India: An Economic Prediction

This is probably the first blog where I am making an economic prediction. Let me start by saying I am not a financial expert. Many (including me) will say that there are thousands of people far more qualified than me when it comes to predicting India’s GDP and stock market growth. And all of them will be right. I am only an amateur economist. I do not have a PhD, and I do not have the expertise to run complicated mathematical models of economic data. Nevertheless, I will persevere in making my own predictions, because as everyone knows, economics is the “dismal science”, and my guess is as good as anybody else’s.

So here goes. India’s GDP grew at a very healthy 7.9% last quarter, on the back of 6.1% for the quarter before that. We are talking real (inflation-adjusted) growth here, not nominal growth. Therefore, India’s real GDP growth for the six months of this financial year stands at 7%. Considering the GDP growth rates in the rest of the world at the moment, 7% is very healthy indeed. In addition, India’s stock markets have risen over 80% in this calendar year alone.

The key question is: will this GDP and stock market growth continue over the next six months?

Some pundits are now saying that the recession is over as far as India is concerned, and the time has come again for celebration. Let the good times roll! I suggest caution, for the reasons outlined below.

First, let us look at the stock markets. In business school, one is taught to look at “fundamental value” of any stock before buying it. Is the Indian stock market currently overvalued, undervalued or correctly valued? I would say that it is overvalued at the moment. It is not domestic investors who are flooding the Indian stock markets with money, but American fund houses and investors. Why American investors? Because the rate of borrowing in the US is ridiculously low right now, thanks to the recession.

Imagine if you could borrow money at 2% and get a return of 20% on that money. You would make a killing. That is precisely what is happening right now. Interest rates in the US are at artificially low levels right now, and these low rates are not sustainable. Sometime in the next six months, US interest rates will rise, as the economy comes out of a painful recession. The US Fed will then start concentrating on controlling inflation, and they will do this by raising interest rates. Also, investors (especially the Chinese) are beginning to get nervous about the returns they are getting on their US investments (Treasury bonds). The Chinese want higher returns on the US $ 1 trillion they have invested in US Treasury bonds. If they don’t get it, they may pull out some of their money and invest it elsewhere. So sooner rather than later, the US Federal Reserve is going to hike interest rates.
When that happens, the plug will be pulled on the Indian stock markets, as the easy money dries up. So, Indian stock prices will fall. I predict that this will happen in the first quarter of 2010.

Second, let us look at India’s GDP growth. Most of the stimulus in the Indian economy today is being created by the government through its borrowing and demand creation schemes. The largest of these is the implementation of the Sixth Pay Commission which has put billions of dollars into the pockets of India’s millions of under-performing government bureaucrats. This has stimulated consumer demand which in turn, has increased demand for goods and services, which has contributed to 7.9% GDP growth in the last quarter. Is this sustainable for much longer?

The answer is no. Unless the Indian private sector now steps in and starts borrowing and expanding capacity rapidly, GDP growth will stall. The private sector expanded capacity rapidly between 2004 and 2008, and they feel that at the moment, there is a surplus capacity of goods and services in the system. Unless the private sector starts investing, job and money creation will not happen and domestic demand and GDP will not grow.

When do I expect this (increased private sector investment) to happen? Not before the last quarter of 2010. By then, the recession should have played itself out and they should feel confident enough.

The last and probably most important factor influencing India’s GDP growth is inflation. The government proudly trumpets the fact that Wholesale Price Inflation is below 2%. This claim is ludicrous. Food inflation in India currently stands at 18%, thanks to a poor monsoon and harvest last year. In a country where spending on food is the highest part of the household budget (for at least 50% of the population), this is alarming.

There is no reason to assume that food inflation will come down in the near future. There is much the government can do to alleviate it in terms of optimizing the food supply chain “from farm to fork”, but so far, we have only heard lots of talk on this front, and no action.


In addition, as the world economy recovers the price of petroleum will start increasing again. Combine increasing petroleum prices with already rampant food inflation, and you have all the ingredients for high inflation levels for the first half of 2010. High inflation means lower savings and lower real GDP growth.
There is much the Indian government can do to improve the situation; such as rapid disinvestment of Public Sector Units (PSUs), increased spending on infrastructure, improving the food supply chain to reduce waste and lower costs, etc. But the government’s record on making and rapidly implementing firm policy decisions is poor, and unlikely to improve anytime soon.

So what is my final prediction?

The stock markets will come down by 15% to 20% in the first half of 2010. Real (Consumer Price) inflation will go up to between 8% and 10%. Real GDP growth will come down for the first half of the year – to about 5% to 5.5%.

We will see light at the end of the tunnel during the second half of 2010, when borrowing by the private sector will start increasing (even though it will be at higher interest rates). This will spur capacity expansion and job creation and a rise in the stock markets and GDP growth. If we have a good monsoon in 2010, we should end with GDP growth of about 7 to 7.5% for the year ending March 31, 2011, on the back of a strong economic performance in the second half of that fiscal year.

Of course, all of what I have just said could be completely inaccurate and things may in fact, turn out just the opposite. But this is my prediction! Your comments (including any mistakes I may have made in my assumptions in this blog) are welcome.