CNBC Business | Dehlicate Balance

Dehlicate Balance

As exports shrink, job losses grow and domestic demand wanes, India is bracing itself for a difficult year ahead, says Amy Kazmin 

For most of last year, Roots Industries, a small Indian car horn manufacturer, could scarcely keep pace with seemingly insatiable demand, from both at home and abroad, for its products. The privately held company, located in the south Indian industrial city of Coimbatore, was running three shifts a day, six days a week, churning out an average of 400,000 horns every month for customers such as Maruti Suzuki, India’s largest car manufacturer.

But in December, with markets reeling from the US financial crisis, Roots was scaled back to just two shifts a day, six days a week, as its monthly orders plummeted by 27.5% from the previous month. In January, production was cut further, to just five days a week, instead of six, to produce just 173,000 horns. 

With the reduced working hours came cuts in the workforce, which was slashed from 1,175 to just 875. Those still employed have also had to absorb pay cuts. “Salaries have to be reduced,” says chairman K Ramaswamy. “Otherwise, we cannot sustain ourselves.” 

The woes afflicting Roots Industries reflect the wider difficulties of the faltering Indian economy, now being hit by the impact of the global economic downturn, and an erosion of domestic confidence and spending in what has been one of Asia’s most dynamic economies. 

After three years of growing an average of 9% annually, India’s economy grew just 5.3% year-on-year in the last quarter of 2008, suggesting that estimates that the economy will expand 7.1% during the fiscal year ending March 2009 may be optimistic.  

“After five years of up and up, it’s a deep, deep decline,” says Surjit Bhalla, managing director of Oxus Research and Investments, a New Delhi-based economic advisory firm. “That’s a shock to the system.” 

India’s export-oriented manufacturers in sectors such as textiles, auto components and jewellery — which had been a growth engine in recent years — have seen cancellation of orders. Exporters shed half a million jobs in the final months of 2008, and are warning of further job losses if business doesn’t pick up. 

As exports have slowed, India’s domestic consumption has also subsided, as consumers reverted to traditional patterns of financial conservatism and saving. Sales of both new cars and new homes — which had been major growth drivers — plummeted sharply in the last three months of 2008, amid concern about how the global slowdown would affect local job prospects. 

“The middle class has really come to life over the last four or five years,” says Bhalla. “But what that means is that the business cycle affects the middle class…the longer this [downturn] lasts, the worse the social and economic repercussions will be.” 

Consumer anxiety has also been exacerbated by the shocks of last November’s terror attacks on Mumbai, the financial capital, and the revelation of massive fraud at software company Satyam, which had been one of the icons of the new economy.  

While India’s large information technology services industry appears to have remained resilient so far, young software professionals also appear to be tightening their purse strings, worried about their prospects. 

The global downturn is also leading to a drop in remittances from Indians working overseas, with some of the estimated four million Indians working in the Gulf reportedly returning home, as jobs dry up, particularly in the construction industry.  

Despite these setbacks, India’s economy is so far proving more resilient than others in Asia. It is still expected to remain one of the region’s best performers, despite the current global difficulties, thanks to the cushion provided by agriculture, the vast government bureaucracy, and government spending.  

Even after the recent years of rapid industrial development, most Indians’ fortunes are still linked to the agricultural sector, which involves around 57% of the workforce, though it accounts for just 17% of GDP.  

India’s government employees and public sector workers will receive salary increases of around 40% this year, part of a once-in-a-decade salary adjustment. The increase will affect around 20 million people, employed by the central government, state governments, and public sector enterprises. 

Although the hefty pay rise for the bureaucracy was criticised by some when it was announced last year — before the global crisis was visible — analysts say the raise will provide a boost to consumption at a time when other engines of growth are faltering. 

“Whatever complaints you may have about government salaries, it will prove to be a stabilising force,” says Subir Gokarn, chief Asia Pacific economist for Standard & Poor’s, the rating agency. “There is no job insecurity in the government sector.” 

However, India’s budget is showing the strain, as tax revenues fall, and the Congress-led government steps up counter-cyclical spending, especially targeting the rural sector, ahead of the general elections that will be held between 16 April and 13 May this year. In February, S&P downgraded the outlook on India’s long-term sovereign credit rating to negative, from stable, citing its concerns that current levels of government spending is “unsustainable” in the medium-term.  

The rating agency estimates that India’s consolidated fiscal deficit — which includes oil and fertiliser subsidies — for the year ending March 2009 was 11.4% of GDP, up from 5.7% the previous fiscal year. “Fiscal discipline has been thrown to the wind,” says Gokarn.  

India could enhance its tax collection by better use of technology, which could help alleviate fiscal pressures. “But,” says Gokarn, “how quickly it can be done is an issue.”  

Individual Indian companies are also showing the strain, struggling after several years of rapid, debt-fuelled expansion. Subhiksha, a young retail chain, has had to close, and there are concerns about the future of India’s money-losing private domestic airlines.  

Analysts do believe India’s pent-up domestic demand — especially from residents of smaller towns — will get the economy expanding at a respectable rate again by later this year. “Large sections of the population are aspiring,” says Bhalla. “They still want a colour TV, a motorbike, and a car, and as long as they have jobs, they will borrow to buy these.”  

However, India’s overstretched infrastructure remains a major constraint to growth — and the government will likely struggle to find financing to meet its expansion needs. Consequently, Gokarn cautions that a return to the levels of growth of recent years is unlikely, suggesting 7%–7.5% is more sustainable: “Anything above 8% is pretty aspirational.”