The Big Fat Indian Crisis.

    
1929: The USA.

1997: East Asia.

2008: Wall Street.

2010: The Eurozone.

2014: India.

     Yes, you read that right. India. But don’t get me wrong. A financial and economic crisis won’t just spring upon the country out of the blue in 2014. The snowball, in fact, has already started rolling and as it goes further down the hill, it will only get larger. The Indian economy is already on the precipice and it might just be a matter of time before it goes off the cliff.
     Most Western economies face a few obstacles on the path to recovery, while the other aspects of their economies seem healthy. India, however, is not that lucky and the country faces a myriad of financial problems. With slowing economic growth, high inflation, a weakening Rupee, a trade deficit, an underperforming bourse, downgrades by global rating agencies, a crisis of confidence and a departure of foreign institutional investor (FII) money from the country, India certainly finds itself in an unenviable spot.
    
     The root of the problem traces itself to the current account deficit (CAD). The CAD, which is already 4.9% of the country’s Gross Domestic Product (GDP), is exacerbated by the fact that India is still a net importer. A weakening rupee does little to aid the situation. India happens to be one of the world’s largest importers of crude oil and gold. When the prices of both commodities dipped at the start of the ongoing fiscal, India could not capitalize on the situation due to a weak currency. And now, gold is back to the peak levels it had attained prior to its crash and tensions in Syria, Egypt and Iran have boosted crude oil prices. A weak Rupee, vis-à-vis the American Dollar has dealt a double blow to the country’s economy. The government, in a bid to control the deficit, has raised fuel prices in India and import duty on gold has been hiked to 10%. These moves have worked to some extent as imports have dropped and the trade deficit has reduced in recent months. That, however, may be too little and too late. India has foreign exchange reserves of a little under $240 billion and those reserves will run dry in six months or so. As a result, global credit rating agencies such as Fitch and Moody’s have already downgraded India. In order to control the high deficit situation, the government will have to resort to further borrowing, a possible sale of bullion in the international market, import curbs and export promotion. However, a negation of the trade deficit and its conversion into a trade surplus anytime soon is a pipe dream at best.

     On the currency front, the strengthening of the US Dollar on the back of an economic recovery seemingly underway in the USA has impacted several currencies worldwide. And yes, the Indian Rupee has been knocked off its pedestal. The Rupee, which turned out to be the worst performing emerging market currency alongside the Indonesian Rupiah, weakened all the way to a level of Rs. 70 against the greenback. This depreciation was fuelled by fears that the US Federal Reserve would begin tapering Quantitative Easing 3 (QE3), its monthly $85 billion bond repurchase program. With QE3 resulting in billions of dollars flowing into the market, these billions were and continue to be routed into emerging countries like India, in search of lucrative investment opportunities. A tapering of QE3 would have resulted in a rise in the value of the US Dollar and less money flowing into emerging markets in general and India in particular. Fear surrounding an impending rollback of QE3 crushed the Indian Rupee but when the Fed decided to continue with QE3 for now, the Rupee breathed a sigh of relief and recovered by close to 15%.
     This, however, may just be a case of the inevitable being postponed and the Fed may have merely kicked the can down the road. The Fed has kept interest rates low and that, coupled with QE3, has sparked a recovery in the American economy, which is growing at a rate of a little under 3%. With economic recovery underway in the west, the Fed will initiate the rollback of QE3 in the next quarter or so. Obviously, this does not bode well for India as even today, its stock markets and most of the major investment projects in the country are fuelled by foreign funds. With India slowing to a 4.5% growth rate and with the US economy speeding up to a 3% growth rate, foreign investors do not have a huge incentive to channel their funds into India. In fact, funds already invested in the country may take flight and head westward. After all, Indian companies have recorded their slowest profit growths ever and India Inc. isn’t exactly renowned for transparency and corporate governance, both of which are viewed very seriously by foreign investors. Indeed, in a few short months, the Indian Rupee may begin its cascade into darkness all over again.

     Oh and just in case you haven’t heard, there’s a new sheriff in town. Raghuram Rajan. He’s the man who was recently crowned the RBI Governor and the man who now calls the shots on Mint Street. It is a known fact that his predecessor, Duvvuri Subbarao and the Finance Ministry could never see eye-to-eye on anything. With Rajan’s entry, that situation was expected to change. Bankers and corporate honchos across the country clamoured for a cut in interest rates to put the Indian economy back on the path to growth and it was widely held that Rajan would play ball. But that was exactly what he didn’t do. In a move that sent shockwaves through the economy, the RBI Governor raised interest rates by 25 basis points and tightened the squeeze. Apparently, when it comes to choosing between spurring economic growth and combating inflation, the latter has a greater priority in the RBI’s game plan.
     All these factors do seem to indicate that an economic crisis in India may be looming on the horizon. And if a crisis is approaching, can the banking industry afford to just sit back and watch? Of course not. Around the world, banks seem have an uncanny ability of being in the eye of the storm. And in India, the situation is no different. With interest rates on the rise, the cost of borrowing has surged and the pace of credit growth has slackened. If that wasn’t enough, most of India’s public sector banks are severely undercapitalized. With Basel III norms being implemented in the banking sector and with the RBI increasing its surveillance, the government has started recapitalizing its banks and over the course of the next 3 years, that initiative could notch up a figure of anywhere between Rs. 3 – 5 lakh crores.

     India Inc., on its part, is partly to blame for the mess that the banking sector finds itself in. Business isn’t exactly booming these days and there has been a dramatic rise in the number of companies seeking a debt restructuring. A plethora of companies such as Kingfisher Airlines, Suzlon and Lanco Infra have already blown themselves out of the water but that may just be the tip of the iceberg. CRISIL, one of India’s leading rating agencies has estimated that around 30% of India’s indebted companies are heading for a default. The NPAs (non-performing assets or bad loans) of public sector banks are already at a level of 4% of their total loan books and that figure is heading towards the sky. As far as the prospects of the banks recovering their dues go, it may very well be all she wrote. For the Indian banking sector, the worst is yet to come. 
     With a multi-faceted crisis of such epic proportions lurking like a spectre over the country, India’s days as the Mecca of economic growth and opportunity may be over. The government and the RBI have a tough task ahead of them and time is certainly not on their side. They will have to walk a tightrope and when it comes to choosing between boosting economic growth and reining in the fiscal deficit, it may really be a Hobson’s choice. For now, judging by the way things are going on the economic front, it may very well turn out to be a déjà vu of India’s 1991 economic crisis all over again. And so, at the end of the day, when all the dust has settled, the blood dried and the Rupee fallen, do I really have the audacity to predict the next crisis that might cripple the Indian economy and bring it down to its knees? Well, it’s not really a prediction. It’s merely an observation. As far as India is concerned, 2013 will end with a Dhoom. The year 2014, however, will kick off with a crisis. Bank on it.

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