There Won't Be a Crisis in India – Unless It Is In One Already
As readers are probably aware, India's government is trying to "fix" its own economic policy mistakes by curtailing the economic freedom of its citizens, or putting it differently, by adding new mistakes to the old ones. Most prominently, it has slapped large import duties on gold, which has led to a soaring business in gold smuggling (policing India's borders sounds like an impossibility). Recently it has also reduced the amount of money Indian citizens are allowed to send abroad (from $200,000 to $75,000). India's prime minister has recently ruled out "a return of the 1991 crisis," even as the Rupee and Indian government bonds have commenced a free-fall. We believe the old "never believe anything until it's been officially denied" rule applies in this case. Here is a report on the official denial:
“There is 'no question' of India going back to an economic crisis experienced in 1991, as its rupee currency is now linked to the market and foreign exchange reserves are adequate, Prime Minister Manmohan Singh said on Saturday.
Asia's third largest economy is growing at its slowest pace in a decade, while the rupee, the region's worst performer this year, is at an all-time low, and the central bank has enough cash to pay for seven months of imports.
"There is no question of going back to 1991," Singh said in a Press Trust of India report published by the Economic Times newspaper on its website, making reference to a balance of payments crisis the country suffered that year. "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." In 1991, with just enough reserves to cover three weeks of imports, India was forced to pledge its gold in order to pay its bills and had to push through reforms to start opening up the economy.
Singh was finance minister at the time and is widely regarded as the man who saved the economy. The news agency report said Singh acknowledged India's ballooning current account deficit, which he blamed on large imports of gold as a contributing factor. "We seem to be investing a lot in unproductive assets," Singh said.
India is trying to curb its citizens' apparently insatiable demand for gold, through measures such as hiking import duties, banning the import of coins and medallions and making domestic buyers pay cash. The government wants to hold bullion imports this year to "well below" last year's figure of 845 tonnes. Imports by the world's biggest bullion buyer hit a record 162 tonnes in May as global prices fell, prompting a duty increase to 8 percent. Though they then fell to about 31 tonnes in June, imports revived to 47.6 tonnes in July.
India's current account deficit stands at a record high of 4.8 percent of gross domestic product, while economic growth has slowed to 5 percent. Concerns that policymakers were losing control over the currency spread this week to the stock market, which dropped 4 percent on Friday for its biggest one-day decline in nearly two years.”
Right. It's not the fault of the boneheaded policies of the government, it's the "insatiable desire of Indians for gold" that is to blame for the "out of the question crisis." When an official tells you that a crisis is "out of the question," it almost guarantees that a crisis is practically at the doorstep. That seems to be the assessment of the markets as well. It matters little that there are foreign exchange reserves covering seven months of imports – if foreign portfolio flows reverse, which they likely will, this figure can get cut down to much lower levels very quickly. Non-resident inflows overall at $75-80 billion per year are bigger than India's imports.
In a recent analysis on India we have come across, it was noted that the central bank tightened by 200 basis points in July two weeks before the scheduled RBI meeting and a mere 48 hours after seemingly indicating it would loosen policy further. This was apparently a panic move motivated by very large capital outflows. Another important point that was mentioned was that debt in India is comparable to that in Korea anno 1997 (ouch!), with most of it "flying under the radar." We have a feeling this isn't going to end well. Here are a few charts:
A daily chart of the Rupee since May (it was trading at 44 in July 2012).
India's 10-year government bond yield (daily) since June.
5-year CDS on India's SBI Bank, which Fitch upgraded to "stable" in mid June. Doesn't look very stable to us (there are no CDS on government debt, so this can be used as a proxy).
The Sensex Index in Bombay: recently stock market punters (always the last group to realize what's happening) are catching on to the fact that something isn't right.
A Central Banker Will Save Us
In India, we may have another example of how extremely overestimated central bankers and their powers are nowadays. This naïve faith in the omnipotence of central bankers is surely fated to meet with major disappointment fairly soon. The Economist reported happily that "a star economist is put in charge of India's central bank". A satirical magazine in India noted with regard to the central planner's stardom:
“In a stunning development that has left behavioral economists across the world awe-struck, the handsomeness of Raghuram Rajan, the incoming RBI governor, has decisively averted India’s economic crisis. This was how the story unfolded: As soon as Rajan was announced as the new RBI governor, reams of column and editorial space in leading dailies and business journals were devoted to hailing India’s messiah, beseeching the MIT trained economist to, inter alia, tame inflation, halt the slide of the rupee, solve the impending CAD and BoP crisis, reform the financial sector, improve the Indian economy’s competitiveness, open bank accounts for all Indians, pass key bills, build more roads and ports, dig out more coal, prevent rapes, even ‘debottleneck’ the IRCTC server!!
The coverage attained saturation levels with even ToI page 3 devoting an entire section to his good looks and telegenic countenance. Concomitantly, his file photo was flashed on all leading television channels and planted across front pages, catapulting him overnight to super-stardom reserved hitherto for the Khans and, perhaps, Sir Jadeja.”
It seems to us though that things have already developed a dynamic of their own and there isn't much a new central bank head can do about that. He cannot "unmake" the mistakes that have been made in the past.
Note that in parallel with the troubles in India, Thailand announced it has entered into recession, just "as the scope for monetary stimulus seems limited" (same as in India), while stocks in Indonesia have just experienced their most severe four day plunge since 2008, in parallel with a falling rupiah. This was also blamed on outflows (foreigners pulled $255 million from the stock market in just the past two days). Turkey is a similarly current account challenged country, and ever since a "few looters" disturbed the tranquility of the ruling classes there, its stock market has been under severe pressure (with a chart that by now only a mother could love), while CDS spreads on its government debt have soared.
Jakarta Composite stock index plunges (trading at 4,128 as of Tuesday).
The Istanbul National 30 Index – this looks ugly and there will likely be more weakness.
5-year CDS on the debt of Saudi Arabia, Bahrain, Morocco and Turkey (the yellow line).
Quite a few emerging markets are increasingly looking like submerging markets lately. Could India be the harbinger of a larger crisis? We wouldn't rule it out – it certainly would be the kind of "left of field event" few people are expecting, which automatically increases its likelihood. Note also that all this recent instability happens after a big decline in the exchange rate of the yen, something that is reminiscent of the late 1990s. Japan's decision to inflate could well be destabilizing the economies of other countries. A weaker yen also preceded the Asian crisis of 1997-1998. It should be noted though that India isn't a very big exporter, so its crisis is probably largely homemade. Lastly, let us not forget that the Asian crisis of the late 1990s began with a single small country (Thailand) getting into trouble – at the time no-one thought it would matter much, but eventually contagion spread far and wide.