Economy: It’s like the 1990s again, so there’s hope yet

The current state of the market and the economy is reminiscent of the 1990s, when India had high inflation and bad loans.
Twelve years later, it’s ditto. And the last time, India came out stronger due to forced reforms. Can it rebound thusly from the current mess too?

Banks then were facing writedowns on loans given to sectors such as steel, textiles, power and cement and it had become a huge issue.

The government had to recapitalise banks and protect institutions such as ICICI and IDBI from going under. Cut to the present and the government has to recapitalise banks as loans given to power, construction, airline and other sectors are going bad.
The State Bank of India, the country’s largest lender, had net NPAs of 2.04% in the just-past second quarter against 1.7% in the same period a year ago.

Inflation at 9.7% is way beyond the Reserve Bank of India’s (RBI) comfort zone, though RBI has forecast it will come off to 7% by next March end.

Inflation in the beginning of the 1990s was consistently over 10% and interest rates were high on the back of high inflation. Ten-year government bond yields were above 10% in the late 1990s, even though inflation had started to trend down in the second half of 1990s. Ten-year yields at present are trading at multi-year highs of close to 9%.

On the global front, the 1990s saw the burst of the Asian tiger economies’ bubble, while it is the turn of the developed economies to face the burden of debt at present.

Global markets are in turmoil over debt issues of Greece and Italy. Italian bond yields have touched unsustainable levels of 7% given its total debt at $2.7 trillion or 120% of GDP.

Markets are worried about the unsustainability of debt levels in European countries leading to a selloff in equities and currencies. European equity indices are down by over 12% since August 2011, while the euro has fallen by over 5% against the dollar on the back of the sovereign debt issues.

How will markets behave going forward?

The problems facing the economy and markets will not go away in a hurry. It is a slow process as governments cut down deficit and central banks fight inflationary pressures. The bright spot is that markets are forcing the government to do the right things.

Euro zone governments are in austerity drives, while the Indian government is fighting to keep its deficit down. The RBI is focused on keeping inflation under control while lenders are becoming risk averse and are focusing on strengthening balance sheets.
The effect of fighting turmoil tells on growth. The euro zone is likely to face a recession in 2012, while India’s GDP growth is forecast to drop by 1% in 2011-12.

Indian is also facing pressures on its currency due to its current account deficit, which could cross 3% of GDP this year on a widening trade gap.

The trade deficit in October at $19.6 billion was a record high leading to worries on the current account.

Markets will be volatile in the short term, but as the dust settles and effects of right policies tell on the economy, markets will look to factor in a stronger period of growth.

The process could take at least six months. Till then, it will be a tough time for investors.