International Forecaster Weekly

India on the Brink

Although there is no indication that things are that bad this time around, such a move were it to take place would be disastrous for a country that was supposed to follow in China's footsteps as an emerging economy that would lead the developing world in growth as it pulled itself out of poverty.

James Corbett | August 24, 2013

Far from being a month where the public (and thus the news cycle) goes on holiday, August of 2013 has been a month of incredible tumult, turmoil and upheaval around the world. The fate of Egypt continues to hang in the balance as the murderous military regime does battle with the authoritarian Muslim Brotherhood, squeezing the public in the middle. The Syrian situation threatens to explode once again, with reports and images suggesting a horrific (and highly dubious) chemical weapons attack has upset the balance of power in that NATO-backed overthrow of Assad's government. The European sovereign debt crisis continues to simmer, with a third Greek bailout package looking more and more inevitable even as Greek unemployment hits record highs. Meanwhile back in the States, further indications of the NSA's unconstitutional abuses continue to emerge while the UK government shows they are willing to go to extraordinary lengths to take part in the crackdown on journalism.

            With all of this turmoil, perhaps it is unsurprising that the pending collapse of a major developing economy is receiving scant notice in the international press. But, sadly, this is exactly what is taking place in India, once the proud middle of the seemingly world-conquering BRICS nations, now reduced to that increasingly marginalized groupings' least stable member. Anyway you slice it, the Indian economy is in deep trouble, and the rosy projections of 8-9% GDP growth that were made just five years ago have proven not only incorrect, but laughably so.

            Some have compared India's situation today to that of its economic crisis in 1991: a plummeting rupee; policy paralysis; rampant corruption; a burgeoning current account deficit. Indian PM Manmohan Singh is quick to deny the comparisons: “There is no question of going back to 1991,” he reassured the country last Saturday. “At that time foreign exchange in India was a fixed rate. Now it is linked to market. We only correct the volatility of the rupee.” And he should know. In 1991 Singh was the Finance Minister who helped pull the country out of its tailspin. This time around, however, it's his political legacy on the line and his denials have to be taken with a grain of salt.

            The truth is that India is facing a growing current account deficit, a rupee in freefall, a worrying inflation rate and even more worrying capital outflow problem. To end the 1991 crisis, India was forced to turn to the IMF for a loan. Although there is no indication that things are that bad this time around, such a move were it to take place would be disastrous for a country that was supposed to follow in China's footsteps as an emerging economy that would lead the developing world in growth as it pulled itself out of poverty.

            To be fair, the origins of this crisis cannot be laid solely at the feet of Singh's government. Suggestions that the Federal Reserve will begin tapering its ongoing easing efforts later this year has caused a buoying of the US dollar and a subsequent outflow of funds from emerging markets generally as they are repatriated to the States. That outflow has helped spur the rupee crash, with the currency hitting record lows after having shed 40% of its value in two years. This has caused an attendant fall in the Bombay Stock Exchange. The subsequent rise of US treasury yields has been the second part of this double-whammy, as US treasury rates factor into capital costs globally, making it even harder for India to finance its own debt, expected to run over US$250 billion over the course of the coming year.

            But as much as these factors have been out of the control of Singh's government, it is governmental incompetence, inaction, and overreach that have brought it to the brink of economic crisis. India has never been known as a country conducive to business. Its bureaucratic red tape and inflexible labor and energy markets are the stuff of lore. Rather than utilize the boom years of the past decade to streamline its economy and prepare it for the growth that they were expecting, however, they actually managed to make things worse. Not only has shoddy infrastructure not been significantly improved, the corruption and red tape that are so much a hallmark of the Indian economy have actually grown worse. As a result, the recent volatility has had devestating effects. Inflation is now running at 10%, while growth is down to 4% and slowing. Capital investments (both foreign and domestic) are being slashed, and now the government is worrying about how to stop the bleeding.

           The government's responses to these setbacks have been pathetic at best. Comically insignificant measures, including a 36% tax on flatscreen TVs, are just the tip of the iceberg. More worrying by far are capital control measures that the government is bending over backwards to deny are capital controls, including limits on the quantity of funds businesses and individuals can move out of the country. Moves this past week by the Reserve Bank of India to calm markets by selling dollars, buying bonds, and reassuring the country that there would be no new capital controls seem belated at best.

            To make matters worse, India also happens to find itself in the midst of a giant (and growing) housing bubble. Year on year growth in the housing market is slowing down somewhat, but only marginally, and prices continue to expand. Compounded growth since March 2009 shows the housing market growing at an annualized rate of 21%, with prices having doubled in that time. And now the bubble is showing signs of popping; quarter on quarter growth has slowed to its second lowest level on record and as credit contracts, the wave of defaults is going to turn the market red.

            In all of this mess, gold has become one of the targets of the current administration. Blaming the ballooning current account deficit on gold imports in the famously gold-crazy nation, the government has taken a series of measures to curb gold imports. In January the government raised duties on both gold imports and raw gold. On March 1st India's finance minister made a personal appeal to the nation to stop buying so much gold. In June they increased gold import duties once again. Later in June India's largest jewelers association enacted a voluntary ban on the sale of gold coins and bars. Then on August 13th they raised the gold import duty yet again and the following day banned import of coins and medallions. Add to all of this the fact that the weakening rupee has led to increases in the price of gold throughout the country, and it is staggering to find that India's gold consumption actually rose to 310 tonnes in Q2, the highest quarterly consumption rate in the past decade. Now, experts are warning that all of the increases in gold duties are less likely to curb demand for the yellow metal and more likely to raise the amount that is smuggled into the country illegally this year.

            So what is the way out of this mess? In years past, analysts may have looked to India's BRICS brethren to come riding to its rescue in this time of crisis. The BRICS, after all, were supposed to take over the world, parlaying phenomenal growth rates in the past decade into a game-changing upending of the world economy by the latter half of the century. This is no longer the case. Now analysts are openly turning their back on the BRICS concept, with the likes of bigshot Indian investment manager Ruchir Sharma claiming that the BRICS era is now over. It's hard to argue with that assessment, especially when looking at the numbers. All of the BRICS members have taken a hit as foreign investment (fueled in recent years by quantitative easing in the US, Europe and elsewhere) begins to flock back to supposedly safer ground in the USA, leaving the formerly high-flying developing nations in the difficult position of having to transform from export-driven economies dependent on foreign capital to self-sufficient economies driven by internal demand. China is the only one even remotely capable of doing that, and even that is questionable at this point. As for the BRICS nations banding together at this crucial juncture, there seems to be little hope of that either. The South African Trade and Industries Minister was recently quoted sniping at India, saying that their instability is dragging the whole grouping down.

            Indians or those looking to invest in India may want to find some bright spot in all of this to console themselves with. Some take solace in the fact that export growth last month reduced the trade deficit ever so slightly. Others point to the recent appointment of Raghuram Rajan, a forward-thinking economist who predicted both the global slowdown and the current Indian slowdown, as governor of the Reserve Bank of India. Yet others take solace in upcoming elections, due to take place before May of next year, that will give the country a chance to wipe the slate clean.

            In reality, none of these factors are likely to prevent the severe correction that is coming to India. The real solace, it seems, is to be found in the long view. After all, just as the crisis of 1991 helped motivate reforms that eventually set the stage for the growth of the last decade, so too can this crisis be used to motivate true market reforms that will encourage the investment that the country's capital markets so sorely need. It may be little consolation to the billion plus Indians who will have to suffer through this crisis, but it may be all they have for the moment.