-- Posted Tuesday, 2 January 2007 | Digg This Article
In November 2006 The Economist ran a story titled: " India's economy" with a byline saying "Too hot to handle."
The story talked of how the Indian economy was vulnerable and unsustainable, specially compared to China. "Despite widespread claims that China's economy is overheating, actually India 's shows more signs of boiling over."
The story discounted India's recent growth, saying "India 's recent acceleration largely reflects a cyclical boom, thanks to loose monetary and fiscal policy", and talked of how the Indian economy was more vulnerable to hard landing. "Despite India's growth spurt in recent years, its sustainable pace is still much lower than China's, which puts its economy more at risk of overheating and rising inflation."
The story also denounced those in charge of Indian finances. "Indian policymakers seem reluctant to admit that economic growth has exceeded its speed limit over the past three years, let alone slow it. They prefer to bask in the belief that India has become another China, able to keep growing ever faster without inflation rising."
Hard words? Not at all. Although The Economist raised many concerns about the vulnerability of Indian economy, I feel it's criticism was far more subdued than it should have been. The fact is that India has right now one of the most mismanaged economies in the world.
To begin with, the country is facing enormous fiscal and budget deficits. According to the latest data released by the Controller General of Accounts, the country's fiscal deficit during April-November 2006 has touched 72.8 per cent of the total budget target for the entire financial year. This, in spite of buoyancy in revenue collections, thanks to higher corporate profits. Meanwhile the fiscal deficit has grown to Rs 1 ,08,201 crores during the same period. And last but not the least, the revenue deficit has been even more pronounced at Rs 84,483 crore in the first eight months of this financial year, accounting for almost the entire of the budget target of Rs 84,727 crore.
Then there is an unprecedented boom in money supply. During last couple of decades Indian money managers have believed - like their American, European, and Japanese counterparts - that artificially increasing the money supply would solve the dilemma. They have been living with the thought that the extra money spent by the government - either for purchases or for employing workers - would stimulate additional demand which would eventually filter through the economy.
As a result the money supply has exploded. In 1970-71, M3 supply - the broadest measure of money supply - was 11,020 crores rupees, today it is in excess of 2,000,000 crores - a growth of roughly 200 times. During 2003-04 alone the supply exploded by a cool 285142 crores - a mere 16.59%.
And then there is that scourge called trade gap. Though Indian exports are rising at double digit rate per annum, the imports are rising even faster. According to the latest figures, India's trade deficit increased to $6.20 billion in October, up sharply from $2.93 billion in October 2005 as demand for imports. The deficit during April-October 2006 touched $30.23 billion from $25.19 billion in the same period last year.
The oil bill itself is burning the pocket. The crude oil imports during October increased by 55 per cent to $5.34 billion compared with $3.44 billion in the same period last year. Crude oil imports during April-October increased by over 39 per cent to $34 billion against $24.38 billion.
As if that was not enough, the country is also importing a whole lot of non-oil - and often non-essential - stuff. Non-oil imports during October increased by 29 per cent to $10.48 billion compared with $8.13 billion in October last year while the cumulative non-oil imports during April-October increased by 13 per cent to $65.74 billion against $ 57.92 billion in April-October 2005-06.
Talking of external trade as a whole, Indian trade deficit is likely to touch $50 billion, or 7 percent of GDP (It stood at 36.04 billion U.S. dollars in the first eight months of this fiscal year.) The trade deficit grows inexorably as Indians continue to consume more than they produce. Economists typically expect India to import high-tech products and sophisticated technology, but what it has been importing of late is a whole lot of agricultural products as well as cheap plastic knick-knacks from China and Taiwan. During last fifty years the agriculture has been so neglected that today the country is forced to import more than two million tonnes of pulses and four million tonnes of edible oil every year. Of course this year she is also importing more than five million tonnes of wheat.
Goes without a mention, the Indian economy is in as much a bad condition as it can be. According to a study titled "Gyrations Of Indian Stock Market Point To Future Economic Instability": "By virtually any measure, and in all but a few sectors, India's economy remains small and backward. Although home to more than 15 percent of the world's population, India accounts for barely 1 percent of total world trade."
The study also highlights disappointing balance of payment situation. "On the fiscal front, both the central and state governments in India are mired in debts with up to 40 percent of revenue set aside for debt repayment."
Given all these serious problems, I don't need to emphasize here, the health of Rupee is fragile, so fragile that it can unleash a storm of inflation at the drop of the proverbial hat. Although the Indian currency seems to be stable since last five years, and in fact it has even improved versus the US Dollar, the fact remains that it's innards have been eaten hollow.
The currency is so weak that it appreciated by a mere 1.7% against the US Dollar, in a year when the greenback depreciated by 5-10% against the majority of important currencies. USD lost more than 9% against the euro, and went down significantly against the Swiss Franc and the British Pound.
Rupee weakness can also be judged from the fact that the South Korean won, the Singapore dollar and the Indonesian Rupiah fared much better, appreciating by 9 per cent, 7 per cent and 8 per cent respectively against the USD.
In fact the Rupee would have already been in the dumps, had it not had a lucky streak due to the rise in global liquidity. Just as the oil price began climbing during 2004 the global money began chasing the emerging markets story. And since India has the population almost like China, and because the Indian outsourcing became a catchword in the West, the global investors went on pouring funds in this essentially impaired economy. According to a recent article in a business daily "FII (Foreign Institutional Investors) flows of $ 8.33 billion till date into the domestic stock market helped the rupee gain against the dollar. The movement of rupee was basically driven by demand of dollars from importers (oil companies) and supply of dollars through FII inflows. During 2006, supplies ran ahead of demand."
And according to a note on Indianeconomy.org : "The Rupee is fundamentally weak, but has been propped up by overly positive sentiments of Foreign Institutional Investors (FIIs), which are now moderating…"
However as it should happen, these FIIs are also the Achille's Heel in Rupee's fortunes. Simply because of their absolute grip on the Indian stock markets. Today the FIIs have about 17% share of total market capitalisation, and more than 40% of free float of the prime stocks, or the stocks which comprise of the SENSEX, the most popular stock Index in India.
The bitter fact is that In fact the control is even more than that, since the entire market looks at FIIs for direction. Lay investors buy what FIIs buy and sell what FIIs seem to be selling. Even a good profit making company gets a low price-earnings ratio just because it is not fancied by the FIIs; conversely a leper is hugged because it is the darling of the international fund managers.
You don't need to be the proverbial rocket scientist to know that such a state of affairs can't last long. Something has to give in. And when it gives in, any small provocation will bring the house of cards down. And as it happens during such periods, the moment the FIIs decide to sell their positions, they would like to take their money out of India, which they will do by taking forward position on the US dollars in the currency market.
This is what has happened every time the stock market has taken a plunge during the recent past. During the December 2006 correction in the Indian stock market; the rupee dropped sharply to end at Rs 44.83.84 per dollar due to heavy pull out of foreign funds from stock markets along with firm dollar against other major world currencies.
What are the chances of FIIs forsaking the Indian stock markets right now? Pretty high. The SENSEX has been having a ball for almost three years, and people have begun to talk how the market is overvalued and thus ripe for a huge correction. Recently Credit Suisse and Citigroup Inc said that though Indian stocks are set to beat emerging market shares for a third straight year, they "remain expensive" and "warrant caution."
How expensive? SENSEX has climbed almost 45% during 2006, more than the Morgan Stanley Capital International Emerging Markets Index's 23% advance. Right now SENSEX is trading at about 20 times expected earnings for FY07 — significantly higher than a couple of years ago. Simultaneously, on a price-to-earnings basis SENSEX is valued 31% higher than MSCI's index.
Not surprising, Global credit rating agency Standard & Poor's recently indicated that the Indian stock markets are overvalued, and recommended under-weighing of the markets next year. Even more forthcoming was Marc Faber, who was recently in India. Speaking about Indian equities, he felt making money from Indian equities from hereon is going to be a tough proposition. "From here on, any advance will become very selective. Majority of the shares did not make a new high in the recent rally. In market parlance, this is a case where the army is staying behind while the generals are advancing. One must ask how long can this continue?"
The long and short of it all: due to the overvalued stock markets and due to the gross mismanagement of the economy, the Indian currency may not remain as stable as it seems right now. In the words of Marc Faber "inflation is a cause for worry, and the currency too, does not appear to be strong."
Here I must mention that Marc is not the lone "worrier." Almost at the same time when he was cautioning about the Indian currency not being strong, Joseph Stiglitz was in Delhi, counseling the Indian policy makers that India should concentrate on "managing its exchange rate problems."
In fact the chances of Rupee devaluation are extremely real, given the fact that it is right now overvalued, especially in the light of its trade deficits. According to one study the rupee "is currently roughly 7% overvalued in comparison with its equilibrium value of 100 (1993-94 parity)." A couple of months back, Michael Spencer, Chief Economist - Asia, Deutsche Bank AG, said that "The Indian rupee was overvalued between 5 and 7 per cent," and that "The weaker inflows would put pressure on the Indian currency, which would depreciate."
And what will happen when the Rupee depreciates? First of all, gold will appreciate by an equal proportion of rupee's fall. This is what happened when the currency crisis blew over much of Asia a decade back. From 1996 to 1997 the gold price soared in Indonesia, Thailand , Malaysia and several other countries as their currencies collapsed. The same phenomenon was seen when the Soviet Rouble turned rubble.
This is what has happened in India over the decades. Rupee devaluations in this country are as common as monsoon rains and during past couple of decades, they have continuously striven to reduce the wealth of Indians collectively. This is the reason why the graph of Indian rupee gold price always goes up, in spite of the bottoms made by the international gold price.
It won't be surprising if the gold in Indian rupees appreciates much more than the extent of Rupee's fall against the dollar. This will be due to the capital flight effect, a phenomenon often witnessed during such times. As the rupee will depreciate, more and more Indians will pile in their savings into the Midas Metal, or take them out of the country, just to maintain their purchasing power.
In ancient India gold jewellery came into being because during the olden days the people did not have access to banking and other financial instruments to preserve wealth. Jewellery at that time was the most convenient and most efficient medium of storing and preserving family wealth. Given the condition of the Indian economy, it seems Indians are yet again running out of the choices about preservation of wealth.
Gold, even today, remains the best bet for them.
©2006 Shailendra Kakani. All rights reserved.
Shailendra Kakani is the Research Head of Commodity Research Group, Bombay, India, and the Managing Editor of www.commodityresearch.in . He can be reached at editor@commodityresearch.in . or at
+91 98678 33034
Mumbai (Bombay), India
-- Posted Tuesday, 2 January 2007 | Digg This Article
