurozone economy is no better. The economy is expected to contract by 2% in 2009 with unemployment rates in many countries touching double digits. Many hope that government action will help. However, they are still hanging on and making long-term adjustments to cope with the turmoil. This, we believe, will continue for another three quarters.

Source: Economist Intelligence Unit; *Revised Forecast

India too is swaying under pressure

India too is swaying under pressure. The global financial crisis has already put pressure on corporate profits. An analysis of about 2000 listed companies showed that while sales have increased by 13.3% compared to a year ago, operating profit and profit margins fell by 26.4% and 11.6% respectively – the lowest in the last 20 quarters. Industrial production and exports have fallen too. During the last two months of 2008, industrial output fell by 2%, while merchandise exports – despite a weaker rupee – fell by over 10% against the previous year. As a result, growth forecasts have been revised downward.

Debate around the quantum and duration of the recession to continue...

In the weeks ahead, the debate will be centred on the quantum and duration of the recession. Few have already hazarded a guess. The EIU expects the economy to contract by 3% this year, from a 9% growth rate in the previous fiscal and expects adjustments in the economy to last for at least 3 quarters. Similarly the RBI and IMF expect the economy to contract by 2% and 3.9 % and that recovery will only start by the end of the year.

Government to the rescue

*planned fiscal package
**estimate

Prime Minister Manmohan Singh has already announced two fiscal packages in the past two months to shore up investment demand. In the same spirit the RBI slashed interest rates to a record low since October 2008. However, the two packages – estimated to be around 1% of the GDP – remains inadequate. And unlike developed economies, India’s capability to boost the economy through fiscal packages and monetary policies remains limited. For instance the RBI was busy fighting inflation by raising interest rates when the crisis began in September. At that time, the rest of the world was trying to combat a slowdown in their economic growth! To add to this uncertainty is the upcoming general election due to be held in April-May; a factor which many analysts believe could prolong the recession and time needed for adjustments. And with weak domestic demand, low consumer confidence and business uncertainty the impact of expansionary monetary policies too is uncertain.

India economic outlook for the coming months is gloomy...

But still in a better position than most emerging economies

Taking cues from these developments the outlook for the coming months is gloomier that what it was a month ago. However, India will remain relatively better than other emerging economies in East Europe and Emerging Asia. Unlike these economies, which have strong dependence on financial services, India is expected to be relatively better off and the domestic economy is expected to provide a moderate cushion in the medium term. The rest is dependent on government action. But we can expect very little on that front till a new government is sworn in May-June 2009.