Ten Questions that will decide how 2012 will pan out for India

At the beginning of the year, it is always fashionable to look ahead and conjecture what will happen in the coming months. Also, given the kind of volatility one has seen both in the economic numbers and the projections made by analysts, one can never be sure of anything. But we can nonetheless still try and assess what things will look like in 2012.

The first big question is whether the euro will collapse?

This talk has been on for quite some time and there have been strong arguments to support the view that it will be nice to break up the union to ensure that the wrongdoers are punished. However, given the close inter-linkages between German and French banks, and the linkages of their own financial systems to the over-indebted nations, they have to stick together for their own stability. Therefore, the euro will survive, but would tend to weaken against the US dollar, depending on how the American economy progresses. 

Question two is whether the world economy will recover?

The answer is yes, but it will be a slow one, since it has to be driven by the US in the west and the emerging markets on the other side of the ocean. The American economy is currently chugging along but would be constrained on the fiscal side with a distinct conflict between the Republicans and Democrats, who separately favour expenditure cuts and tax increases.

The euro region, especially the PIIGS (Portugal, Ireland, Italy, Greece and Spain), will have to resort to austerity to ensure that their budgets are under control -— or else there could be repercussions in terms of the financial assistance other nations are willing to provide. Therefore, growth has to be from within rather than any kind of fiscal stimulus.

Question three is whether the Indian economy will perform better in 2012?

There is a strong reason to believe that the Indian economy will do better this year relative to 2011 as some of the daunting issues like inflation seem to be moderating. The Reserve Bank and the government can now focus on bringing the economy back on rails. Growth should pick up, albeit gradually, and one can actually see us move towards the 7.5 percent mark in terms of GDP growth, provided the external environment remains stable.

With the state elections out of the way, we may see Parliament debating economic issues and passing some of the more pressing bills.  As usual, a lot will depend on how the monsoon directs farm prospects, the policies pursued by the government in its budget and the RBI’s policy stance.

Question four is, will the RBI reverse the interest rate hike policy pursued so far?

It appears that it most probably will once it is convinced that inflation is under control and no longer poses a threat to the economy. While the market would like the hard money policy reversed as soon as possible, it will take some more time. The direction is certain unless extraneous factors upset the apple cart, which looks unlikely at the moment. Interest rates have peaked and from now on things can only look better for industry, though not for savers. The unanswered question is when will the RBI signal a reversal.

Question five  is whether inflation will come down?

This year, the Food Security Bill could be passed, which means there will be more demand for foodgrain procurement. Reuters

Surely, inflation will move downwards, as can be seen from recent food inflation numbers. However, sticky issues still remain for the government. This year, the Food Security Bill could be passed, which means there will be more demand for foodgrain procurement. Can this be inflationary? The present stocks with the Food Corporation of India can actually meet this target (for one year) and hence need not be an immediate concern.

Further, will the government raise  prices of petro-products this year? Probably it will do so once the elections are over, which will have an impact on prices. Lastly, core inflation today is up more due to rupee depreciation as global prices are benign and there are no signs of excess demand in an environment of lower industrial growth. Therefore, there can still be pressures on prices. The comfort is that two successive high base years will lead to lower inflation numbers. But, price levels will still be high and affect household spending.

Question six  is whether the industrial climate will improve?

Interest rates are one part of the story, but more importantly, there has to be movement on both demand and supply. India has not really been hit by the global slowdown directly in a significant manner, which means that the recovery will be a tad easier. Therefore, consumer demand should pick up along the way while investment activity should be buoyed by lower rates.

However, there is no certainty about the pace of recovery. Lower interest rates should aid investment. A lot will also depend on whether the government will return to the path of reforms this year. While there will be opposition to some of the reforms like retail FDI, some other action may be expected.

Question seven is what the fiscal deficit will look like for the next year?

The government has to take a call on whether it wants to move towards the FRBM (Fiscal Responsibility and Budget Management Act) norms or whether it would prefer to help the growth process. Actually, the government should have a well defined policy on subsidies so that we treat it as a given constant against which the budget is formulated. As of now, the practice has been to blow hot and cold on food and petroleum subsidies, which makes it appear as if the government is not sure whether it is for or against such subsidies.

The budget should this time hopefully provide this clue. More importantly, it will focus once again on a fiscal stimulus, a la Keynes, so that growth is restored. A big bang may be expected, which will probably mean the maintenance of a high fiscal deficit in the region of 5.5 percent, which is not really bad.

Question eight is how will the rupee behave?

One cannot see the rupee strengthening, given the future scenario. Dull global growth will not help exports while imports will keep pace with domestic growth. Foreign institutional investor (FII) flows will probably be stagnant as financial flows remain restricted. External commercial borrowings (ECBs) will depend on interest rate differentials and exchange rate volatility while foreign direct investment has to support the bridging of the external deficit.

At the same time, the dollar will remain strong versus the euro, thus pressuring the rupee. The rupee will remain weak and at best could move towards, say, Rs 48-49, though presently the range of Rs 52 with a band of Rs 2 either way looks likely.

Question nine is whether liquidity will be adequate?

Greater demand from the government as well as the private sector will put pressure on banks. Banks will also have to brace themselves for meeting Basel III standards, which involve building Tier I capital. This sector holds the clue to future growth of the country as banks have to not only finance growth but also meet their capital norms. Liquidity will, therefore, continue to be under pressure and government bond yields will remain in the range of 8-8.5 percent for 10-year securities even if the RBI lowers rates.

Finally, question 10, how will the stock market behave?

One never can really tell, given that any movement or non-movement on any of the other nine questions can have a bearing on stock indices, impacting their amplitude as well as direction. The main driving force so far, FII investment, appears to be less likely this year, which means investor sentiment will be the main trigger for most of the year. This, in effect, means one cannot be sure. Our best guess is a guarded shoulder shrug.