Since most of us believe in today's "feel good" state, it is important that we make an assumption before laying out a contrararian view.
The assumption we would like to make here is that there is no "feel good" factor prevalent in the country. In such a situation, this is how one would go about evaluating the economy's health. Below we take a look at five factors that are important from the point of view of judging an economy's health.
1. Non-food bank credit
Let's take a look at the growth, which at over 15 per cent, y-o-y, looks good.
According to the Reserve Bank of India, the decline in bank credit is mainly due to the fact that industries are preferring internal resources (which are rising due to increased profits) and external commercial borrowings to meet their financing requirements.
A quick look at that data for euro issues shows that there were only five issues during the April to November 2003, which mobilised Rs 1,100 crore (Rs 11 billion). Among the other sources of financing, the same period witnessed a decline in mobilisations from the primary market. The private placement market however posted robust growth in mobilisations (here too the public sector accounted for all the growth even as the private sector saw a drop in mobilisations).
Given that corporate India is more profitable today. But it is unlikely that large scale investment activity can be undertaken without resorting to loans (incl. for working capital requirements). It would therefore be wise to exercise caution of any suggestion that there is large scale investment activity that is under progress.
2. Freight movement via the railways Growth in freight traffic gives credence to the view that there is an increase in economic activity i.e. more raw materials and finished goods are being transported.
3. Growth in non-oil imports & in domestic capital goods sector
The domestic capital goods sector too has posted robust growth so far in FY04. But first let's take a brief look at the annual growth performance over the last couple of years.
The One can thus assume that corporate India has been funding initial capital expenditure from its internal resources.
4. Foreign Direct Investment The FDI inflows over five years are depicted below -
FDI brings with it several benefits. The most obvious of these is 'money' which helps build productive capacity. Importantly, FDI, usually, brings with it access to the latest technologies and also an opportunity to export to global markets (sometimes). These benefit in terms of a more productive and efficient economy, and a growth in foreign trade.
The low level of FDI inflows remain an area of concern.
5. Fiscal deficit However, the overall fiscal health (central and state combined) of the economy is another story altogether. In the last three years, the combined fiscal deficit has been between 10 per cent to 11 per cent. Although this year it is projected to decline, past trends indicate the final number could be higher than the projected 8.8 per cent of GDP.
There are definite indications that the Indian economy is speeding up i.e. it is shining. Investors who bet prior to April 2003 that this would be so are today probably counting their spoils. However, from here onwards where the economy will depend critically on the success/failure of the monsoon in 2005. A long term sustained boom will again be subject to India's ability to reduce its fiscal deficit to manageable levels and ability to attract FDI. Of course, the monsoons will continue to play a major role.
What should you do? Most importantly, stick to your asset allocation. Do not increase allocation to stocks just because as an asset class they have done well. There is no surety that returns will be as exciting going forward.
Finally, a growth in business activity does not mean an increase in profits, which ultimately drive stock prices. So be careful before you latch onto the next economy linked growth story.
Over the last three years the growth in railway freight traffic has been between 3.7 per cent and 5.3 per cent. This year the CMIE projects the growth to be in excess of 6 per cent, and this is clearly indicated from the graph below.
Non oil imports are another good indicator of the level of economic activity. After posting negative growth in FY01 (-7.5 per cent), there has been a steady pick up.
Non Oil Imports: Rising growth
Growth % (YoY)
FY01
-7.5%
FY02
9.0%
FY03
16.6%
FY04E
26.0%
Capital Goods Sector: Turning around
Growth % (YoY)
FY00
7.0%
FY01
1.7%
FY02
-3.4%
FY03
10.5%
FDI is an indicator of how foreign economies perceive India to be as an investment destination. FDI represents investment by foreign entities in Indian business (leading to creation of real assets, employment opportunities etc.) as against FII which basically represents investment in equity and debt securities. Also, FII money is 'hot' i.e. it can leave the country as fast as it comes in, unlike FDI which is much more stable.
The finance minister in the recent interim budget announced, to everyone's satisfaction, that in FY04 it was expected that the fiscal deficit as a percentage of the GDP will actually decline to 4.8 per cent. If this were to turn out the way it has been projected, it would be for the first time in several years that there would be a education.
Do not get carried away in the frenzy. Also avoid investing on the basis of reports that project India to be a superpower in 2040. By then the markets would have gone through probably 10 bull/bear markets!