The Credit Crunch Creeps Up on India

Credit problems in the U.S. and Europe have finally crept up on India, writes Chetan Ayha in Morgan Stanley's latest Global Economic Forum. The impact could drive down its GDP growth, and cause particular difficulties for sectors such as financials and industrials. Initially, it was thought that the troubles would be contained in the U.S. and Europe, but things have been changing. As Ahya reports:

The Asian credit market has also been feeling the heat. This is reflected in a sharp rise in Asian dollar bond yields. We believe that this, coupled with a slowdown in portfolio equity inflows, private equity inflows and real estate investments, will weigh adversely on India’s growth outlook. For the last 3-4 years, India’s growth acceleration trend has benefited more from the globalization of capital markets than from the globalization of trade. This trend now appears to be reversing.

According to Ahya, the credit default swap [CDS] rate, which measures perceived risk, has risen sharply: The average CDS rate in AXJ, as measured by Bloomberg’s iTraxx Asia ex-Japan Index, which comprises 70 equally weighted entities, has increased from 48bp as of early July 2007 to 285bp currently. Similar rises across the board, should they continue, would make foreign capital-raising for India all that more difficult. And there's the rub, for India has relied heavily on large capital inflows to support its extraordinary growth rate (average GDP growth of 9.3% in F2006, F2007 and F2008).

The credit crunch has toughened the conditions for global financial institutions to raise funds, and Indian companies, inter alia, are withdrawing their foreign currency bond issuances. According to Morgan Stanley, capital inflows into India could slow to "US$30-40 billion over the next 12 months compared with US$106 billion in the last 12 months, unless there is a dramatic turnaround in the global credit market environment."

The impact on India is more pronounced than on other countries in the region, Ahya writes, as, unlike the others, India runs a current account deficit, and its large balance of payments surplus has been driven by capital inflows. Also in contrast to other Asian economies, India has pursued a loose, pro-cyclical fiscal policy. The overall impact therefore of the credit crunch, Ahya believes, will be to push India's growth down, with some sectors being more at risk than others:

We believe that capital access for capex and household spending will become more constrained over the next few months, affecting aggregate domestic demand and GDP growth. We estimate that GDP growth will slow to 7% during the quarter ending December 2008 from 8.9% during the quarter ended September 2007. In our view, the downside risk to our below-consensus estimates has increased. Morgan Stanley strategist Ridham Desai believes that the key sectors affected by this trend are (i) banks with large international operations, (ii) property and (iii) capital goods and construction. In general, he expects that companies with floating-rate foreign exchange liabilities, asset side exposure to equities and sub-par fixed income securities will likely surprise negatively. Hence, financials and industrials are the main underweight positions in his model portfolio.

Comments

[BonVivant:]

The headline should read: "Despite Credit Crunch in the West, India Still Expected to Grow 7%." Wow! That is some statement. Looks like India is substantially decoupled from the travails of the U.S. economy. Must be something to do with that huge internal, consumption oriented economy. And, only 4% of her economy is from exports to the U.S.

2008 Mar 12 05:10 PM

[ravi1967:]

india is growing onlt due to government spending on infra- 4 laning of national highways, new airports etc. only person earning money is the politician with the contractors getting their share. the common man is being made to pay through his nose. high food prices and inflation is eating into the savings.i am a citizen of india and earn about 20000 rupees per month pre tax and this is not sufficient to make my end meet.so beware of the growth story as it is only on paper.Many malls are empty and new ones will not find takers as consumers will not have money to spend on non food items.Long live INDIA with 7% growth.Funny on paper but being back to reality?

2008 Mar 14 06:29 AM

[ratsharp:]

Indians have never been confident of growth prospects in india. Its only the ambitioius indian entrepreneur and the enthusiastic foreign institutional investor who has put in the money where their mouth is. That led to a 5 fold rise .. and today when we are down by 30%, in the face of headwinds ( which are for real) ..should we abandon the india thesis. NO ....The problem with the non believers is that they have never seen growth led by infra and capex spending ever before and it is natural for them to pooh pooh it. Empty malls are a reality in every market ... they force rentals to come down and the budding entrepreneurs open up shops again ...so the dynamics works as long as he can afford it.

There was a comment by a ubs guy ..which pretty much sums it up...
" In 2006-07, according to data provided by the Reserve Bank of India, the savings rate in India was 34% of the GDP (gross domestic product). India’s GDP stands close to $1.1 trillion in 2007. This means total savings were to the tune of about $370 billion last year.
Household savings were 28% of the economy, translating into $300 billion, and corporate savings accounted for another 6%. Half of the $300 billion household savings last year went to real assets such as gold and property while another half was parked in financial assets including bank deposits, insurance, provident and pension funds, and equities. Only $9.45 billion, or 6.3%, of household savings ended up in equities in 2006-07. This will go up to 10% this year, say analysts. Even if the economy grows by 8.5%, this 10% will translate into $16 billion. In 2005-06, only 1.1% of household savings ended up in equities. Small investors could soon call the shots in India’s equity markets say some analysts, who expect up to $32 billion (Rs1.26 trillion) of household savings to have flowed into the market in the 12 months to March 2008. This amount is almost double the record $17 billion purchases of Indian equities by foreign institutional investors (FIIs) this year, till mid-December" .... Those who invest need to understand fund flows and these numbers to guage the end to this story... dont start splurging your free advice at every sharp fall...

2008 Mar 14 08:58 PM