October 2013 Issue
The Indian rupee, the worst performing currency of all the emerging markets, fell dramatically throughout August, leading many to believe that the nation stands on the edge of a financial precipice.
The US Federal Reserve’s announcement in May that it intends to reduce monthly bond purchases has exposed the fragility of the economies of not just India, but other emerging markets, all of which have experienced routs in recent months. The removal of the Federal Reserve’s $85bn a month bond buying scheme has served to unnerve investors, leading many to retrench from the emerging markets entirely. Historically, India has benefited enormously from the scheme, which released large amounts of cheap money into the system, much of which gravitated towards emerging markets. In turn, this influx of capital led to unparalleled growth across many regions, particularly the BRIC nations.
However, with the decision to ‘taper’ and eventually end the program of quantitative easing after around five years, many emerging economies have seen their respective currencies and economies plummet. Stock markets have also suffered.
At the time of writing, the rupee had fallen around 20 percent in 2013 as concerns abound about the nation’s burgeoning current account deficit – estimates place India’s deficit at around $70bn to $80bn. The scale of the deficit means the Indian economy is particularly susceptible to shifts in investor attitudes. In recent years the Indian government has also amassed a considerable amount of debt. The Mumbai stock market, the Sensex index, has dropped throughout the summer; with Indian stocks losing 10 percent of their value. The total valuation of listed companies in India also fell below $1 trillion.
Furthering the nation’s economic gloom, India’s gross domestic product (GDP) rose by just 4.4 percent in the three months to 30 June, down from the 4.8 percent growth witnessed in the first quarter of 2013. In the 2012-2013 financial year, the Indian economy grew at an annual rate of 5 percent, the slowest pace for a decade.
In response to the growing economic malaise, the Indian government has introduced a number of new measures which are direct attempts to stop the outflow of investor money. Although the measures do stop short of imposing capital controls on investors, they are still quite restrictive. “There’s no cause for the panic that seems to have gripped the currency market and is feeding into other markets,” said Indian finance minister Palaniappan Chidambaram. “There was, and there is, no intention to introduce any type of capital controls”.
Despite these calming words, on the 14 August the Reserve Bank of India moved to limit outward direct investment by limiting the ability of Indian individuals and firms to take money out of the country. And although this measure currently applies only to Indian nationals, it has served to further spook foreign investors. International investors have withdrawn nearly $12bn in shares and debt from India’s markets since the beginning of June.
The limit on personal remittances for Indians has been cut to $75,000 per year, down from $200,000 per year. Companies have also been banned from spending more than their own book value on direct investments abroad unless that spend has been authorised by the central bank. The reserve bank has increased import duties on gold three times as a means of encouraging financial stability. The central bank also took the decision to inject $1.3bn into the country’s financial system by acquiring long term government bonds in August. The move is expected to make credit more readily available while also lowering borrowing costs for the government.
In late August the Indian government approved infrastructure projects worth $28.4bn in an attempt to revive the economy and boost the falling rupee. Projects in the oil, gas, power, road and railway sectors were all green lit by the government. However, just one day later the rupee fell by nearly 4 percent to a new low of 68.7 to the US dollar. This drop represents an almost 20 year low for the currency.
If the measures announced are to have a significant, positive impact on the economy, it is vital that the Indian finance ministry and central bank clarify and reinforce the position of foreign investors who will remain immune to the tightening of capital controls. It is crucial that the fears of foreign investors be allayed as they currently own roughly half of all freely traded Indian shares. Furthermore, India is currently in desperate need of reform. Although much work has been done to improve the situation, in many areas the economy is still bogged down in bureaucracy, regulation and corruption. Land reforms and labour market liberalisation are also required.
With a general election due in May 2014, it is unlikely that the government will enact any vigorous economic or social reforms that could threaten the position of the ruling Congress Party. However, with the spectre of an Indian financial crisis looming, many are calling for more direct and definitive action from the Indian government.
© Financier Worldwide
BY
Richard Summerfield