Is a crisis at hand?
The INR took a massive hit yesterday and overnight after the latest IIP figures finally established what many already knew – the economy is hurting, and its bad. Industrial Production came out lower by 5.1% y-o-y and equity markets soon followed it down, shedding over 2% of the index value after the numbers were announced at 11 AM. But if it were only about equity markets, it wouldn’t mean a thing. The problem is the currency; and the politics.
The INR has been the worst performing currency in the last quarter, dropping from ~INR 45 to the dollar to ~53.50 earlier today. The RBI, while prepared to intervene, has indicated that its war chest is not quite large enough and will only serve to dampen the moves. With no respite in sight, India’s import bill is set to rise dramatically. On top of this, with high inflation and rising perception of corruption in the country (India fell from the 87th to the 95th position in Transparency International’s corruption index), capital inflows through portfolios as well as FDI are likely to continue to recede. The Balance of Payments (BoP) situation is likely to deteriorate. To an extent, the currency depreciation is itself an indicator of the rising perception of this. A slowdown in the west which would dampen software/services (IT and ITeS) exports, and an increasing risk-off attitude which accelerates capital flight can combine with the above problems to form the perfect storm.
Unfortunately, policy in India is at a stalemate. The recent roll-back of FDI in Retail is, in my opinion, a very bad sign. Being an economist and a survivor of the ’91 BoP crisis, Mr. Manmohan Singh probably stays awake at night worrying more about that than the mess that his colleagues in the UPA have created. Unfortunately, he does not seem to be in a position to do anything about it – yet. The RBI, which has been trying to fight inflation for the last one year, unfortunately, is now in a jam. Any more rate increases and it risks a massive collapse in industry. On the other hand, the rate increases seem to have done nothing to stem rapid rise in prices. The RBI has complained that without fiscal discipline (which I read to mean cutting back on populism) on the part of the Government, it cannot handle the inflation problem alone. That brings us to the other big problem. If there is one thing the UPA Government is committed to, it is giving out easy money to keep its electorate happy. So there is little hope of fiscal discipline.
Here’s a summary of all that is scary:
1. the deteriorating rupee – leading to a rising import bill
2. high corruption perception – leading to capital flight
3. slowdown in the west – leading to shrinking demand for Indian exports
4. high inflation – stoked by supply side problems and Govt’s fiscal profligacy
5. industrial slowdown – prompted significantly by RBI’s hawkish stance to curb inflation
6. persistently high oil prices – impacting our import bill (this is the only factor which might reverse trend if a global slowdown materializes)
So is a crisis at hand? If the rupee fails to stabilize even at this level, we could see a dramatic panic and the Government could be forced to push through reforms despite any expected political fall out. The only hope is that they still have the guts and integrity to do so.