R Gopalakrishnan: Tougher times ahead
Business Standard — April 18, 2005

This is a call to Indian business to recognise an emerging problem. The solution to this problem was suggested by Samuel Johnson 250 years ago in a different context: “Make an impartial estimate of your revenue, and whatever it is, live on less.” Economic managers are trained to look at analytics as far as possible, and to give less weighting to the anecdotal. The global economic performance in 2004 was terrific. India too did well. Rightly, the mood among businessmen is buoyant. In spite of global economic numbers generally being right, suddenly there is a lot of “noise”.

There is no reason for international agencies, markets, and media commentators to suddenly appear worried. Yet that is the case; something is happening out there if one goes by very recent reports. The first report (not necessarily in chronological order): on April 7, the Financial Times wrote: “[The] World Bank says poor countries face dollar risk.” The report stated that the bank had identified the “gravest risk for emerging markets as a deep and disorderly dollar decline, which could create volatility, including a dollar collapse”.

Countries with big dollar reserves face capital losses, and China, India, and other Asian countries have significant dollar reserves. The second report was about the US truck industry, which is a barometer of economic activity in any country. After crushing difficulties five years ago, the American truck industry had done extremely well in recent times. Then, all of a sudden, on April 6, the Financial Times reported: “The truck sector suffers slump in orders ... The booming North American truck market hit the brakes unexpectedly in March, reinforcing recent evidence that high fuel costs and transport congestion might be taking a toll on economic activity.

In March, the industry recorded the first year-on-year decline since May 2003! Several haulers had issued profit warnings in recent weeks, sending share prices in the sector lower.” In the third report, again on April 6, the IMF warns of risks to global stability. “The success of financial markets has heightened the risk of downward correction,” the IMF warned, “the economies can withstand one shock or another but if several risks materialised at the same time, it could turn out to be problematic.” What are these risks in the view of the IMF?

The reduction of support for the dollar by Asia, the vulnerability of bond markets to unanticipated inflation and interest rates, and the possibility of disappointing company earnings. This last comment is surprising, considering that US corporate results peaked last year. Gerd Hausler, the IMF director of international capital markets, insists that the credit cycle may have started to turn for corporate borrowers and investors, so things are likely to deteriorate. The fourth report appeared on April 5: trouble was expected as equity ratios climbed higher.

Economic consultant and historian Peter Bernstein published his “Economics and Portfolio Strategy” on April 1. Studying the ten-year P/E ratios of US equity markets over long periods of time, he avers, “I am not going out on a limb to say this is the beginning of the decline, but the probabilities are much greater. Goodness knows what provokes it or how long it takes, but this is pretty bearish.” The reader may well think what a pessimistic assembly of international newspaper reports this is, and that it is always possible to assemble polarised reports; maybe that view is right, who knows? But there is other news trickling in also which we must recognise.

Warren Buffet has started to get it wrong! Although the Chinese demand is fuelling demand everywhere, it appears that the Chinese stock market has declined over the last few years and the investor is unable to benefit from economic growth. That is really strange. The growth rate of the Chinese car market dipped in the March quarter. The recovery of Japan is unsteady; Europe is the tired old man of the global economy. Real estate prices have shot up in almost every country in the world, bringing images of Japan of the late eighties to mind.

India is far more connected to the global economy; every businessman demonstrates this by his savvy in following global trends. The head of India’s leading truck company explains how a difficult year lies ahead. The growth rate of the Indian white goods market slowed down in the March quarter. If we place the growth rates achieved by the car marketers for the last three years and the forecast for next year alongside, there is a clear and consistent deceleration. Warnings about a poor March quarter have come from the pharma sector as well.

The Indian stock markets have been inexplicably volatile, resulting in warnings by the finance minister to manipulators. Real estate prices in the country are pretty much at a peak, thanks to easy finance and an element of speculation. Consider raw material prices and the ability of users to absorb those cost increases. Steel leads the pack; steel consumers have resigned themselves to lower margins, relying on volume for profits. Coal, coke and paper prices have shot up. Oil prices are feared by some to reach $75.

When the political leaders recognise and admit the impact of higher oil prices, the inflationary effect must be for real! Economic thinkers have commented upon the definite dampening effect on economic growth. Surely, all these portents cannot be ignored by business. I had pointed out these sorts of factors in two articles written in our financial papers over the last six months; unfortunately, it is turning out that way. I may have already earned the moniker “Cassandra”! Here I am at it again. The world economy and therefore Indian industry as well should expect a more difficult period from September this year.

This does not mean a collapse of demand or markets, but a distinct and palpable slowing down. That will cause an adjustment, which means less buoyant news and a cautious, perhaps even a less confident corporate sector. However, the fundamentals continue to be very sound, for India and indeed all of Asia. The adjustment process could take 24 months, till mid-2007; while the prudent would be prepared, the optimistic diehard could be caught unawares. To tide over such an adjustment, it is good to follow the Swiss dictum, i.e. earn a lot; spend little; concentrate on your work.

Conservative expenditure plans and measures to be liquid with cash would be wholly appropriate. It cannot do any harm, it just might help.

The author is executive director, Tata Sons. The views here are personal.