Invoking and exorcising the ghosts of 1991 has become fashionable. Everyone, including the prime minister, has taken pains to point out how much better off India is in 2013. Indeed, that is true on the basis of multiple indicators.
One can however, point to some nuances, that actually make change more difficult to initiate in 2013. The biggest difference perhaps, is that external trade has multiplied. Back in 1991, trade (imports+exports) amounted to 14 per cent of the gross domestic product (GDP), whereas it is now around 41 per cent. Therefore, between 1991-93, the rupee could depreciate from 17-19/dollar to 31-32/dollar with relatively less inflationary impact. Depreciation now has larger and broader inflationary consequences.
Similarly, capital controls were default mechanisms in 1991. Lack of external financing mechanisms meant that Indian businesses did not seek growth via external funding. Nor did Indians invest abroad, or educate their children abroad in anything like the same numbers. Hence, public resistance to capital controls was far less. (Click for charts)
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In 1991, many structural reforms could be initiated to enhance efficiency. The reforms deferred in 1991, such as labour laws, land laws, energy and fertiliser subsidies, judicial and legislative changes to reduce corruption and red tape, capital account convertibility, tax reforms, etc, were deferred due to entrenched vested interests. There are no low-hanging fruits left in 2013.
Another reason 2013 is more difficult politically is demographics. Indians are better off now. The middle class is much larger and more likely to complain volubly about deprivation. There are more low-income aspirants to middle-class status. India also has a very young population with high expectations. First-time voters will be impatient, hoping for rapid economic improvement.
So, depreciation is politically unacceptable. So are capital controls. So is a broad reform agenda. And, the electorate is also unwilling to wait. What does that leave in the way of policy options? Going to the International Monetary Fund is also politically a no-no. Opening international swap lines will require much in the way of persuasive financial diplomacy. Convincing overseas capital to return in the absence of reform is also going to be hard.
The multiple cartoons comparing the onion to gold, stocks and other assets suggest inflation is top of the mind. The headlines have also focussed on the rupee, which swung down to 65.55/dollar and went well over 100/pound before a partial recovery last Friday.
Rising inflation and falling purchasing power are both among major concerns. It is very likely that policy will continue to be oriented towards stopgap measures to temporarily shore up the rupee.
This is wrong-headed. India's current problems are not receptive to stopgap measures. They have developed over years and they will require massive structural adjustments to alleviate.
The proximate causes cited for the weak rupee are symptomatic. Portfolio investors have cut back India exposure because of low growth and high deficits. They will only return if those lacunae are rectified.
To put it bluntly, the rupee is down because India imports far more than it exports and it borrows large sums abroad. Food prices are up because the agricultural sector is very inefficient. GDP growth is down because there are multiple regulatory barriers to efficiency across every sector.
This situation also creates vicious feedback loops. Some 40 corporations with $2 billion of outstanding foreign currency convertible bonds (FCCBs) are on the verge of default because they cannot generate the profits required to redeem them. If they could generate the profits, they would not have to redeem; share prices would be higher and FCCB-holders would convert to equity.
The liquidity squeeze has also created a weird situation with mispricings and bond yield inversions galore. The Reserve Bank of India (RBI) issued last week's Rs 22,000-crore tranche of 35-day cash management bills (CMB) at yields of above 12 per cent. Meanwhile, the 10-year government bond is trading at 8.5-9 per cent. Banks are also borrowing over Rs 50,000 crore/day from the marginal standing facility (MSF) at 10.25 per cent, over and above borrowing Rs 38,000 crore/day at 7.25 per cent from the Repurchase window at 7.25 per cent. There is a ridiculous arbitrage of 1.75 per cent to 2 per cent available between CMB and the MSF and this suggests short-term rates will rise soon enough.
On the external front, the US Fed's tapering looks likely to start in September. That could set off another wave of Emerging Market exits. Another worry is the fear of sovereign rating downgrades. If growth slowed as the rupee fell and the RBI started its squeeze in June-July, the credit rating agencies are very liable to go thumbs down in the next quarter. India is already at the very lowest investment grade rating and a downgrade from here will shut down hopes of substantial foreign direct investment expansions.
The revelations from the National Spot Exchange Ltd scam are also now looking increasingly likely to impact broader sentiment. It will also be interesting to watch developments on the telecom affair with Anil and Tina Ambani now giving witness.
Technically, the market saw some recovery in the last two sessions. To put this in perspective, the Nifty dropped a high of 6,093 points on July 23, to a low of 5,254 on August 22 and then seen a recovery to 5,471. Since the late May peak of 6,230, the market has fallen 13 per cent.
This looks like the beginning of a classic long-term bear with a steep fall, a sharp upwards correction followed probably by another sequence of steep falls. Indian bear-markets can be long (lasting several years as in 2000-2004) or short ( less than a year in 2008-09) but usually at least 35 per cent is knocked off peak values. Will history hold this time around?
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
