|»5 Minute Wrap Up by Equitymaster|
On This Day - 26 JUNE 2013
Will government wait for 1991 like crisis to respond?
In this issue:
Now it is not as if 1991 was the last crisis that came India's way. But thanks to the prudence of Reserve Bank of India (RBI) and some key learning on external debt, the East Asian crisis in 1997-98 hardly impacted India. The same can be said about 2008. However, as Indian policy makers chose to ape the US, Europe, China and Japan, all learning went out of the window. The result being that India may be one of the worst hit when the balance of payment (BoP) crisis hits Asian nations this time around!
Allow us to back this argument with more statistics. In 1991, the proportion of India's short-term debt to foreign exchange reserves was a gargantuan 146.5%! The debt service ratio was 35%. So that we never revisit these figures, in the decade that followed, the government and the central bank put a lid on short-term debt. It raised maturities for foreign borrowings by Indian corporates and made policies in favour of long term funds (FDI). The scenario changed dramatically 2002 onwards. From a low of 5.1% in FY03, short-term debt to reserves rose to 14.8% in FY09 and ballooned to 31.1% in December 2012.
Another key indicator, the import cover of foreign exchange reserves, i.e. ratio of a country's imports to its reserves, is not in a very comfortable position either. Readers will recall that India's import cover had gone down to three weeks when the country had to pledge gold with IMF. The same now stands at 6.5 months from 15 months in May 2008, when the economy, capital flows and the rupee were much stronger.
The RBI is this time in a denial mode about the possibility of India revisiting a 1991 like crisis. The government on the other hand has its sight firmly focused on the 2014 elections. Industries across sectors are facing unprecedented challenges in sustaining growth and profitability. And global investors are hardly finding Indian investments very lucrative from risk-reward perspective. The proverbial ball therefore seems to be in nobody's court! Should investors therefore wait for a crisis situation to unravel before expecting some corrective action?
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Turns out that day traders in Japan never had it this good before. What has led to the opening of the flood gates is deregulation of margin trading whereby investors can borrow three times as much as their brokerage account balances! What more, they can easily turn over their loans when they exit a trading position. Just to put things in perspective, one of the day traders out there leveraged his US$ 4.5 m in cash into as much as US$ 67 m in daily stock bets! It is not uncommon to find day traders buying and selling between US$ 80 m to 100 m worth of stocks every day.
Needless to say, this is a dangerous trend and something somewhere will certainly go wrong. In fact something has already seriously gone wrong if Shedlock is to be believed. All we have to do is just wait for the dust to settle.
As per the report, if US immigration bill gets passed in its current form, it is likely to erode India's GDP. In a bid to protect jobs, the US bill suggests a hike in the visa fees. If the bill gets passed, it will mean a huge addition to costs for Indian IT companies and hence a threat to their business. But this is not all. There is more to this issue than meets the eye. This is because of the multiplier effect that the software sector has on the economy. If the IT industry gets impacted, the other ancillary industries like travel, transportation, hospitability and real estate will also be dragged down. The report estimates the overall loss to the GDP to be around 0.3% - 0.4% in FY15.
While there is nothing final yet, if the worse does happen, the IT industry is likely to react by changing the hiring policies and the way the business is done. While such changes have already started taking place, all adaptations take time. In the meantime, the Indian economy does have serious reasons to worry.
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