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WHAT 2011 MIGHT HOLD

The year 2010 has been a strange one in many ways — a year that flattered to deceive and that belied the expectations and optimism with which it had started. The report card is straightforward. The political stock of the UPA fell suddenly after the second half of the year with one scam after another and the results of the Bihar elections. The Opposition, on the back foot for much of the year, suddenly found its voice with its performance in Bihar and its combined demand for a JPC probe into the 2G scam.

The stock market has done little being up by 12% for the year at the time of writing this, despite record inflows of FII money — more than $25 billion. And this, after doubling last year. In sports, the CWG was both a fiasco and a success, while in the Asian Games we got only one seventh of the medals won by the Chinese — but which were yet declared a success for us — “record medals in the Asian Games, surpassing Doha and Delhi” — despite there being 20% more medals on offer.

The media and the Supreme Court moved into front row in terms of protecting civil society from the depradations of the ruling class and becoming our moral champions. We had a telecom success in auctioning 3G spectrum and raising Rs 70,000 crore, but that only highlighted the losses of 2G which is anywhere between Rs 70,000 crore and Rs 1,70,000 crore. The selling of stakes in state companies such as Coal India went on successfully, but sales of other state-owned assets such as land and mining assets continued amidst patronage and cronyism.

The economy grew at more than 8%, but inflation kept pace. The monsoon rains were robust and agricultural growth will be higher, at 4% this year. Interest rates, however, continue to rise, aided by foreign inflows. Globally as well, risks continued to ebb and flow based on the latest eurozone fortunes.

The US also had its share of problems with President Barack Obama’s popularity waning, the Congress changing hands to Republican leadership, thus setting the stage for even tougher policymaking. Meanwhile, China is now the second largest economy in the world, but there is a large amount of government stimulus spending going on that has been creating excess capacities.

Central banks in the developed world continues to pump liquidity into their economies with buybacks and phenomenally low interest rates. This should weaken their currencies, but their biggest trading partner, China, continues to cling limpet-like to the US dollar, thus pretty much frustrating a large part of the US strategy. Yet, the dollar strengthens on the back of risk aversion, making the task of the US policymakers that much harder.

On the geopolitical front, the war in Afghanistan continues, Osama continues to evade Obama, while Pakistan continues to propagate terrorists. Whether this is a state strategy or that of certain elements in Pakistan is not clear — after all, which clear thinking state would want to create a weapon which as often as not also targets its home soil as well? North and South Korea keep rattling their sabres, while nuclear weapons apparently continue to proliferate into newer countries.

Into this already seething mix, we had the release of the Wikileaks tapes and closer home, the Radia tapes. The US administration was put into the embarrassing position of having to explain the exposed inner most workings of US diplomacy. However, for the domestic observer, the Radia tapes were much more fun, shall we say?

Journalists, corporate chieftains, lobbyists, ministers — were all exposed saying things they never would have in public even if they were true. The taped conversations exposed the seamier side of the nexus between business and politics, lobbyists and journalists and have raised a series of ethical questions.

WHAT does the outlook for next year look like? Macro uncertainty continues , notwithstanding growth of 8%. It is masking poor macroeconomic management with inflation continuing to stay unabated into next year and thereby, interest rates as well.

Consumption-driven sectors will continue to drive the economy while investment-driven ones might start to see a slowing as corporates and overseas investors react both to the more volatile investment environment and the lack of new sectoral reform. But one cannot predict yet how the current political situation will resolve itself. It could either lead to a cathartic cleansing of the system from top to bottom that will cause significant short-term anxiety, but which will be healthier for the country and much better in the longer term.

On the other hand, given the involvement of so many in the system, it might be ring-fenced around a few individuals and thereby contained. However, there is the outside probability of significant political volatility and it is impossible to predict which way things will shape up. Early elections cannot be ruled out at this stage. All this will not create a conducive investing environment.

In the US, President Obama is significantly weakened by the loss of his legislative majority and issues around the US housing market and structural budget deficits. These could lead to a sustained US campaign to cheapen its currency. Risks of a double-dip have not yet waned.

In Europe, the UK is taking its bitter medicine by slashing government spending, but Spain is where the worry is, with unemployment at 20% and much less room to maneuver politically. The Spanish economy is the fifth largest in Europe and its problems could have disastrous consequences for the future of the euro. There is a distinct possibility slowdown in China’s growth next year on the back of higher inflation and higher interest rates.

All this could lead to a global risk aversion and counter-intuitively, a flight to the dollar in the short term, and the withdrawal of FII flows from India. But if none of these negative scenarios play out, then markets could gradually find their confidence and after consolidating at current levels could make a break for higher ground.

But given the numerous event risks out there, and the various uncertainties still prevalent, it would be a good time to be cautious. For Indian corporates this would imply avoiding making large acquisitions until the fog clears, and certainly not leveraging their balance sheets with large quantities of debt. This is a time to be cautious, to wait and watch. The year 2011 will definitely hold surprises.

Source: Economic Times