India: Interconnectedness of Issues Makes Scenario Planning Critical

Growth is likely to bottom out as a few positive trends are emerging that are likely to create near-term gains

  • Cost of Borrowing: Reserve Bank of India, India’s central bank, cut the key lending rate, bringing down the total cost of borrowing by 75 basis points during 2013, in order to promote growth in investments and consumption
  • Price of Goods: India’s stubborn inflation has also fallen to a 41-month low of 4.89%, into the central bank’s comfort zone of 4–5%, as food and fuel prices have fallen significantly over the past few months
  • General Demand: Industrial production growth has also exceeded market expectation, growing at 2.5% during March. It benefited from the positive expansion in manufacturing output and capital goods production, highlighting slow but sustained demand
  • Rural Demand: Private-consumption demand from more than half of India’s total workforce from the agriculture sector is set to increase, because meteorologists expect normal monsoon rains this year after parts of the country suffered from drought last year

However, interconnectedness of issues makes scenario planning critical in the medium to short run in India

A bullish view on India’s long-term potential is justified, but it should not overshadow the need for careful planning in the short-to-medium term as several fundamental issues remain unresolved and in a precarious situation. The causes of some of India’s critical pain points are factors beyond the control of most MNCs can impact their businesses (see diagram below):

Cause and effect diagram for India

 

Global price impact: Fragile current account deficit can benefit from global decline in commodity prices

(a) What is the status of the current account deficit (CAD)?

  • India’s current account deficit has grown more than five times (in USD) over the past six years, driven by the country’s insatiable demand for oil and gold imports. The overall CAD is estimated to be at around 5% of GDP, which is twice the sustainable level

(b) Why is this important?

  • The trade imbalance, caused by subdued exports demand, and terrific import growth has led to a high CAD, which in turn has caused a major devaluation of the rupee
  • Such volatility affects a MNC’s ability to import goods in a price-sensitive market, hurts the bottom line when repatriating income, and increases the USD import bill for the country

CAD v USD/INR

 

(c) What is likely to change moving forward?

  • The global prices of gold and oil have decreased this year, directly reducing pressure on the CAD. Moreover, the government has introduced a US$ 550 million stimulus package to incentivize export growth while increasing the import duty on gold
  • The government also slashed the tax rate levied on the interest that foreign investors earn on their investments in local bonds from 20% to 5%, encouraging more capital inflows in the debt markets

Companies’ short-term (12 month) scenario analysis should incorporate these key trigger points:

Key movements diagram

 

 

 

Tagged on: ,

Leave a Reply

Your email address will not be published. Required fields are marked *