labels: rex mathew, economy - general
2006: A stable and promising year beckonsnews
02 January 2006

The Indian economy should maintain its growth rate and stock markets would be stable this year, if the government succeeds in increasing the pace of reforms. By Rex Mathew.

After a fairly satisfactory performance in 2005, the New Year offers an opportunity for consolidating the gains of the last few years and laying the ground for accelerated growth in the medium to long term. The Indian economy has almost become immune to domestic calamities like insufficient monsoons, political change, flooding and other disturbances in major commercial centres, etc.

However, sustained growth in future requires further reforms. The last couple of years have seen a revival in investment spending as capacities are being built up across many sectors. The manufacturing sector has reported robust growth figures over the last few years and the country looks all set to alter its manufacturing fortunes even further in future.

Many economists believe that the country has reached an inflection point where a 7 per cent GDP growth is the base. We may sustain growth at this base rate even without speeding up the reforms process. However, to accelerate the growth rate further and to ensure longer term sustainability, the economy needs further reforms in key sectors.

It is in this context that the year 2006 could become an important year in our economic history. After a particularly subdued year, the government has to take the reform process with a higher sense of purpose and commitment.


As mentioned above, the GDP can continue to grow at around 7 per cent per annum without any significant reform initiatives even on the face of domestic or overseas disturbances. The manufacturing sector would continue to do well as long as investment spending remains strong. The services sector can sustain growth at the current levels as most of the segments have built up strong competitive strengths.

The farm sector requires major reform inputs to insulate it from the vagaries of the monsoon. If the necessary policy framework is put in place, the country can emerge as one of the major exporters of farm produce. More significantly, it can alter the financial fortunes of millions and help in attaining a significant reduction in poverty levels.

The economic outlook for the current year is stable, even if the rains were to be less than satisfactory. Consumer spending is seeing no signs of a slowdown and good salary growth in the organised sector along with stable interest rates should keep the momentum going.

The economy has survived the rise in oil prices without showing much strain and this year too should not cause worry. Global economic outlook for the current year is also stable, which should help sustain export growth. Even if the US economy cools down, other major economies like Japan and continental Europe are showing signs of a revival in their fortunes.


As long as there are no dark clouds over the economy, the stock markets should do reasonably well this year. Though the market valuation is one of the highest among emerging markets and looks somewhat stretched, the downside is limited. Higher quality and transparency of earnings in India and growth potential over the medium to long term should keep investor interest alive.

The bigger risk in the short term (up to 1 year) is a slowdown in corporate earnings. After three years of growing above 25 per cent per annum and having squeezed most of the efficiency gains, corporations would find it difficult to grow margins this year. Capacity expansions by most of the large companies would go on stream only in subsequent years.

Index returns of around 40 per cent achieved last year would be difficult to repeat, especially if there is a marked slowdown in earnings growth. Much would depend on domestic flows into the market and some high profile new listings would help sentiment.

FII inflows would continue to be robust, though beating the record of $10 billion posted last year may prove to be difficult. Last year saw many new and long term investors from diverse geographies entering the Indian market. This trend would most probably continue this year as well as the India story is still going strong.

The year should see more overseas acquisitions by Indian companies. Availability of overseas capital would remain strong, further aiding the overseas forays of Indian companies. Not many big ticket domestic mergers and acquisitions can be expected, except for intra-group consolidation and restructuring exercises.

Pace of Reforms

One of the major disappointments of last year was the slow pace of reforms. Many major reform initiatives were stuck in the politically opportunistic stance of the Left parties and the opposition. The government seems to be aware of the time and opportunity lost and is gearing up for a change in pace.

This year should see the implementation of VAT across most states which would further integrate the domestic market. The opposition ruled states have already announced their intention to initiate the new regime. It would be difficult for other large states like UP and Tamil Nadu to stay out of VAT much longer, on the face of positive results for most states which have implemented the new tax structure last year.

Another big ticket item on the agenda is pension reforms. This year may see the pension bill finally getting passed, which would give statutory backing to the pension regulatory authority.

FDI in retail may not progress much, unless the government is willing to give in to at least some of the demands of the Left parties. With no change in the stance of the opposition expected, the Left is sure to extract its pound of flesh before yielding to the ruling alliance. Expect a watered down policy with stringent controls on foreign players to 'protect the interest of small traders'.

Disinvestment would continue to take a back seat as the Left parties would be least willing to yield any ground after the high profile spat on this issue last year. However, the government may be able to sell its minority stakes in companies like Maruti and VSNL. It may also succeed in selling small stakes in low-profile (non-navratna) PSU's like Neyveli Lignite and some of the fertiliser companies where the public holding is very low.

This year's budget should see a continuation of tax reforms. One major initiative expected is the introduction of exempt-exempt-tax regime for small investments. Indirect tax rates may see some further rationalisation in view of the stated intention to bring them down to the levels in other Asian countries. Expect no major changes in direct tax rates.

The year may see accelerated investments in infrastructure, especially in roads and airports. The airport modernisation programme would finally get off the ground and the national highway development programme would expand further. Expect more attention on the power sector with the appointment of a new minister for power at the centre.

Oil Prices

Oil prices hit record highs in the third quarter of 2005 before cooling off towards the end of the year. A year-end survey among oil analysts in the US reveals the expected average crude prices for 2006 to be around $58 per barrel. These analysts expect prices to rise during the first quarter of the year before stabilising.

The same survey conducted at the end of 2004 had forecast an average price of $40 per barrel for the year 2005. They were way off the mark as average price for the year was more than 30 per cent higher than the forecast at $57 per barrel. However, there are reasons to believe that the forecast for the current year may not be so wide off the mark.

The surge in crude oil prices during 2005 was triggered by somewhat hyped up reports about future demand-supply mismatches. Strong demand growth in emerging economies like China and India and steady demand in developed markets cannot be satisfied from existing capacities, these reports said. Insufficient refining capacity in western countries prompted forecasts of product shortages and led to a rally in refined products, pushing up crude prices further.

Growth in demand from China was not as high as expected last year and may not see any major change this year either. US retail demand for fuel slowed down during the second half of last year because of high prices. US consumers are shifting to more efficient vehicles. Sales of sedans overtook pick-up truck and SUV sales in the US by the end of last year.

Since the demand-supply imbalances and refining capacity shortages have already been factored into current crude prices, the scope for increased speculative activity in oil is limited. Unless there is a major political or natural disturbance in any of the large oil producing countries, average crude prices should remain at the current levels this year.

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2006: A stable and promising year beckons