India shining

For stark signs of how the global economic downturn has affected India, look no further than the diamond polishers of Surat and their industry's accounts in December.

Diamonds are one of India's great business success stories from the past 30 years. One of the country's key export sectors, its polishers import rough diamonds, cut and then export them to the big jewellery markets of the US, the Gulf and Europe.

Today, India has a 55 per cent market share of the world's diamond cutting and polishing business. Some 800,000 jobs were created in this sector by virtue of India's low-cost but technically skilled labour force. And the sector is at the forefront of the economy's integration into global markets.

The industry imports more than half of its rough diamonds from Belgium and has strong links with De Beers, the global diamond group, Alrosa, the Russian diamond producer, and BHP Billiton, the resources group. By 2007-2008, diamond exports had risen to $14bn.

But in December, the industry juddered to a halt and with it years of uninterrupted rising growth. It has yet to recover. That month there was a near 100 per cent decline in imports of rough diamonds from $1bn a year before to $85m. Worried about tumbling diamond sales in developed markets, Indian industry leaders took a controversial decision to stem supply and avoid flooding their production pipeline.

"In the worst period, sales went down more than 50 per cent," says Vasant Mehta, the chairman of India's Gem and Jewellery Export Promotion Council. "The sales have stopped going down further. We have stopped dropping and that's where the hopes of revival are. We are now in wishful thinking."

Over the past eight months, the diamond industry has shed about 200,000 jobs. Hopes are pinned to a revival in the big US market ahead of Christmas, but there is more talk now of the domestic market and consumers in China coming to the rescue.

Similar stories, and hopes of revival, are to be found across India's other export sectors, from IT to leather goods. Even the most bullish Indian export sector, IT outsourcing, has pared its forecasts. The global financial crisis has inflicted at least a year's delay on the industry's drive to reach its short-term revenue forecasts, with key markets in the US and Europe suffering from the financial downturn and some clients simply disappearing.

IT outsourcing, and companies including Tata Consultancy Services, Wipro and Infosys, had helped propel the economy to higher growth rates and create almost half of the new urban jobs during the past decade. But a study by McKinsey, the management consultants, and Nasscom, India's information technology industry lobby, said the IT outsourcing business would miss its target of $60bn worth of exports by next year.

"The Indian IT industry is in the midst of unprecedented times because of the current economic environment. We expect the next few quarters to be extremely challenging," says Som Mittall, Nasscom's president. "Eighty per cent of incremental revenue growth by 2020 will be driven by opportunities outside of the current core markets."

Still, India is faring better than most. Asia's third-largest economy is expected to grow at 6 per cent this year, according to the Reserve Bank of India. Many economists expect an improvement in the second half of the year in an economy that is untroubled by toxic banking assets at home and is being supporting by a raft of government fiscal stimulus measures and aggressive interest cuts by the central bank.

Nonetheless, India has had to make a painful adjustment. Between September and January, a thriving economy and a rising stockmarket transformed into top business leaders appealing for deep interest rate cuts and emergency support from the government, falling exports and job losses. Shares of some of India's leading companies in sectors such as property, pharmaceuticals and IT outsourcing fell sharply. Foreign portfolio investment drained swiftly from the emerging market.

Only two years ago, India's economy was growing at 9 per cent and China-style double-digit growth was almost in reach. Now the RBI's prediction for the 2009-2010 fiscal year is at the upper end of economists' predictions. It has also trimmed its forecast for the fiscal year that ended on March 31, saying GDP growth had fallen to 6.5-6.7 per cent from an earlier forecast of 7 per cent.

"The extent of the impact (of the global financial crisis) has caused dismay mainly on two grounds: first because our financial sector remains healthy and had no direct exposure to tainted assets and its off balance-sheet activities have been limited," says Duvvuri Subbarao, the governor of the RBI. "Second, because India's merchandise exports, at less than 15 per of GDP, are relatively modest."

But in spite of the dismay, there is optimism. Bright spots for Mr Subbarao are a comfortable level of foreign exchange reserves at about $240bn - posing no threat to the balance of payments - lower inflation as energy prices have eased and strong rural demand buoyed by mandated agricultural lending and a social security pay-outs.

According to some analysts, India fortuitously launched a fiscal stimulus package ahead of the global financial crisis with a rural employment programme and a hefty rise in pay for civil servants. But since September, it has announced several tranches of government spending that have raised concerns about the size of the fiscal deficit and how quickly it can be pulled back in the years ahead.

Another concern is how effective monetary policy has been in stimulating growth. A series of interest rate cuts in India has failed to lead to cheaper commercial lending.

The RBI has been exasperated that monetary adjustments to stimulate the economy in the face of the global financial crisis had not resulted in significantly lower lending rates by commercial banks to the private sector.

During the second half of 2008-2009, the RBI reduced its lending rate by 400 basis points, but most banks lowered their lending rate in the range of 50-150 basis points. The repo rate, the central bank's key lending rate, is now 4.75 per cent.

The shortcomings of the banking transmission mechanism have intensified calls by India's industrialists for more monetary easing. They complain of a severe stoppage of credit to small and medium-sized businesses and paralysis in the mortgage market that threatens to prolong the downturn.

Although India's commercial banks are free of toxic assets and liquidity has been restored to the banking system, analysts are doubtful that bank credit growth will revive easily.

"We will have to wait and see whether the RBI proves sufficiently persuasive," says Robert Prior-Wandesforde, senior Asian economist at HSBC, the banking group. "But even if it is, the positive effects on the real economy won't show up until 2010, given the lag with which monetary policy operates."

Some sectors appear to have been impervious to the global slowdown. The rural economy, supported by high commodity prices, has held up well, as have consumer goods and telecommunications. A recent headline accompanying the annual report of Bharti Airtel, the mobile operator, proclaimed: "As good as it gets."

One of the most often quoted figures to illustrate the promise of a domestic market of 1.2bn people is the number of new mobile telephone users who sign up each month. This raised sceptical eyebrows when it was 5m a month. But now the figure has grown to nearer 15m a month. Mobile operators are driving growth by offering call rates for less than Rs1 a minute.

There are also some early signs of recovery. Motor vehicle sales, cement and steel production and the purchasing managers index back the view that improvement awaits in the second half of the year. No doubt, government spending, monetary easing, a fall in the exchange rate and foreign direct investment will bring relief in the months ahead.

But the risks are also great. Few can be sure of a swift recovery in the developed world, or of how the new government will affect the economy. Either one of these uncertainties could spell slowdown.

Copyright The Financial Times Limited 2009