Part 1 News: Growing Too Slow

As Growth Stutters, India Woos Foreign Investment

Regional News

Acute stress in India’s economy, exacerbated by Europe’s financial woes, is prompting the government to restart a long-stalled and politically controversial reform agenda aimed at reviving growth and attracting foreign investment.

The latest evidence of India’s woes came Wednesday when the government reported economic output in the June-September quarter was up just 6.9% from a year earlier, the slowest pace in two years. Weakness struck the country’s biggest growth engines, with expansion in manufacturing, construction and agriculture all in the low single digits.

Just a year ago, India was an investor darling, accustomed to near double-digit gross domestic product growth and talk of rivalry with China to be the fastest-growing big economy in the world. Today, the country of 1.2 billion people is watching its 20-year economic boom fall victim to a toxic mix of swelling government debt, stubborn inflation, infrastructure bottlenecks and a lack of foreign investors. The Reserve Bank of India’s campaign of 13 interest-rate increases since March 2010 has choked off borrowing and slowed growth, but done little to subdue its target, inflation. The latest GDP numbers may give the central bank leeway to pause on rate increases, analysts say.

In a sign of India’s precarious position, its currency has lost more than 15% of its value against the dollar since August, making it the worst-performing currency in Asia. And many economists forecast that economic growth next year will drop to around 6%—strong by global standards but well below India’s potential and slow enough to harm its banking system as well as its efforts to relieve poverty, the government’s often-stated top priority.

“All these macroeconomic vulnerabilities have come back to haunt us,” says Samiran Chakraborty, head of India research for Standard Chartered. He says India’s biggest risk in 2012 is that the economy slows further, while inflation persists—the classic stagflation scenario.

India’s central government has acted in recent weeks to implement reforms aimed at preventing a crisis. Recent moves include lifting quotas on foreign ownership of Indian bonds and efforts to allow foreign pension managers into India for the first time.

Most notably, the cabinet approved loosening rules on foreign investment in the retail sector, a move that would allow Wal-Mart Stores Inc. and other international supermarket and department store chains to own 51% of an Indian joint venture; previously they were barred from retail joint ventures.

However, the retail move sparked ardent protests from opposition political parties as well as some government allies, who fear the impact it would have on India’s millions of mom-and-pop traders. The winter session of Parliament, which began last week, has been dominated—and scuttled—by the opposition over the issue.

Even thought the move doesn’t require parliamentary approval, there were signs the government was looking for a compromise that would let Parliament resume, possibly by putting the retail measure to a vote.

These actions will take years to have an impact on India’s economic health and many more reforms are needed, say analysts.

These include changes in land-ownership rules, food security and taxation. New electricity generation, food distribution and road-building projects have fallen well short of government targets.

Unlike other Asian emerging economies, India runs a current-account deficit and needs capital from abroad to keep its financial system afloat. As the euro-zone crisis intensified this year, global investors and lenders withdrew money from emerging markets, and India has been among the most affected with its currency tumbling.

“This is a tsunami for us,” Ved Dewan, director of Dewan Steel Industries based in Mandi Gobindgarh in Punjab state. Until mid-November he had been placing the usual amount of orders abroad for scrap metal, figuring that by the time he had to pay for the shipments, the rupee would have stabilized.

Instead, the rupee plunged to its lowest level ever against the dollar recently. Mr. Dewan cut back import orders by two-thirds, saying he can’t pass on the higher costs to buyers.

While India has made strides increasing exports in recent years, selling goods abroad remains a modest part of its economy. That means unlike more export-oriented countries, India doesn’t benefit as much from the flip side of a weaker currency, making its goods cheaper in the global marketplace.

The falling rupee is creating a mess for India’s policy makers by sending prices higher domestically for imported goods such as oil and food, swelling inflation that’s already at dangerous levels of nearly 10% a year, based on wholesale prices.

That high inflation has kept the central bank on a path of lifting interest rates, despite consumer spending and business investment levels that point to a significant slowdown and would normally mean rate cuts.

“We have to think about whether we want to keep investing in this environment or whether it will slow us down,” says Sumant Sinha, chief executive of ReNew Wind Power, a Mumbai-based wind and solar generation company launched in April which has a $200 million equity investment from Goldman Sachs. “Maybe this is a temporary blip for two or three years,” he says.

State-run companies still represent a significant portion of Indian industry. As the economy deteriorates, New Delhi will be expected—if it can afford it—to increase spending further to support struggling enterprises, including banks, airlines and energy companies.

With the cost of imported oil rising because of the rupee, the government also has announced new expenditures on subsidies to alleviate the pain of rising prices. The expected increased need for government borrowing has driven up financing costs.

But a further deterioration of the government’s fiscal position could lead to a ratings downgrade that would ripple through the economy, according to Mr. Chakraborty at Standard Chartered.

India is currently rated just above investment grade by Moody’s and Standard & Poor’s, so a single downgrade would send it into “junk” status, making bonds untouchable for a certain class of risk-averse investors. Moody’s cut its outlook to negative on India’s state-dominated banking system this month.

“India’s fiscal situation is reaching grave proportions,” says Sanjay Mathur, economist for Royal Bank of Scotland.

Some private Indian companies borrowed aggressively in dollars in 2006 and 2007, when the Indian economy was healthy and expectations were for the rupee to strengthen. Many of those lending arrangements had five-year terms and are set to be repaid in the coming year and the weak rupee is now making life difficult.

Zenith Infotech Ltd., a Mumbai-based software-services firm that recently sold a part of its business to U.S. private-equity firm Summit Partners, defaulted on $33 million of foreign-currency convertible debt due in late September.

The company was “in negotiations with the bondholders to extend the time for repayment,” Zenith said in a statement to the National Stock Exchange in India in October. A company spokeswoman declined to comment.

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By: Alex Frangos and Shefali Anand
Source: The Wall Street Journal, November 30, 2011
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