Moderately opened economy has proved always good for India - be it Asian Economy Meltdown or Current Credit Mess. Here is an interesting insight on how India could be less affected in the current global economic crisis (Courtesy: Economis.com).
How India could benefit in the long termThe global financial crisis has hit Indian stockmarkets hard. By October 13th the country's benchmark indices had fallen some 50% from the record heights they scaled in early January 2008. India's second-largest lender, ICICI Bank, has suffered a sharp drop in its shares following rumours that it is over-exposed to toxic US and UK assets. Equity outflows from foreign institutional investors (FIIs) during 2008 so far are a net US$9.9bn, compared with net inflows of US$17.4bn in 2007.
This painful erosion of investor wealth and confidence is not the only fall-out in India of the global panic. The rupee has been depreciating rapidly against the US dollar, owing to the global dollar liquidity shortage, heavy outflows from FIIs looking to transfer funds home, and purchases of dollars by Indian banks to fund their overseas operations. By early October the rupee had slumped to a six-year low, negating the recent fall in crude oil prices and keeping India's oil-import bill high. The continuing depreciation means that the Reserve Bank of India (RBI, the central bank) must keep up its heavy intervention in the foreign-exchange market to stop the rupee from falling too sharply.
To do that, the RBI sometimes sells as much as US$2bn in a single day through state-owned banks. But this is creating a different problem: it is sucking out rupee liquidity from the system, despite the RBI's stepped-up daily repurchase operations to inject funds into the market. Equal pressure comes from high government borrowings, sustained credit demand and the RBI's frequent recent interest-rate hikes aimed at controlling inflation. As a result, local liquidity has tightened and rates in the cash market rose to an 18-month high of 17.5% in the first week of October.
Government responseThe government has acted decisively to try to mitigate the situation. On October 6th the Securities and Exchange Board of India removed its year-old restrictions on participatory notes (offshore derivative instruments that allow unregistered foreign investors to invest in Indian stockmarkets). The next day, external commercial borrowing rules were liberalised to include the mining, exploration and refining sectors in the definition of infrastructure. That raised the cap on overseas borrowing for companies in these sectors from US$50m to US$500m—although there may be little international money to borrow.
On October 6th the RBI also unexpectedly cut the cash reserve ratio (CRR, the amount of deposits that banks must keep on reserve with the RBI) by 50 basis points to 8.5%, effective October 11th. The temporary measure was intended to release Rs200bn (US$4.2bn) into the banking system and to ease liquidity. However, that money will be sucked up by the RBI's foreign-exchange interventions and by government bond auctions, rendering the cut more of a confidence booster than much real help. As cash rates soared to 20% and the rupee continued its fall, the RBI increased the CRR cut to 7.5% on October 10th.
Although the government has said that it stands ready to take further measures to ease liquidity, regulators have an opposing but equally urgent priority: the need to contain inflation. Wholesale price inflation touched a 13-year high of 12.6% in early August, driven by higher oil and commodity prices globally, although it fell to under 12% by late September and is expected to moderate further. Record inflation has already prompted the central bank to raise key rates repeatedly.
Economic fall-outHigh interest rates and resulting higher costs—coupled with high oil prices, decelerating global growth, slowing export markets and the global financial turmoil—have taken their toll on India's economy. GDP growth in the first quarter of fiscal year 2007/08 (April-March) was the slowest in over three years, at an annual 7.9%. The government maintains that the economy will grow by almost 8% during the current fiscal year and recover to 9% in 2009/10. Most independent estimates, however, are far less optimistic. The Economist Intelligence Unit expects India's economy to expand by 6.5% in each of the next two fiscal years. This relatively sombre view seemed to be confirmed by the unexpectedly poor industrial production numbers for August released on October 10th.
India may not have escaped the global contagion, but it's not all bad news. After all, GDP growth of around 7% would still put India among the world's fastest-growing economies. Many of India's fundamentals remain sound. During April-August 2008, exports rose 35% in dollar terms, while imports rose 37.7%, indicating sustained demand. Capacity is being added in numerous sectors, including power, steel, oil and cars. Foreign direct investment during April-August 2008 was a record US$14.8bn (a 114% rise over the corresponding period of the previous year), although this could turn very quickly, just as portfolio inflows by FIIs already have. Finally, India's banks are well-capitalised and well-regulated, there is no domestic bad-loan crisis, and Indian banks have only a marginal exposure to overseas credit markets.
Ironically, the current global situation is also making India's measured pace of economic reform look wiser than before. At a time when Western countries are frantically nationalising banking assets, the Indian government's reluctance to sell more than 49% in its state-owned banks—which control some 70% of banking assets—now seems reassuring. In addition, India has not yet introduced full capital-account convertibility, which protects its currency, while its careful control of foreign borrowings by domestic companies limits dependence on the global financial system. Regulators have also periodically introduced curbs to slow the formation of potential asset bubbles, such as higher provisioning and prudential requirements on real-estate lending.
OutlookAll of this might mean that once the dust settles, India is likely to re-emerge as an attractive investment destination. At least in the short term, growth in India's flagship IT-services sector is likely to slow because of the financial-sector crisis. But the rupee's depreciation will help to shore up the profitability of IT and other exporters. More importantly, Indian IT companies, as well those in other industries, are stepping up acquisitions. Strong growth in the past few years has given Indian companies the financial muscle for large acquisitions, just as the global slowdown is putting good international companies on the market. For example, in October 2008 HCL Technologies (India's fifth-largest IT-services firm) outbid Infosys Technologies (India's second-largest IT company) for UK-based Axon. This will be the Indian IT sector's largest outbound merger. At home, meanwhile, India's biggest IT company, Tata Consulting Services (TCS), announced that it would become India's second-largest business-process outsourcing (BPO) company by buying US-based Citigroup's captive Indian BPO, Citigroup Global Services, for US$505m. TCS also agreed a multi-year, US$2.5bn contract to provide Citi with outsourcing services.
Both Indian companies and regulators recognise that India cannot escape the global meltdown. However, Indian companies are looking for opportunity in the crisis, while regulators remain on standby to ease conditions as much as possible. That, perhaps, is as much as anyone can do in the current situation.
