2011: Could it be worse than 2010?

The fear stems from the fact that Asia now seems to be falling prey to the western disease.

I have heard the sermons from both the warring pulpits of globalisation and decoupling, and I am not sure which of these faiths will work the right miracle in 2011.

The decouplers tell me that all is well and despite what happens to the western economies, India is safely on the track to double-digit growth. The corollary is, of course, that the wall of liquidity that the US central bank has created will chase Indian assets.

Thus, there might be a couple of corrections in between but there is only one that Indian asset markets are headed and that is up.

This doctrine had its day in the sun during the recent bull-run in the local stock market but the recent crisis in Ireland and the events in China seem to cast a pall of doubt.

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The "globalisers", on the other hand, see reason to fret about the state of the world at large where they see a number of risks lurking. If these risks unfold, they claim, neither Indian financial markets nor the real economy is really safe.

It would be difficult to disagree with the claim that the global economy's problems are far from over.

In fact, from that perspective, 2010 has been disappointing.

Forums like the G20, in which the world's heavyweights were supposed to put their heads together, have left more issues unresolved than they cared to address.

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However, the critical question is: are these problems of the global economy likely to impinge on India's growth and financial markets?

Or, have we effectively managed to build a thick enough wall around ourselves that effectively protects us from the chilly downdraft of the West?

I would argue that not only are we exposed to the woes of the western world than some of us care to believe, but there are a couple of new problems that we need to grapple with on the domestic front.

Take the monetary situation. We started with a largish surplus in the banking system (about Rs 100,000 crore) and low rates.

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Today the banking system faces a severe liquidity shortage and RBI's policy rates are a good 2.75 per cent higher than at the beginning of the year.

Some of this liquidity tightness has been engineered by RBI, but it seems now that it has ended tightening much more than is desirable.

There are also growing indications that RBI is somewhat helpless in tackling this problem as it seems to believe that any efforts to assuage liquidity would seem like a compromise on inflation.

This sharp swing in the liquidity situation has come when credit growth has been somewhat sluggish.

A back-of-the-envelope credit multiplier of three coupled with the projected growth rate of 8.5 per cent should have yielded a credit growth of about 25 per cent this year. The actual growth rate is barely 20 per cent.

This would explain the fact that despite the shortage in funds and the hike in policy rates, lending rates have hardly increased.

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The risk, of course, is that if credit growth does pick up, lending rates could ramp up quickly. The risk of rising borrowing costs taking away the proverbial punchbowl before the party starts.

The second risk stems from the fisc. A closer look at how the government's balance sheet has fared this year reveals a couple of things. First, some expenditures like subsidies were grossly under-budgeted in the February Budget.

This has meant that the FinMin has grabbed all the extra money that came from the spectrum auction through supplementary demands for grants.

If we do manage to stick to the fiscal deficit target this year, it would be because of exceptional buoyancy in tax receipts.

Government spending in the April-September period grew at 20 per cent (the government's target for the year was relatively mild at 8.5 per cent) while gross tax receipts increased by 25 per cent compared to a Budget target of 18 per cent.

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Next year could prove to be trickier. For one, we might not get the massive windfall that we got this year from 3G.

Second, if inflation does slow down as everyone expects it would, it is likely to hurt nominal GDP growth and tax revenues.

Third, there could be large expenditures on social sector programmes like the Right to Food and Right to Education.

The upshot of all this is that it might be difficult to stick to the path of fiscal consolidation in 2011-12. If private appetite for credit does improve, it runs the risk of being "crowded out" by aggressive government borrowing.

The fourth risk stems from the external environment and I am not referring to a teetering Europe or a somnolent US economy here.

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One could argue that despite the problems in the West, our growth momentum got a helping hand from our neighbours in Asia.

Thus, the rise in intra-regional trade provided the crucial offset to the sluggishness in the West.

However, over the past couple of months, Asia has been slowing down rather sharply. China seems to be fairly serious about grappling with inflation through monetary tightening.

Thailand is in technical recession. South Korea has decelerated sharply. Thus, unlike the first few months of 2010 when Asia seemed to be clearly bucking the global trend, Asian economies now seem to be falling prey to the western disease of slow growth.

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Ironically enough, inflationary pressure in these economies is building up and is likely to force their central banks' hands. This could hurt growth further.

The year 2010 failed to deliver on the promises that it's first few months held. It might not have been quite the annus horribilis that 2008 was, but the last few months have shown some rather ominous trends.

I just hope that these trends reverse in 2011. It certainly doesn't have the makings of a good year.

The author is chief economist, HDFC Bank. The views expressed are personal

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