Fixed income in India increasingly looks to be in a sweet spot, not just domestically, but from the global investors’ standpoint as well. The strategy for bond investing in 2012 will be determined by the growth/inflation outlook for our country. As per our internal framework, we believe that the following scenario will play out in our economy:
• India will grow at below seven per cent for FY12 and FY13. Only towards the end of FY14, will we get back to the ‘normal’ or ‘potential’ growth level, i.e. 8.5 per cent.
• The inflation situation in India will subside. In March 2012, inflation will be closer to 6.5 per cent, and FY 13 inflation will be in the range of 5.5-6.5 per cent.
In order to understand the expected slowdown in growth, let’s first revisit the factors that drove our economic growth after the 2008 crisis. A massive fiscal and monetary stimulus was unleashed in our economy, since the world was facing a financial crisis. Government spending shot up, taking our fiscal deficit from 2.5 per cent to almost 10 per cent. Most of the incremental spending by the government went into the wallet of the common man, whose propensity to consume is very high. The Sixth Pay Commission, Farm Loan Waiver Scheme, NREGA and various such schemes fueled a consumption boom. Life looked easy. Pundits concluded that India had decoupled from the rest of the world.
Alongside, there came a huge asset price boom. Everyone in this country had a story to tell about how his/her friends and relatives had become millionaires by buying some parcels of land. An Indian already ‘earning more’ received a booster shot of wealth, and was suddenly richer, and the property price rise wasn’t the only reason for it.
A typical Indian owns two asset classes – gold and real estate. On one hand, government spending and loose monetary policies spelt magic for real estate prices. On the other, gold prices rallied for non-domestic reasons (largely driven by the chase for an alternative currency, as confidence in global currencies sank). Gold, which is typically bought as insurance by the average Indian, began to look like an investible surplus. Gold loan companies flourished, as people began to leverage their gold holdings. Thus, both gold and the real estate price boom added fuel to the consumption boom.
However, times are different now. The wealth and income effect that drove consumption growth are fading. Property prices have stopped rising in most parts of the country for the past six months. Gold prices too, have come off (optically though, they still look high due to the currency depreciation). The government doesn’t have money to spend, as it failed to consolidate its finances in the ‘good times’. The world economy is struggling to grow. Growth in 60 per cent of the world (mostly in the developed nations), is likely to either stall or decline into a recession. Interest rates are very high and taxing. All these reasons explain my first view, i.e. there is an economic growth slowdown ahead for us, and our models tell me that the growth next year will be as low as 6.5 per cent.
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