Current global credit crisis: Is India vulnerable too?

The current economic crisis that started off as a sub-prime crisis in the US housing mortgage sector has snowballed into the largest credit crunch the world ever faced since the Depression of 1929. When the crisis erupted, there were some premature talks among the Indian policymakers that India would relatively be immune to this crisis but the fact remains that no country has been spared from this crisis.

India has been one of the strongest performing economies over the years registering growth rates of over 8% for the past four years. Although India has not faced a financial meltdown of the kind experienced in the US, owing to its strong fundamentals, well regulated banking system and controls on domestic finance, it has experienced the knock-on effects of the global crisis. Following are some of the major impacts on the Indian economy:

Firstly, the immediate impact has been the outflow of FII’s from the Indian equity markets in order to cover losses in their home countries and seek havens of safety in an uncertain environment. In 2007-08, net FII inflows into India amounted to $20.3 billion. As compared with this, they pulled out nearly $13 billion in the year 2008-09 resulting in a net outflow of FII money from India, the first time in 11 years. Given the importance of FII investment in the Indian stock markets, this pullout triggered a free fall in the BSE sensex from its closing peak of 21,000 in January 2008, to sub -9000 levels in early months of 2009, eroding millions of investor money.

Secondly, this reversal of capital flows has led to a sharp depreciation of the Rupee; the Rupee fell from Rs 39.20 to the dollar to Rs 48.86 between January 1 and October 16, 2008. While some argue that this depreciation may be good for India’s exports which have declined sharply due to the slowdown in global markets, it is not so good for those who have accumulated foreign exchange payment commitments.

Thirdly, it is a known fact that credit financed consumption and housing underpin the 8% growth trajectory India has been experiencing over the years. In this uncertain environment banks and other financial instructions have cut back on credit, especially the huge volume of housing, automobile & retail credit given (auto loans increased marginally by 1.2% in the year 2008 as against a 30% increase in the previous year whereas loans to finance consumer durable fell by 33% in the year 2008). India Inc. which till now did not have any problems in finding money to fund their acquisition and expansion plans is also finding the going tough due to this curtailment of credit.

Fourthly, this crisis has forced many companies to resort to drastic measures in order to reduce costs and cover their losses. Some of the measures include layoffs, salary cuts, bonus cuts and freeze on hiring. This has led to an increase in the un-employment rates in India and the world over.

Lastly, the indirect impact is in the form of the losses sustained by non-bank financial institutions especially mutual funds, as a result of their exposure to domestic stock and currency markets. Such losses are expected to be large, as signalled by the decision of the RBI to allow banks to provide loans to mutual funds against certificates of deposit (CDs) or buyback their own CDs before maturity. These losses are bound to render some institutions fragile, with implications that would become clear only in the coming months.

In conclusion, we can say that India is neither thrashed nor is safe from the crisis and if the Citigroup’s Vulnerability Index is any indicator then India remains the most vulnerable economy in the Asian region.

Emerging markets: Have they decoupled from the rest of the world?

The decoupling theory caught the fancies of the world when until last year the gradual slowdown in the US had little or no effect on the growth of the other countries and trade linkages with the US had become less important. The subprime crises which started in the US has now become a more insidious paralysis of credit conditions moving across different markets and thereby questioning the very essence of the decoupling theory. But in my view there are signs that the decoupling theory is in fact true at least to a certain extent. Let us examine them below:

Firstly, linkages between the emerging economies have strengthened. As per the IMF data the emerging markets trade with the group of advanced economies as a share of the emerging market total trade has declined from 70% to 50% whereas flows between emerging-market economies have more than doubled in the past two decades. For instance, demand for commodities from large emerging markets like China and India has bolstered growth in commodity exporters such as Brazil, Chile, and Russia.

Secondly, financial flows between emerging economies have increased. China gets nearly two thirds of its foreign direct investment from other Asian emerging countries. In turn, China has begun to undertake substantial investments in many commodity-producing countries. Other emerging markets also have built up massive stocks of foreign exchange reserves. All of this makes emerging markets as a group less dependent on financial flows from advanced economies.

Thirdly, although some emerging markets are highly export dependent, countries such as the BRICs nations are large enough to have sufficient diversity and a growing domestic demand. As per recent Merrill Lynch estimates, emerging economies could spend as much as $6.6 trillion on infrastructure in coming years. Although some projects have been delayed or cancelled due to the global slowdown, the opportunities are substantial. Also with more than 1.3 billion people in China, 1.1 billion people in India, 190 million in Brazil, 140 million in Russia, 85 million in Vietnam, 71 million in Turkey—and hundreds of millions more in other emerging economies, the potential for growth is huge.

Lastly, global stock market events since late October seem to underscore the theory. While October/November was the tough for emerging markets as a whole, the major US, European, and Japanese markets fared badly after this period. Despite the sharp recovery in March, the developed markets are still just near their October levels. With some exceptions (Eastern Europe and Mexico), the emerging markets are well above these lows suggesting strong fundamentals and healthy financial position.

In conclusion, we can say that no longer is it such that when the US would sneeze, the whole world would catch a cold. The emerging economies are now viewed as the drivers of growth in the global economy and the emerging markets have indeed decoupled from the rest of the world to a certain extent, but not completely.