Recession: Worse yet to come?

Six months ago, the conversation was about rampant inflation. A year ago, respectable economists were saying that the trend rate of Indian gross domestic product (GDP) growth had risen to over 8 per cent. Things change fast.

In the last month, government spokespeople dismissed the likelihood of deflation, which means that it is a distinct possibility, with the year-on-year wholesale price index (WPI) below 4 per cent. The interim Budget estimates were reckoned optimistic, and those "optimistic" estimates were well below 8 per cent.

Things could change quickly again. One characteristic of this crisis has been the rapid pace of change. The world went from boom to bust inside a single quarter. Things tend to happen quicker, for better or worse, in a world of instantaneous communications and frictionless cash-transfers.

Given the speed of the collapse, we may see a recovery that comes faster than anticipated. However, certain prerequisites have to be met. One is that the next government must at least give the impression of being stable. That in itself is a tall order. But without that, consumers will not participate and their participation is a necessary condition for an economic turnaround.

Another useful situation would be one last contraction that drives valuations in stocks, real estate and consumer goods down to a point where bargains become irresistible. This would have to involve interest rates falling quite a bit as well.

Panic during the election process should do the needful where stock prices are concerned. One can see manufacturers dropping prices in desperation to clear inventory – it's already happening if all the "Sale" banners are any indicator. Real estate developers too are hitting levels of desperation. Even the banks will eventually have to drop rates to bring back business volumes. The market is clearly signalling its irritation with the banking sector for keeping rates high.

Despite the passive nature of this Budget, it does a few good things. It's committed to maintaining the excise rate reductions of the stimulus package. It's committed to the alphabets soup of NHDP, JNNURM, and to the Bharat Nirmaan. Those are big-ticket infrastructure programmes. Like all big government spends, they will not deliver even results across regions. Efficient state governments will corner more resources and use them more efficiently.

But in the present climate, any committed investment is positive. Unfortunately, the assumed private commitment to infrastructure PPP projects is likely to be delayed considerably and some of that money has plain evaporated.

That may be a good thing in the end. Mega-schemes will have to be reviewed and the more extravagant will be discarded. Contracts and projects may come through on the cheap because construction costs have plunged and the low fixed returns of the infrastructure sector are attractive in the current climate.

There is a degree of predictability about the next four to six months, for it will take that long for a new government to prepare a new Budget. That same period of four to six months is also likely to be the point at which the recession hits its nadir.

The new government will really have its work cut out. Apart from threading a thin line in terms of managing deficit financing, it will have to project a sense of confidence and hope in order to induce consumers to reach for their wallets again.

Economics is an inexact discipline at the best of times. Gauging consumer sentiment is among the least amenable to exactitude. If the rate of change of economic activity has indeed risen, everybody will get their guesstimates of consumer behaviour wrong.

There is no question that current equity valuations are attractive for the long–term. But if time to recovery shrinks, then those valuations are also attractive for the medium-term. In that case, you may be seeing gains by end 2009-10 rather than late 2010-11. 

History makes a fast recovery look unlikely– the last time there was a crash of these dimensions, the world took well over a decade to recover. On the other hand, the structure of global economics has changed so radically that extrapolating from the Great Depression is near-useless.

Regardless of the rate of change, infrastructure should be a haven for capital seeking new outlets. Maintaining or increasing exposure to the vast plethora of infrastructure sectors and plays seems to make a great deal of sense.