beyondbrics

The rapid depreciation of the rupee since August is bleeding into all aspects of the Indian economy, leading some analysts to predict a crisis the likes of which India has not seen in 20 years.

But economists told beyondbrics that, while India’s financial situation was indeed dire – given the weak rupee, widening trade deficit, high fiscal deficit and slowing growth – the country is not yet on the brink of crisis. Sounds bad, though – so what are the prospects?

Earlier this week, Reuters reported:

India may face its worst financial crisis in decades if it fails to stem a slide in the rupee, leaving the central bank with a difficult choice over how to make best use of its limited reserves to maintain the confidence of foreign investors.

Beyond India’s borders, Europe is the biggest worry. As its banks deleverage, investment money has flooded out of India’s markets. If Europe’s debt troubles deteriorate, India could be hit with a balance of payments crisis as severe as the one that forced a sharp devaluation in 1991.

But A Prasanna, economist at ICICI Securities, told beyondbrics that things aren’t quite that bad.

“The rupee has clearly depreciated, and we are having an issue with current account deficit and capital flows drying up,” he said, “but saying it will be a crisis is a little bit overblown because the Reserve Bank of India does have reserves. If you look at what the RBI has said, they are saving their reserves in case something big happens.”

Still, Jagannadham Thunuguntla, head of research at SMC Global, told beyondbrics that even if the RBI wanted to aggressively intervene to save the faltering rupee – there have been limited moves in recent months – it simply doesn’t have the ability to do it.

“[In order to intervene, a] central bank needs two things: intention and ability, this time even if they have intention they don’t have ability ,” he said.

India’s total external debt stood at $316.9bn up until June 2011, the latest data available, while the RBI’s total foreign exchange reserves stood at $316bn, meaning it has a fx reserves to total external debt ratio of 99.6 per cent – untenable in the opinion of Thunuguntla.

In 2007-2008, India’s ratio stood at 138 per cent, meaning its reserves comfortably covered its external debt, and helped India survive the 2008 financial crisis relatively unscathed.

“If the European crisis completely unfolds from here, RBI may not have enough buffer to withstand the shocks on Indian currency,” Thunuguntla wrote in a research report this week. “There is one main difference between the 2008 crisis and 2011/12 crisis from the Indian economy point of view. We went into 2008 crisis with strength on our side, we are entering into 2011/12 crisis with weakness on our side.”

But even that ratio may be overblown, Shubhada Rao, chief economist at Yes Bank, told beyondbrics, because it only really comes into play in the worst-case scenario when all of India’s debt obligations are called back for payment immediately – a point which, despite a continued lack of eurozone progress, the global economy has not yet reached.

“It’s a concern that is probably getting exaggerated,” she said.

Rao added that the same could be said for the idea that India was facing a major balance of payments crisis. FII outflows are cause for concern – they stand at $45.8m for the year up to Friday, down from a record $29bn last year – as is Delhi’s inability to enact any sort of meaningful fiscal reform, like the recently dead FDI in retail reform, which might bring in foreign money.

“It’s a concern… but I do not think it’s exactly the way it’s being projected as a payment crisis,” she said. “These are the factors that lend credence to the increasing sense of pessimism, but is it a crisis of confidence? I don’t think so.”

Related reading:
India industry: definitely slowing down, beyondbrics
Rupee heads lower and lower, beyondbrics
Reforming India, FT
Slowing domestic demand hits rupee, FT