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Updated: August 10, 2013 00:31 IST

Crisis looms on the horizon

Prem Shankar Jha
Comment (25)   ·   print   ·   T  T  
The Hindu

With the RBI refusing to lower interest rates, foreign investors have lost confidence in the government, and speculation on the rupee has mounted

Till barely a month ago, industry was pleading with the Reserve Bank of India to end the high interest rate regime that has brought its growth to a standstill and caused a wholesale flight of savings from the share market into land and gold. So the most puzzling feature of its reaction to the RBI’s July 30 decision to keep policy interest rates unchanged has been its silence.

Dire threat

This curious reversal begins to make sense only when seen against the backdrop of the dire threat the Indian economy now faces. This is the imminence of a foreign exchange crisis that can wreck the economy in much the same way as the 1990-91 crisis almost did. The parallels between 2013 and 1991 are striking. At close to $400 billion, India’s foreign debt is a third larger than its reserves. The short-term component of the debt has risen sharply in the last two years. Partly because of this, the servicing of the debt will absorb a staggering 59 per cent — $169 billion — of the country’s total reserves in the coming 12 months. To this must be added a deficit in the current account balance of payments that had risen alarmingly to $88 billion — 4.8 per cent of the GDP — in 2012-13. It is no surprise, therefore, that hedge funds abroad have begun to circle the Indian economy, sensing the possibility of another “kill.”

A foreign exchange crisis now will be far more damaging than the crisis of 1991. In 1990, when Iraq’s invasion of Kuwait triggered the crisis, industry was growing at 12.8 per cent. What is more, Indian companies had raised no capital abroad. So the foreign exchange crisis did not threaten them directly with insolvency. All they needed to resume growth was a renewed supply of foreign exchange and the freedom to grow.

Today, industry’s growth rate has been below one per cent for 20 months. So it has little of the resilience that it had in 1992. But what is giving India’s entrepreneurs nightmares is the foreign debt they have contracted since 2006-07. The outstanding amount is now $140 billion and the rupee’s fall is making this increasingly difficult to service and repay. What is worse, all but a fraction of the debt has been incurred by around 100 large Indian firms that also account for close to 70 per cent of the domestic credit extended by commercial banks. If a rising debt service burden abroad forces them into insolvency, it will create a domestic liquidity crisis that will bring bank-lending to industry to a halt.

For the embattled firms, the only way out will be to sell their prize assets. Since there will be many sellers and few buyers, this sale will take place at bargain basement prices and, as happened in Thailand and Indonesia in 1998-99, foreign companies will cherry-pick the best of them. Suzlon’s attempts to stave off bankruptcy by selling three quarters of its Indian assets, and Jet Airways’ agreement to sell Etihad Airways a controlling share in the company are therefore only harbingers of the flood that will follow.

This catastrophe can be averted only by reversing the outflow of capital from the country. For that to happen, foreign institutional investors have to start believing once again that they can make money by investing in the Indian economy. They will do so only when share prices begin a sustained rise. For this to happen, there must be a revival of demand and investment in the economy. And this, in turn, will only happen if the RBI brings interest rates sharply down.

Had the RBI cut rates two years ago when the rupee was at 44.15 to the dollar and foreign exchange reserves were comfortably in excess of debt, FIIs would not have needed much convincing. But today the government needs to combine a cut in interest rates with steps to bring down the current account BoP deficit (CAD) sharply, and reduce the private sector’s exposure to debt. For only then will investors feel reassured that the rise in imports that will accompany a revival of demand and investment will not tip India over into a balance of payments crisis.

Need for decisive action

The need of the hour, therefore, is coordinated and decisive action on several fronts. But the government’s responses have been uncoordinated and almost entirely reactive. Over six weeks, the government and the RBI have quadrupled the customs duty on gold and limited its imports to five times the export of ornaments and jewellery; eased the entry of foreign direct investment into 12 sectors and raised the interest rate on bank borrowing from the Marginal Standing Facility by two per cent.

But the RBI has refused to lower interest rates and Delhi has remained a helpless spectator. It is no surprise therefore that confidence in the government’s capacity to manage the economy has seeped away and speculative pressures on the rupee have mounted steadily.

In June, $9 billion of foreign capital left the equity and debt markets. Since then, the pessimism abroad about India’s future has deepened. One indicator of how deep it runs is that on July 30, when the RBI again did not lower the interest rates, commercial banks borrowed Rs 26,500 crore — $4.25 billion — from the Marginal Standing Facility at 10.25 per cent to enable their depositors to buy dollars. As the French bank, Credit Agricole, put it, “the situation in India is quickly turning into a vicious circle. […] Higher rates […] lead to higher debt-servicing cost and worsening fundamentals (such as slackening demand and higher investment risk), which are the root cause of the rupee’s weakness.” Not surprisingly, the rupee ended almost 3 per cent lower in a single day.

Unsuccessful attempts

Delhi’s attempts to attract FDI have been equally unsuccessful. On the very day that it eased FDI entry in 12 sectors of industry, Posco, the Korean steel giant, pulled out of its 6 million tonne steel plant venture in India. Arcelor Mittal followed a day later. Walmart has yet to invest a single dollar in the retail sector.

India still has one shield against catastrophe — the rupee’s lack of full capital account convertibility. By slowing down the fall of the rupee it is once more buying the government time, as it did in 1997, to turn the economy around. If the government acts decisively now, it can do so with relative ease. India is already well on the way to reducing the CAD, for the import of gold has fallen from $7 billion in April and 8.4 billion in May to $2.45 billion in June and about $4 billion in July.

Since gold and jewellery exports totalled $70 billion last year, the pegging of gold imports to jewellery exports is likely to bring future imports of gold from the current 800-1000 tonnes to between 300 and 400 tonnes a year. This will cut the import bill by $25 billion to 30 billion.

There has also been a seven per cent drop in the price of oil and an 11 per cent drop in those of industrial inputs since January. This should shave another $ 15 billion off the import bill. Exports also seem set to rise by about 10 per cent. India does not therefore need to do much more to limit the CAD to 2.5 per cent of the GDP.

Another measure that can ease the pressure on the rupee is the closure of the automatic approval route for external commercial borrowing, till stability is restored. This will halve new borrowing and give the RBI more room for manoeuvre.

But all of these will prove to be temporary palliatives if the RBI does not lower interest rates, not two months from now as it has ‘half-promised’ but within days. For till FIIs sense the possibility of making money on rising share prices once again, the pressure on the rupee will continue to grow until it overwhelms the puny defences the government has set up.

(The writer is a senior journalist)

More In: Lead | Opinion

Falling crude price and making Gold import difficult by Govt will certainly cut down our import bill but CAD is not the real elephant in the room at least for now but rupee devaluation is.
Rupee devaluation is good for export based economy but Govt should act swiftly to calm the volatility of the market and work closely with RBI to invent measure to arrest foreign capital outflow trend.

from:  Saurabh Souran
Posted on: Aug 12, 2013 at 00:33 IST

This revives the debate should we be so much dependent on Foreign
Investment for our growth? Should we not focus more on self-reliance ?

When we are dependent on others, the technology and products are so
expensive. eg: Russian Aircraft Carrier almost doubled from earlier
prices. The nuclear subs we leased in 1990s were taken abruptly.

Now that we are able to make world class missiles, nuclear subs the
other nations are keen to collaborate with us.

In long term strategy, domestic driven growth, with the empowered
citizen makes the nation far more stronger.

from:  ARUN
Posted on: Aug 11, 2013 at 22:14 IST

Reducing interest rates will make the rupee fall even further specially
now long term interst rates in US is going up.

from:  Anurag
Posted on: Aug 11, 2013 at 18:01 IST

India should concentrate on domestic oil and gas exploration for long term stability.India should have medium term target to reduce oil imports to 40 percent of domestic demand and the rest to be produced in india. India should concentrate on mass tranport system because india's energy needs in future are going to rise only.Also india should move to full conertibility although fiscal deficit wont allow it right now,but we can strart with Financial SEZ where full convertibility is allowed in that zone. The idea should be to create demand for indian rupees in world markets.All the solutions are for medium term with no overnight remedy.We should earn foreign exchange for our imports instead of relying on borrowed money for our imports else it will have the potential to create crisis every 7-8 years on external front.


from:  hemal
Posted on: Aug 11, 2013 at 12:41 IST

I think RBI has other things in mind like checking inflation and price
rise. It cannot lower the interest rates just to make FII and other
investors happy. It has to take the side of both the corporate sector
and middle class.

from:  Tanish
Posted on: Aug 10, 2013 at 23:41 IST

The first question that comes to mind after reading the article is what about inflation?Let's not forget that it's the common man who feels the greatest pinch of inflation.Also the author seems to suggest that short term repo rate is the only basis on which a FII investor makes his decission. Though insightful at places like the relation between external debt and internal banking system the article seems to be uni dimmensional

from:  Anton Babu
Posted on: Aug 10, 2013 at 23:36 IST

Despite opening of FDI sector in retail why retails giants are not
putting single penny in India? The fact is opposition is equally
culprit in making rules stringent for FDI. Retail giants are waiting
for best time to invest in India because they know country's economy
and growth are in tailspin. At any cost country needs dollars to curb
CAD. India's manufacturing is in shambles this is can be prove by the
fact that even an ID card cover is imported from China. Trade
imbalance is eating FOREX reserves and that depreciation of rupee
further fueled by plausible FIIs.

from:  Rakesh Kumar
Posted on: Aug 10, 2013 at 22:00 IST

Another big difference between 1991 and today is there are no attractive places in which for foreign capital to invest. In 1991 there was the growing software and services boom> It is now saturated. The Government should have created opportunities for infrastructure development-- roads, water by river linking and recycling, renewable energy (solar) and waste management. This would have created job growth as well as attracted foreign investment. I say this based on participation in international programs like the GIBM (Global Indian Business Meet) a year ago where these ideas were voiced.
Where will foreign investors put their money today? In 1960s type failed programs like MNREGA, the Food Security Bill? All are spendthrift programs. FDI in retail will be a drop in the bucket even if it succeeds.
Of all the Government's misdeeds, the neglect of infrastructure and squandering resources on unproductive programs is the worst-- putting the clock back by 20 years.

from:  N.S. Rajaram
Posted on: Aug 10, 2013 at 18:08 IST

India is not America who can print notes and increase debt to create
chaotic financial condition later on.

from:  Ashok
Posted on: Aug 10, 2013 at 18:03 IST

our tax policies particularly the service tax has to be reviewed..by
charging reverse taxes for foreign services,govt has made foreign
services very expensive..foreigners are afraid to get into India..other
countries do not do this..our govt is collecting too much money by way
of service tax,taxing anything in site,curtailing growth particularly
cross border transactions..this mind set to pluck as much as possible
from foreigners,consultants has got to go.Hope the next govt does
something about this.

from:  kannan
Posted on: Aug 10, 2013 at 18:02 IST


I think the author is right in pointing out the danger that lies ahead.
It may be a little heartening to note that there's a slight improvement on the CAD or BoP front, thanks particularly to the rigorous measures on import of gold, but there's no room for complacency. Instead of letting the situation drift, the Government, the economists and planners and the RBI, and also the industry bodies should get together to see how to regain the confidence of investors, particularly FDI. We can't afford to have another precarious economic situation repeated, we have come a long way too far by now. No one can suggest quick fix but a mix hard regulatory measures to curb unproductive and avoidable expenditures (like gold, crudes) and a judicious, cautious slew of proposals to attract FDI have to be reinvented. Even if it means tight rationing in some areas, and somewhat liberal concessions for selective foreign investments, with more investments on infrastructure and manufacturing sectors.

from:  M. Shankar
Posted on: Aug 10, 2013 at 17:04 IST

the notion that only big business can redeem the economy is a myth, which this article seems to reiterate. a skewed one dimensional analysis.

from:  S.Ezhil
Posted on: Aug 10, 2013 at 15:09 IST

RBI is watchdog,acts on the ground realities & propagation of government policies. RBI has consistently informed government during last three years to act on its policies and bring the inflation and CAD under control, but was unheeded due to policy paralysis due to instability of government, thus the author is erroneous on putting the whole blame on RBI. Leave aside the industries (which any way is not doing charity and will pass on the enhanced cost to consumers) and think of the faith of common man on government when the rate of inflation is plus 10 % and rate of interest of borrowing is minus 7% all during the periods.
The solution would be increase exports, decrease imports, decrease CAD, decrease inflation (govt control), enhance domestic savings, less reliance on FII (short term gainers), manufacturing in technology oriented sectors, propagate the South Korean model business operations of Indian companies to grow and earn foreign currencies instead on only local dependance.

from:  Mukesh
Posted on: Aug 10, 2013 at 14:53 IST

immeditate step to dose fire is to to reduce the interest rate cosiderably so that
industry and economy will improve supply will increse and FII's will bring foreign
exchange .we have to produce more what is consumed by general public so that
consumer inflation will come down.Govt is always talking about relaxing norms for
FDI and opening retail and defence sector to bring foreign exchange instead
concentrate to boost expors in the same way Japan and china are doing.It is
unfortunate Govt is not even talking about this.Govt allowied Bans and post offices
to import Gold and sell customer that tempted people to consider gold as investment
destination and this made the matter worst.Now we are paying the price.

from:  N.Swaminathan
Posted on: Aug 10, 2013 at 13:53 IST

The much concern raised about the ballooning CAD affecting macroeconomic stability has not been carefully redressed and a plethora of expectation is being made towards the RBI to calibrate its monitory policy to promote growth sustainibilty.It is intended to emphasise that monitory policy is but only a part of the financial policy.Actions taken pertaining to improvement of the twin deficits of CAD and Fiscal Deficit instil little confidence.What we done so far to convert the challenges of declining rupee into an opportunity for accelerating exports.By the same token the effort to rationalise the composition of subsidy is not substantialy reflective in policy interventions barring a few.The import bill of oil and petrolium products seems incapable to be rationalised under the duress of import lobby.No cosequential action is in the sight regarding the "White Report(Paper)" on "black money".These are and should be the concerns of the government not the RBI.

from:  R.R. PRABHAKAR
Posted on: Aug 10, 2013 at 12:31 IST

Forgetting everything for a liberal interest rate policy, hoping
every other thing will be okay by just this preference is unfair.
Through the article, there’s too much scaremongering to discomfit
those taking a balanced and informed view of things. (A) Upon
projecting FIIs as a genuine saviour and listing things to please and
pamper them, the article wrongly sees reserves as a debt neutraliser.
When much of those reserves is debt itself, doesn’t the whole idea
seem like a Ponzi scheme? (B) In India, there isn’t much money going
to ‘the share market’ as into bank deposits and, of course, gold and
land. With lower interest rates meaning reduced returns on bank
deposits, won’t the remedy be worse than the disease? (C) ‘Demand’
does lift things up, but the case isn’t that everything else is hunky-
dory and demand is waiting for that little dilation lower rates can
give for it to show up. (D) And demand is a problem worldwide, which
is the real reason for Posco’s and Arcelor’s quitting.

from:  Devraj Sambasivan
Posted on: Aug 10, 2013 at 12:22 IST

The thesis that only industry friendly policies would ensure growth
has been turned on its head in recent months. The inflation is
affecting very badly those whose pockets the government is trying to
target: the middle class. On the one hand our so called burgeoning
economy has created multi billionaires whereas on the other the common
people are struggling to cope with increasing prices.

Inflation is engendered by those very companies who seek cheap credit,
by increasing the product rates astronomically. Who is talking of the
biggest sham of independent India on the people : the wayward MRP
indicated on the consumer products and drugs which are several times
more than the actual selling price? Who are we helping by demanding a
reduction in interest rates?

from:  Shivaram Nayak
Posted on: Aug 10, 2013 at 12:00 IST

The article completely/wilfully ignores even mentioning the reason why RBI didn't lower the rates..Inflation.. Persistent high inflation has eroded what was india's biggest asset the high household savings forcing small households to invest in the only asset they believe was an hedge against inflation, gold..This again has led to huge impoer bills and CAD..Lowering interest rates would force the remaining folks away from the banks to physical assets..

from:  Pradeep
Posted on: Aug 10, 2013 at 09:31 IST

This commentary addresses only one side of the equation. Monetary stimulus in the form of reducing the rates will most likely create more inflation . This is the time for a balanced approach and RBI's wait and see attitude is better than some knee jerk reaction.

from:  Sankar
Posted on: Aug 10, 2013 at 08:52 IST

While these measures will help stave off a crisis in the short term, it
does not provide a long term solution. The economy needs a healthy dose
of reforms, and preferably an end to the populism of the food security
bill. It is often said that India does not reform until there is a
crisis. Well here is to hoping for a crisis. It should help the economy
in the long term by initiating much needed reforms that will help in the
economy in the long term while kicking the Congress out after 5 years of
absolute incompetence.

from:  Anuj Shah
Posted on: Aug 10, 2013 at 08:50 IST


Prem Shankar Jha points out "the imminence of a foreign exchange crisis
that can wreck the economy in much the same way as the 1990-91 crisis
almost did". Another report in today's paper explains how Robert Vadra
executed sham transactions for land in Gurgaon. Maladministration and
rampant corruption seem to mark the rule of the UPA government. Where do
we go from here?

from:  K.Vijayakumar
Posted on: Aug 10, 2013 at 07:37 IST

Politics play a huge role which the author has not dealt on. Only monetary policies have been stated. India should increase its exports fast in order to earn foreign exchange and make it available for importers so in the first instance the huge deficit on the trade front will be taken care off. The trade deficit is not sustainable and will lead to the collapse of the Indian economy. Countries which provide a market for Indian commodities, both engineering and otherwise should be targeted. Companies like L & T instead misinforming the public of getting huge contracts in Iran and Saudi Arabia to increase their market share values should be more honest. Iran and Pakistan should not be be targeted for exports. Instead more friendly countries such as Iraq, Saudi Arabia, South America,Africa, etc should be targeted. Oil imports from Iran should be brought to a halt immediately as the country will never be a major market of Indian goods. Only the corrupt bureaucrats who take a cut enjoy the benfits.

from:  Singh
Posted on: Aug 10, 2013 at 07:34 IST

Whenever a currency falls,the interest rates must be raised.This is the
advice of all economists and IMF etc.How this author is asking to lower
rates?

from:  dr.r.p.rajan
Posted on: Aug 10, 2013 at 06:22 IST

I am surprized that the author didn't touch upon the impact of lower interest rate on inflation.
The flip side of lowering the interest rate is that already high inflation would be even higher
that would kill the economy also. Depending on short term FII is short sighted and temporary
at best, India cannot possibly continue depend on that form of investment to cover for high
CAD and BoP. Only structural changes as addressing infrastructure and policy bottlenecks
or rampant corruption that puts a high price on doing business that drive away FDI like
Posco or ArcellorMittal or fails to get even single multibrand retail investment need to be
addressed in an urgent basis, coupled with removing govt red tapes and liberalizing labour
laws need to happen to allow for mass manufacturing in the country to make domestic
manufacturing competitive to allow for larger export. India needs to be able to pay for its
massive imports of oil, defense armaments and gold if it is to have long term security

from:  Suvojit Dutta
Posted on: Aug 10, 2013 at 04:32 IST

The author argues that RBI should have reduced interest rates 2 years
ago..If that would have been done economy would have been in a better
shape but at what cost? Inflation was ruling at that time and reducing
rates would've hurt only the lower strata of the society...
Further, it is correctly argued that the economy is being undone due to
large scale investments of FII which are fleeting... I think this is
the time India starts raising domestic capital and avoid dependence on
FII... FIIs are primarily short term and they would always turn away on
a smallest sign of crisis...

from:  Rahul Jareda
Posted on: Aug 10, 2013 at 02:32 IST
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