European crisis: is India de-coupled?

November 11, 2011 / By  

The world has pondered, time and again, whether the recovery since the Global Financial Crisis is a bear market rally, a sort of dead cat bounce, with a possible “double-dip” dominating the jargon of economists, policy makers and researchers. Since 2009, several events have induced the possibility of another slowdown – the likely default by Dubai World in December 2009, sovereign debt crisis in the PIGS (Portugal, Italy, Greece and Spain) nations and the debt downgrade of the USA in 2011. Most agree that if measures of restructuring and bailout fail, Greece might eventually default, also leading to its eviction from the Eurozone by end of the year. What is linked to a credit event such as this is the likely contagion that would spread to other vulnerable sovereign states, the foremost being Italy. Demand in European nations would contract, as they get drawn inwards, focus on their own backyard and put austerity measures in place, having implications of political instability.

With all this happening in Europe, the Lorenz question on contagion in global financial market arises: “Does the flap of a butterfly’s wings in Europe set off a tornado in Indian real estate?” Indian real estate, as was witnessed in 2009, is not “decoupled” from global events. Despite the fact that India’s GDP grew by 6.7% in 2009, rents of office and retail space fell by 40%-50% and absorption of office space fell by over 40% from 33.1 msf in 2008 to 19.6 msf in 2009. A confluence of global events, high deficits and stagnation in the residential sector might lead to a difficult 2012 for the real estate industry in India.

      – Nearly 50% of the demand for investment grade office space in India is

contributed by the Information Technology (IT/ITeS) sector

      . Over 80-90% of the revenues of the IT & BPO sector

come from North America and Europe

      , which are the worst affected in the current sovereign debt crisis.

– Over 70% of the demand for investment grade office space in India is contributed by firms which are headquartered abroad. Many of them thrive on domestic demand; however, severe demand contraction in their parent countries will definitely push them to exercise caution.

– India’s high twin deficit of fiscal and current account is not only a threat to its growth, but has also reduced the ammunition that it has for facing a possible contraction of demand from foreign countries.

– The rapid increase in prices and monetary tightening by the Government has led to stagnation in prime residential markets, which is facing slowing sale velocities and lesser housing starts in metropolitan cities. Having leveraged themselves extensively, if demand contracts in the office sector, developers can’t rely on sales from residential to sail them through this time around.

However, there are certain upsides to the downside as well.

      – While absorption levels improved in 2010 to regain those witnessed in 2008, the supply overhang ensured that rents remain stable. Hence, the downside risk remains muted, as rents are already at their cyclical lows across most active markets.

– The short term devaluation of the Indian Rupee has made Indian exports more attractive, and should help the IT/ITeS industry favourably over the next 6-9 months. It will also make Foreign Direct Investments in India cheaper. However, it will nullify the effect of the expected decline in oil prices, which could have helped domestic inflationary concerns somewhat.

– The Reserve Bank of India has always been a very conservative regulator, which is evident from the monetary tightening during 2010-2011. It has enough leeway to infuse liquidity by cutting interest rates, which will directly benefit the residential sector.

The 2008 crisis is so fresh in the public memory, that a collaborative effort is visibly seen in the attitude of governments worldwide and policymakers are tactfully taking steps to prevent a Lehman-scale bankruptcy. Only time can tell if this collective wisdom and consciousness can change those initial conditions of the Lorenz Attractor, that can significantly alter its eventual shape. For now, the step ahead is to remain cautious!

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