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Cracks in the concrete

Sanjiv Shankaran | Print Edition: October 2, 2011

Indian capital markets went into the last weekend of August fearing the worst. The Bombay Stock Exchange's benchmark index, Sensex, touched an 18-month low of 15,848 on Friday, August 26, ahead of the announcement of gross domestic product, or GDP , numbers for the April/June quarter on August 30. But the data proved to be better than expected, thereby buoying the markets, lifting the Sensex by a whopping 828 points in two trading sessions. The economy in the first quarter of 2011/12 had grown 7.7 per cent over the corresponding period in the previous year.

But the excitement on the bourses did not find any echo elsewhere. The reason: sifting through the data showed the headline number could be misleading, and the country may well see earlier growth forecasts for 2011/12 being marked down, given the negative portents both at home and abroad.

Among GDP components, the data showed growth in construction activity had dropped precipitously. Construction activity in the first quarter of 2011/12 grew 1.2 per cent, noticeably lower than the range of 7.7 per cent to 9.7 per cent growth in the four quarters of 2010/11.

Pronab Sen, Senior Adviser in the Planning Commission, who was earlier chief of India's statistics apparatus, says the pace of infrastructure activity in the country first shows up in the growth rate of construction activity. The term construction activity in GDP data encompasses all types of construction and is derived primarily from the performance of cement and steel factories. If the pace of infrastructure activity has begun to ebb, "construction is where it will show up initially," says Sen.

N.R. Bhanumurthy, professor at the National Institute of Public Finance and Policy, who publishes macroeconomic forecasts, also says investment is declining. "Construction is a leading indicator of overall investment activity and also that of employment," he says.

Analysts abroad, though, seem more upbeat about India's economic prospects. Economist Intelligence Unit, or EIU, has forecast India will grow 7.9 per cent in 2011/12, but by next year the trajectory will trend upward again. It even says India's growth will outpace that of China's in 2013 and 2014. "Overall, I don't see big negatives," says Singaporebased Manoj Vohra, Head of Research, South/Southeast Asia & Australasia at EIU. "For now, we are not panicky on India."

Many analysts tracking India's macroeconomic data have begun to supplement macro data with feedback from the ground to get a sense of the economy. The volatility in official macro data and frequent revisions have led even the Reserve Bank of India, or RBI, to openly crib about quality of data. Indicators from the ground are not optimistic: they suggest the economy may be shifting to a lower gear quicker than most analysts and the government expect. For now, the finance ministry has forecast 8.6 per cent growth in 2011/12 and RBI eight per cent, both of which are higher than most private sector forecasts.

In August, HSBC Markit's purchasing managers' index, or PMI, for the manufacturing sector in India was 52.6, the lowest since April 2009. Even the PMI for the services sector fell to 53.8 from 58.2 in July. "On the ground, the capital expenditure cycle has slowed significantly," says Munish Dayal, Partner at Baring Private Equity Partners (India). "Infrastructure projects have issues and you have large components of the economy that look like they are under some stress."

The stress has been largely created by 11 policy rate increases of RBI since March 2010, which has taken the repo rate, the rate at which banks borrow from RBI, from five per cent to eight per cent. The rate increases are the primary tool used by RBI to beat down inflation, which averaged 9.65 per cent in 2010/11 and remains above nine per cent. RBI's current assessment is that the threshold level of inflation in India is four to six per cent.

Beyond this level, medium-term economic growth is undermined. The country may not have seen the last of the rate hikes.

The combination of domestic factors, and the dent in confidence being transmitted through companies with an exposure to developed markets, has business jittery about committing to long-term investments. "Anybody looking to raise capital for long-dated investments will want to postpone it," says Raj Majumder, Founder & CEO, Auroch Investment Managers.

Majumder is keeping a close eye on Europe, a region he knows well thanks to a stint there with Goldman Sachs. "Anybody with exposure to the Organisation for Economic Cooperation and Development, or OECD, has become bearish," he says. The Paris-headquartered OECD has 34-member nations, most of which are European.

In the backdrop of negative portents, September will provide important economic cues for the economy, including RBI's mid-quarter policy announcement, and signs from the US Federal Reserve and Europe's politicians on what the future holds.

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