India's Economic Growth Falls Below 8%

By Guneet Singh Sahni - India Analyst

India's markets ignore the country's slowest economic growth since 2004.

Article interests NYSE: SAP, NYSE: NYX, NYSE: SAY, NYSE: WIT, (AMEX: DIA, SPY, DOG, SDS, QLD, PUA, NWD, CZJ), (Nasdaq: INFY, QQQQ, ASIA, PRASX, MEAFX, EBASX, EVASX, MACSX, MATFX).

Indian markets remained in volatile territory throughout the week (last week), but ended on a strong note supported by positive global cues, easing inflation numbers and healthy derivatives expiry rollover. WPI Inflation slowed down to 12.42% Y/Y, marking the first weekly decline in five weeks and alleviating fears of another interest rate hike. Below expected inflation numbers, along with strong US growth data, led the markets to ignore the slowest economic growth since 2004, at 7.9% Y/Y for 1QFY09, against the market expectation of 8%.

The BSE Sensex ended last week with a modest weekly gain of 1.1%, or 163 points, to close at 14,564.53. Interest rate sensitive stocks led by financial sector and IT stocks were the major gainers for the week. While the financial sector surged on the belief that the RBI would not increase rates, the rupee weakened against the dollar. It made an intraday low of INR 44 during the week, driving an IT sector surge. The week finally witnessed the launch of currency derivatives by the Indian Finance Minister P. Chidambaram, fulfilling India's commitment toward becoming a more transparent and dynamic financial markets hub.

Growth Slows Below 8%

India's first fiscal quarter (April-June) GDP growth slowed down to 7.9% Y/Y, versus 8.8% Y/Y in the fourth quarter of fiscal 08 and 9.2% in the year ago period. India now runs the risk of losing its status as the second fastest growth economy to Russia. The slowdown in growth is a clear outcome of 1) Tightening monetary conditions 2) Declining demand and 3) Soaring commodity prices.

GDP Continues to Slow Down

A downturn in the manufacturing sector (sub sector of Industry) slowed down the Indian economy, as it dropped to 5.6% growth, from 10.9% last year. Services sector growth slowed to 10% Y/Y, from 11% last year, on the back of higher interest rates and oil costs. On the other hand, industrial growth continued with its lacklustre performance, as it offered growth of 6.9% Y/Y (against 9.1% Y/Y last year). The last component of GDP, Agricultural growth, came along at an expected 3% Y/Y rate, as compared to 4.4% Y/Y in the year ago period.

Fiscal Stimulus to Support Growth

GDP fell below the 8% mark for the first time in the last 9 quarters. The most worrying factor within the growth data, apart from the slowdown expected in the Industrial Sector, is indication of an imminent slowdown in the Services Sector. However, we believe that the fiscal stimulus injected by the government: 1) Salary hike for 5 million government employees (by 21% in the sixth pay commission); 2) Farm debt waiver of more than $17 billion; 3) and tax breaks via the increase of threshold taxable limits, will help partially offset the tightening monetary conditions and provide for a weak recovery in services.

The industry will likely continue to underperform, as the construction sector faces the brunt of high input costs, burgeoning interest rates and the risk of executing upon a large order book. Finally, Agriculture is expected to fare well, after a revival in monsoons.

Fiscal stimulus makes the economy more vulnerable, by widening deficits. One of the major risks for the Indian markets is its deteriorating Marco factors, which is evident from 16-year high inflation and widening fiscal deficits. While the government seems inclined towards containing fiscal deficit at a targeted level of 2.5%, rising off-balance sheet items on account of fiscal stimulus remain a cause of concern. We believe that if the deficit increases past the government target of 2.5%, tightening pressure will increase on monetary policy. This could result in a down spiralling effect, with earnings downgrade leading to general domestic slowdown. India faces strong risk of capital expenditure cuts by the corporate sector, as high interest rates would hold back their plans for expansion.

Inflation declines for the first time in five months

On a week-to-week basis, WPI inflation declined for the first time in five months, to 12.42% Y/Y for the week ended August 16th; this came against the consensus estimates of 12.78%. Headline inflation had earlier touched a 16-year high of 12.63%. The decline is primarily on account of a drop in the fuel price index, as a result of sliding oil prices. Inflation inched up for manufactured products and remained unchanged for primary products on a weekly basis. Inflation found contribution from a 16.76% rise in the fuel price index; 11.63% surge in manufactured products; and 11.02% jump in manufactured products.

Be prepared to face challenges from domestic factors

RBI Governor V.Y. Reddy, in his Annual Policy Review Statement, clearly mentioned that inflation is going to be the topmost priority for the central bank, and he said that India now faces strong domestic challenges. His quote goes as follows -
"Bringing down inflation from the current high levels and stabilising inflation expectations assume the highest priority in the stance of monetary policy....Looking forward, the global and more importantly, the domestic factors pose severe challenges to monetary management and warrant reinforced policy actions on all fronts."

Don't see inflation peaking out

The latest weekly decline in inflation cannot be seen as a sign of inflation peaking out as – 1) The base effect in the coming weeks will lead to a high inflation figure 2) The easing of food prices on the back of favorable weather should lead to lower inflation only in the second half 3) The depreciating rupee should make imports more costly and 4) Oil prices still remain a threat, even though crude has shown signs of cooling off.

Depreciating rupee favours Indian IT sector

The Indian rupee weakened against the dollar, hitting a 17-month intraday low of INR 44.26 on Tuesday, before closing at INR 43.93 on Friday. Importers bought dollars to cover their month end imports bill, and fears of foreign investors selling shares led to a decline in the rupee to fall below RBI's comfort level. Consequently, the BSE IT Index surged by 3.4% for the week, as the IT sector tends to gain from a depreciating rupee. Satyam (NYSE: SAY) gained 8.6% for the week, followed by Wipro (NYSE: WIT) and Infosys (NASDAQ: INFY), which gained 3.5% and 3.2% respectively. Infosys announced the biggest overseas acquisition in the Indian IT industry by placing an all cash deal for the UK-based SAP consultancy (NYSE: SAP), Axon Group plc (LON: AXO) for $753mn. The acquisition is expected to be moderately accretive for Infosys, and expected to go through smoothly unless a counter offer emerges.

Rollovers see best of times in recent months

August month's derivatives expiry witnessed a healthy rollover of 84%, as against 79% rollover last month and an 81% 3-month average. The expiration date for derivatives in the Indian market falls on the last Thursday of every month. Even the National Stock Exchange (NSE) benchmark index Nifty witnessed a rollover of 75%, as against 65% the previous month and 68.5% six month average.

India continues a proxy play for oil prices

Indian markets would have been expected to open on a weak note following the weakness in US markets on Friday. If oil surges as a result of damaged oil rigs from hurricane activity, Indian markets would likely witness a sharp down slide. Crude prices and Indian equity markets have shown a strong inverse relationship this year. Therefore, if crude remains at current levels or declines from here, we could expect a strengthening dollar and positive result for IT companies. One note, a nuclear supplier group will meet on 4-5 September to consider a waiver for India.

Please see our disclosure at www.WallStreetGreek.blogspot.com and Guneet's disclosure on his bio page at the site.