Emerging Economy December 2009 Indicus Analytics

Highlights • 7.9% growth in second quarter powered by govt, lower growth next quarter • Growth in 2009-10 still estimated by us at 6.7%, agriculture well factored in • As expected, exports decline even lower in October, return to low levels of positive growth by March • Inflation hits manufacturing as well as commodities rise on stronger growth • Capital controls on the radar as inflows increase From the beginning of this year, we have been predicting a growth rate for 2009-10 at 6.7%. While most analysts have been revising their estimates upwards throughout this year, we maintain our growth estimate, despite the high 7.9% release by the government for the second quarter. There are two reasons for this – one, as the government itself has pointed out, the impact of the drought this year will make itself felt only in the Q3 estimates, when the kharif output is out, and two, the high growth in the second quarter is largely powered by public administration sector. In fact, if the community services, public administration and defence sector is given half its growth estimate of 12.4% in Q2, in line with previous quarter’s growth, GDP growth comes down to 7%. The government and the Reserve Bank know this, which is why a rate hike before January appears unlikely. Rising inflation is leading to rising tempers in the Parliament, not quite a healthy way to resolve an issue that is hurting so many. Wholesale prices of many essentials are up: milk by 8.27% since March-end, pulses by 25.02% and though the sugar price rise has moderated, it is still expected to rise after March as supplies get tighter globally. So what is the solution here? Market reforms in the supply chains of agricultural produce have been mooted many times but not acted upon enough. Improvements in storage and processing of produce will also go a long way in improving supplies. And there are more linkages being ignored in the inflation story. Take for instance, the change in visa rules for employment of foreigners last month. On the face of it, this has nothing to do with inflation, but this is one example of how the government creates hurdles in the smooth flow of goods and services across the country. The new rules have taken Chinese workers off a road being constructed in Himachal Pradesh. A road bringing better connectivity to the apple belt, which contributes 40% of the state’s apple cultivation and which annually suffers from wastage of Rs. 1200 crore due to poor transportation. The new visa rules in fact are a true symbol of how the government works. One ministry has little to do with the other, the impact of a policy change is not fully understood, and the government effectively just treats the symptom and ignores the underlying cause of the problem. The main reason why foreigners with the same skill sets as Indians are getting jobs here are because efficiency and productivity, much needed by Indian firms, are not a part of ‘skills’ as defined by the government. It is of course easier to just change visa rules, rather than change vocational training education on a large enough scale to account for these deficiencies. But then again, without any structural changes, talking of a 9% growth rate becomes as unsustainable as the previous years. Overall therefore, there will be some tempering of the growth numbers next quarter. Inflationary pressures will continue in the short, medium and long term. Commodities will once again face inflationary pressures and so will real estate. The economy is warming up, and we see every reason for it to heat up in a couple of quarters. The real challenge for macro management will emerge in a couple of quarters.