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India's fear of the unknown

Anand Adhikari     March 31, 2015

Anand Adhikari, senior editor, Business Today
A research paper by economist Liliana Rojas-Suarez on 'most vulnerable emerging market economies' is attracting eyeballs.  Suarez, a senior fellow at the Washington-headquartered Center for Global Development, has said India is among the few select economies whose position has deteriorated significantly since the boom years of 2007.

India actually shares the space with half a dozen other countries, including Latvia, Lithuania and Estonia, which are hard to locate on the global map. Suarez's stress test on emerging economies is based on three big events: the US Federal Reserve tightening its monetary policy for the first time after the 2008 global crises, new global debt crises and Russia launching a full-scale invasion of Ukraine.

Contrary to popular perception that India is the only bright spot in the world map, Suarez's findings have come as a bit of a surprise for many market observers. An Indian professor venting his anger on Twitter termed it as "completely biased and anti-Indian". There are some who tweeted, "Where is Turkey?" and "Why no African country?"

But if one analyses the three big events, there is a danger to the Indian economy or fear of the unknown. One, the tightening of monetary policy by the US is a certainty in 2015. The Russia-Ukarine conflict will also have its repercussions. Russia is already facing economic sanctions. Its economic condition is deteriorating. If the conflict escalates, it's not good news for the world economy, which is, at present, recovering from a recession. Three, a global debt crisis is also looming large. A recent study by consulting firm Mckinsey said that rather than reducing indebtness or deleveraging, all major economies today have higher levels of borrowing relative to their gross domestic product (GDP) compared to what they were in 2007. China's debt has quadrupled since 2007, rising to $28 trillion by mid-2014 from $7 trillion in 2007.

I, for one, agree with Suarez's findings. India is vulnerable due to high interest rates, widening fiscal deficit, over-leveraged corporates and a capital-starved banking system. Most of the benefits that have accrued so far is because of a fall in commodity prices, oil and higher foreign inflows, backed by the change in the sentiment because of a stable government at the centre. Low interest rates and quantitative easing have created surplus liquidity in the system, which has found its way into emerging markets. India is no exception. If the US tightens its monetary policy and raises interest rates, the US market will turn attractive for investors. This will result in outflow of foreign funds from emerging markets back to the US.

Recently when IMF chief Christine Lagarde was in India, she cautioned that emerging markets need to be prepared for the impact of a rise in US interest rates, which could still surprise the markets in terms of both timing and pace. The 'pace' could accelerate dollar outflows from emerging markets, creating havoc in the currency market.

India, which saw its currency appreciating to the 40 levels in the boom years of 2007/08 on the back of dollars inflows, saw  the rupee depreciating to 67-68 levels since then. The East Asian currency crisis is also a good reminder of a contagion effect.

Meanwhile, global rating agencies are also in no mood to upgrade India's sovereign ratings because of the delay in the fiscal consolidation roadmap. In the Union Budget 2015/16,  the fiscal deficit target has been extended from two years to three years. I guess, even as India puts its house in order under the new government, global events mentioned above will also play out their role. That's India's fear of the unknown.


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