1. India is still dependent on the IT sector. This sector has been affected by the global slowdown, but things are not panicky. The “cautious” IT sector has affected the trickle down effect. Unfortunately, no other sector in the Indian economy can counter balance the IT sector for its revenue generating strength.
2. Manufacturing has to grow- especially export linked manufacturing. It is a good sign that foreign investments in manufacturing have been strong and continue to be so.
3. Salary increases of the last 5 years are the buffer for the population against inflation. The blue collar worker will see this disappearing fastest (6-12 months). Unless the economy changes by mid 2009, we will see serious social tensions.
4. Critically, slowdown could become a self fulfilling prophecy in India. We need to be optimistic at this time. Remember that for the per capita GDP of India to catch up to western European standards requires at least 30 years of 9% GDP growth. So lets focus on that and continue to find new opportunities of growing...instead of realigning our growth to western expectations from India's GDP in 2008.
I write this note to help me think through inflation and recession in the Indian context today. It’s a broad brush approach, but the story seems coherent to me and so I go with it.
I have integrated inflation/ exchange rate weakness (the Rupee has weakened in the past few months), the weakness in the US economy (which I hold as the driver of all weakness and strength in the "Western" economies) and the commodities boom (which
need not always be accounted for in the Consumer Price Index inflation numbers.)
I have looked at the impact of the above parameters on the IT sector/ Manufacturing/ Financial sectors/ Agriculture/ retailing and "other services"
I present here my qualitative assessments. These are simply "gut feel"…based on my understanding of the dynamics of various industries.
Comments:
The IT industry over the past few years has expanded significantly into Western Europe. SO while its exposure to the US is still strong, to an extant these are mitigated by the type of contracts with the US (long term, fixed annuity type) as well as emerging exposure to Europe. European economies at this stage (financial sector) seem better positioned than the US financial sector. In addition, since European companies have only just started their "outsourcing" initiatives, there are sufficient low hanging fruits to be gained.
Indian inflation impacts the industry, although earnings are largely export based. Inflation however reduces the buying power of the currency and in that context, impacts the resources allocated to IT purchases both in India and abroad. The exchange rate does have a strong role to play and the recent weakness of the Rupee has been well received.
Again, the commodities boom also does not impact the industry significantly. The US economy however has a very strong impact (although as mentioned before, mitigated by emerging European business).
Manufacturing for the domestic market is very sensitive to inflation and commodity prices. This will see a slowdown in the current economic environment. However export focused manufacturing is completely different and is discussed in the next section.
Services: in a high inflation environment, services are likely to see a slowdown. India's contribution to the global service environment (except IT) is negligible. Healthcare services to foreigners may benefit in a weak exchange rate environment but are adversely affected when the global economy itself is sluggish. Indian consumers will also postpone any not critical expenditures.
Agriculture: If the monsoons are consistent, this sector should perform to a 3-4% growth. Input prices such as fertilizer costs however need to be controlled. Global agriculture produce markets being rightly controlled and subsidized means this sector is usually not impacted by booms and busts in the global economy.
So what's the problem?
The problem I see stems as follows.
1. The IT industry is being cautious. Not panicky. Cautious. This is not a bad thing in itself. But today, this sector is the value creator and distributor in the Indian economy. No other sector takes college graduates from cycles to motor cycles as quickly as the IT sector. When they slow down hiring, we're effectively getting less demand for clothes, machines, white goods (these grads need to set up their apartments).....the whole trickle down effect is reduced.
2. As mentioned, domestic manufacturing is affected. But the bright side is manufacturing for the export market. This continues to boom. Here India has two big advantages that continue to attract FDI in manufacturing.
1. Low cost labour.
2. Well educated engineers that can provide a base for R and D.
In tight global economic conditions, these strengths will be amplified and manufacturing for the export market should continue to boom . Companies will continue to see more benefits in establishing themselves in low cost countries. This is the best bet against rising commodity and raw material prices. Particularly fuel costs.
I see the world moving more to smaller, more efficient cars. India is well on its way to be the global hub for small cars. The govt is motivated to make this happen. In the next 5 years, this "export" oriented manufacturing will become a counter balance to the IT sector.
Going beyond cars, India has the opportunity to extend its manufacturing and design strengths to white goods, low cost furnishing , aeroplanes, ships. Indian design frugality can apply to a wide range of industries.
The FDI investment in 2008 has not slowed, tell us all the major banks. There is a rather large silver lining to the current economic environment of grey clouds. No country has developed itself without a strong manufacturing set up at some point in its history. India needs the same, more so given its large population of less educated persons. Now is the time to be optimistic and take initiatives.
In my view, the economy should start to panic when Infosys, TCS and Wipro start to lay off employees. This has not yet happened. These three represent for India what the performance of GE and Walmart mean for the US. Sure, they are delaying hiring, but as long as mass lay offs are not yet in the news, I have confidence. Again, this will ring true for the next 5-10 years, till our export manufacturing competence develops.
3. Finally then to inflation. 12% is a very high rate. Yet, I don’t see around me panic. Apart from the political parties organising rallies and protests, I don’t see a spontaneous expression of anguish from the public. (perhaps the anguish is being saved for the elections). Why? Here is my understanding. I believe that he top 10% of the Indian economy working in high end jobs has seen its salary grow so quickly in the past 5 years that they are immune to 10% inflation. Salaries in this segment have increased between 3-5 times in the past 5 years. So there is a buffer against inflation.
Then, lets look at the families that are dependent on agriculture (the rural poor). If I look at the Consumer Price Index basket (listed below), it consists of veggies, fruits, milk, eggs, cereals, pulses, house rent, electricity etc. The farmer's family usually does not pay for these items. It generates them within the household. And India's intensive agriculture sells into the market only the surplus after domestic requirements are taken care off. In a cynical way, I say that this segment is inflation resistant. What will affect them is now their inability to buy next order goods such as TVs and refrigerators. This is an element that appears in the lower rate of manufacturing growth this year.
But it’s the segment of population between these two extremes that I believe is at highest risk. The blue collar worker. One who has seen his salary increase but not as much. One for whom the buffer against inflation is the lowest. Indeed I would add that recent growth in manufacturing and retail has shifted a lot of labour from manual sectors to the organised sector. People dependent on agriculture growing at 3-4% have moved to the manufacturing sector growing at 9-10%, reaping the accompanying benefits. However their benefits have been less than those at the top end (knowledge workers).
In conclusion the summary of this story that I would like to leave behind is the following:
1. India is still dependent on the IT sector. This sector has been affected by the global slowdown, but things are not panicky. The “cautious” IT sector has affected the trickle down effect. Unfortunately, no other sector in the Indian economy can counter balance the IT sector for its revenue generating strength.
2. Manufacturing has to grow- especially export linked manufacturing. It is a good sign that foreign investments in manufacturing have been strong and continue to be so.
3. Salary increases of the last 5 years are the buffer for the population against inflation. The blue collar worker will see this disappearing fastest (6-12 months). Unless the economy changes by mid 2009, we will see serious social tensions.
4. Critically, slowdown could become a self fulfilling prophecy in India. We need to be optimistic at this time. Remember that for the per capita GDP of India to catch up to western European standards requires at least 30 years of 9% GDP growth. So lets focus on that and continue to find new opportunities of growing...instead of realigning our growth to western expectations from India's GDP in 2008.
Comments and feedback welcome.
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NOTE: CPI Index: The total expenditure on consumption of goods and services was divided into the following groups/sub-groups:
I- Food :
(a). Cereals & Products (d).Meat, Fish & Eggs
(b).Pulses & Products (e).Milk & Milk Products
(c).Oils & Fats (f).Condiments & Spices
(g).Vegetables & Fruits (h).Other Food
II-Pan, Supari, Tobacco & Intoxicants;
III-Fuel & Light :
IV-Housing;
V-Clothing, Bedding & Footwear, and
VI-Miscellaneous :
(a).Medical Care & Effects
(b).Education, Recreation & Amusement
(c).Transport & Communication
(d).Personal Care & Effects
(e).Others
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