Posted on behalf of my dear friend who chooses to keep his identity secret
In a growing economy (like India which was growing at high levels for the last few years and was expected to grow even faster), the required growth rate for sustaining employment is more than zero. This is blended growth for Indian economy has a whole. For the 55% of the economy in service sector, the 30% in manufacturing and the rest in agriculture, growth rates are different.
Think of a software company. it would hire so many people assuming a growth rate of say 30%. normally these people are benched till needed. when suddenly demand reduces, companies will have no option but to reduce workforce. even if the company is growing by 15% i/o 30% as projected during the hiring plan, they would still need to cut workforce. in auto sales and allied businesses like vehicle loan sales etc it was india shining story till 3 months back. just think of how much "bench" workforce would be hired based on projected growth and now needs to be pruned..
thus for economy as a whole, for India, it is estimated that about 6% growth rate is required to maintain employment at current levels. ofcourse for 1.5 m people loosing jobs, there may be 0.5m people getting jobs also...since we are linked to the global economy (just think of the salary increases all you professionals got in India in the last 4-5 years) even the slump will be felt here. do you think the Re appreciation was because of domestic demand? or suddenly what you were doing is worth paying more because of domestic business? it was only because of global linkages and global trends.
economy is a vicious cycle.. based on confidence.. people behave according to what they expect will happen... lets take an expample of something you would know about...auto companies.. export demand has gone down.. but anyway exports were small percentage of total sales.. say last year the auto company was operating at 80% of capacity (infact this is conservative estimate.. so much new capacity has come up in last few years much of it for export markets).. with no exports, it is now operating at 65% capacity... so they hope domestic demand is enough to keep them going.. but there is no retail credit.. hence car sales are slow in domestic market (july- sept last year) .. so dealers and auto manufacturers suffer.. operating capacity goes down to 55% very close to break even capacity...bonuses are cut.. jobs are on the line.. auto sector employees are scared and not buying new cars... or houses... so housing companies can't sell under construction projects and get advance payment from buyers.. they don't have money to complete projects.. banks are not disbursing loans to buyers because projects are held up.... there is no new capital coming in.. companies had started projects/ made acquitions expecting to get money from booming equity markets (2007-2008)... all IPOs are cancelled because no one wants to invest in equity issues (sept-dec last year) .. FDI is stuck because foreign funds have redemption pressure at home... till the IPO money comes in, companies had borrowed in USD over last few years because it was cheaper to borrow in USD.. now Re is depreciating.. suddenly instead of needing INR 40 to repay USD 1 they need INR 50.. this is ok if you have export sales.. because you would earn more as well, but with no export sales, this hits profitability of domestic sales.. cost of imports has gone up because of depreciating Re... there are no other sources to raise funds for these companies.. people expect house prices to go down further and delay purchases.. distribution pipelines are clogged with unsold stuff.. companies stop producing new vehicles (Telco had closed its plant)... auto companies go below break even levels..builders have to reduce rates... auto companies, dependent ancillary companies and construction companies start making losses.. they don't have money to repay previous loans (Unitech)...banks fear non performing assets.. they are scared to lend.. cost of financing goes up.. sales go down further.. proftability goes down further (dec quarter results for most Indian companies).. jobs are cut to save cost... employees are more scared to spend.. companies go into deeper trouble, default on loans (this will happen after march 09) ... unemployed people default on personal loans.. banks tighten lending and increase rates and so on.. you can imagine how this extends to other industries and economy as a whole....
So india will still grow, but all plans have been made on much higher growth projections.. say 9% growth. to add to the problem, every company had planned to increase its market share in the growing pie. this means that if the software industry is growing at 30%, each company in the industry had assumed growth of 40% because of increased market share it hoped to acquire in a growing industry. if the actual growth of Indian economy is less than 6%.. we are in big trouble, if it is more than 6% we are in less trouble. The slump and recovery is expected to be "L" shaped..sudden drop (which we are seeing right now) and then straight line at the bottom for few months/years with very late and slow recovery.
on ligher note, the current situation reminds me of typical scene in cartoons.. Tom & Jerry style... Tom is running very fast.. and he goes over a cliff but still continues to run.. then suddenly he feels that there is no ground under his feet.. and then, only after he looks down and sees the huge empty space below him, realisation sets in... says bye, bye...and goes down... in a vertical freefall....
but seriously, the big question is: what can govts do to get us out of all this mess? govts have 2 tools.. monetory & fiscal stimulus..
monetory stimulus is what RBI or US Fed does.. reduce key rates and increase liquidity. India has done this. key rates are reduced (the rate at which RBI would lend banks) .. so also has US, UK, Europe etc.. how do you increase liquidity? by reducing CRR/SLR for banks, which has been done.. but still no use.. banks are not lending to each other.. banks don't want to go to RBI to borrow, because RBI is the lender of last resort.. so if market knew that the bank has gone to RBI, all its other funding sources would freeze.. so today this benchmark rate means nothing... banks are not lending to corporates/ individuals.. actual interst rates charged on loans are not reducing....consumers are not borrowing.. this policy worked in the US post 9/11 slump and dotcom bubble burst.. because of cheap credit people started spending borrowed money and it also fuelled the real estate boom to create "wealth".. this is supposed to have been the reason for todays problems.. cheap credit creates asset bubble.. but its not working now.. plus creating another bubble just postpones the enevitable and generally the new bubble is bigger causing more pain when it bursts..today US rates are close to zero.. UK, Euro rates are at historic lows and approaching zero..there is no room left to go further down this path..
fiscal stimulus is done by finance ministry in India or the current stimulus bill being put to vote in the US. this includes reducing taxes & increasing public spending.. by reducing rates, govt expects that people/ companies will invest/ consume more with the money saved or rebate received due to tax breaks.. this has also worked in US in the near past.. but this is not working today, because people & companies are scared.. with the tax breaks, they are paying down debt or just hoarding cash... when private sector is scared and not willing to invest or increase consumption, govt has to do it. so china, india and now even US govt want to increase public spending.. say build roads, bridges etc. theoretically even if the govt employs millions of people to dig ditches, fill the ditches then build a wall and then break it to down make a ditch and again fill the ditch etc... it is supposed to break the vicious cycle. it creates demand for materials, creates jobs.. which would further create demand for other things, increase operating capacity of manufacturers.. make them profitable.. increase employment.. improve bank's loan portfolio..ease liquidity.. increase investment in new capacity... create more jobs and so on. but of course if the govt builds roads/ bridges its better because there would be longer term use of the money spent (the New Deal by FDR in US after the 1930s recession). but for all this the govt needs money. but actually, govt has less money because tax revenues decrease and money is needed to bail out banks/companies.. India has bailed out 3 nationalised banks today by infusing capital.
which poses the grave and serious question: where will all these govts get money for all this proposed huge public spending, specially when revenues are decreasing? answer is as simple: by printing money..
all governments are printing money.. US,UK, Europe..thats the only option left. "printing money" is just a term to indicate monetising of deficits (govt expenditure is more than revenue).. this does not mean that actually Rs 100 and Rs. 1000 notes are printed for circulation. it means that govt has increased the money supply.. e.g. when govt issues treasury bills, it is increasing supply. just like a Rs 100 note is an IOU from the govt (read what it says on the note), so is a treasury bill. only the treasury bill is denominated in crores.. so its a faster way of monetising. normally with this policy the inflation should go up, because there is more money in the system, but in india the inflation is falling.. because of reduced oil prices and also because of demand slump.. so more needs to be done to spur activity.
when you print money, naturally value of the currency goes down.. when you reduce rates also, currency should go down.. all countries are doing both.. so all currencies are down..except in the US.. US is printing money like crazy and rates are close to zero.. but because everyone else is also printing money and reducing rates, in the end investors choose USD as a safe heaven... people expect the US to come out of recession first.. or rather till US comes out of recession there is no hope for anyone else... so USD is safe heaven..illogical.. but thats the way the market is working.
unfortunately all tried and tested methods as well as theoretical approaches are failing one by one.. no one has any idea what will save the world.. there is no unanimity on what to do.. co-ordination between political parties and countries and trading zones is impossible because of internal political dynamics. what is good on individual level (do not spend, pay down debt) is not good for the whole country. what is politically good for countries (protect industries, go swadeshi) is not good for the world economy.
anyway, i don't think the indian govt will make false reports about the money supply. what the report would mean is that the money supply increase is fudged eg. the govt issues petroleum bonds to PSU oil companies to offset marketing loss. the effect is actually increasing money supply.. but it may not be classified as T-Bill or printing money. none the less, this figure is published by the govt under another heading. this has been happening for last few decades. nothing new here. US has stopped disclosing its M3 or the aggregate money supply in the system, so india is still a lot more transparent.
in summary, enjoy the ride.. hold on to your cash (preferably in USDs) and hope everyone else spends money. when the timing is right (who can guess that?) start investing in stocks & real estate.. get 1000%returns on your money in a short time after the recovery... all traditional fortunes made in the last century were by taking advantage of the 1930s depression and economic recessions..
make the most of this mess, if you survive.
