Why the economic pit can get deeper
Aug 16 2013
We may head for a financial emergency unless dire measures are taken
One line of thought is that though the situation is precarious and the immediate future bleak, India is still far from straits that will constitute a financial emergency.
State-run companies are sitting on piles of cash (Rs 1,80,000 crore) and even private enterprises have no liquidity problem. The top 100 companies hold cash balances of about Rs 12,00,000 crore. And rural prosperity is spreading beyond district centres. That’s a view that will please finance minister P Chidambaram. But to be sure, I did pose the question framed in the opening paragraph of this article to several industry veterans and economists. Are we heading for an economic tempest?
By and large, they all agree that things are not great and the economic gloom will continue for quite some time, certainly not before the next general elections are over and a new government is installed at the centre. The consensus view: we may not be in a financial emergency right now but are heading for one unless some dire measures are taken.
Witness the desperation of the government and Mint Street to defend the rupee. Never in the past 13 years has RBI departed from its set course of liberalising capital flows both ways.
Now, for the first time, RBI has clamped capital controls to stem foreign exchange outflows and thus help prevent the rupee from a free fall. Private companies’ investments abroad have now been restricted to 100 per cent of their net worth. Earlier, the limit was 400 per cent. Even the individual’s freedom to invest abroad either in property, bullion, stocks, mortgages or debt paper has been curtailed to $75,000 from $200,000 a year. As one analyst points out, what this means is that Kumar Mangalam Birla may not be able to invest freely in assets or factories abroad even though the investment climate at home is messy. Likewise, Cipla’s Yusuf Hamid or Apollo’s Neeraj Kanwar will have to wait till RBI eases the restriction. Even cooperatives like Iffco may have to go slow on investing abroad.
What if the capital controls had come some years ago? For one, Ratan Tata could not have bought Jaguar Land Rover or Corus. Kumarmangalam Birla’s Hindalco could not have been owner of Novelis. Mukesh Ambani’s Reliance Industries could not have picked up shale gas assets abroad. And it would have been virtually impossible for Sunil Bharti Mittal to acquire Zain Telecom. It’s not only about Indian companies. Even simple things like gold coins or medallions cannot now be imported.
For foreign investors, the obvious question is: can they bring in and take out funds easily with these controls in place? The government may have created more opportunities for them to invest in more sectors. But then unless foreign investors have the freedom to bring in or take out funds, would they consider India as the favoured destination?
Domestic companies, sitting on piles of cash, too are equally handicapped, though Chidambaram tried to sooth their nerves, saying the measures were temporary and aimed solely at curbing volatility in the currency market. Likewise, NRIs too feel handicapped, as the individual’s freedom to move funds across has been limited.
The restrictions also widen the possibility of mischief. Exporters will happily under-invoice even more than they have done so far —neatly skirting the capital controls. The restrictions on gold imports and duties have worked in that gold imports through legitimate routes have come down in a big way. But smuggling in the precious metal has increased. Mind you, smuggled goods pay no duty, which would have gone to coffers if these goods came through legitimate routes.
Despite the official data on lower gold imports, gold consumption in India has increased — which only means smuggling is on the rise to meet the shortfall caused by the official clampdown on legitimate imports. World Gold Council (WGC) data suggest that gold consumption in April-June in India at 330 tonnes was the highest in a decade. A couple of months ago, the prime minister’s economic advisory council chairman C Rangarajan had cautioned against just this. He had proposed a careful calibration of duty rates so as not to give a fillip to smuggling. In this all-pervading gloom, few sectors are spared. If things carry on like this, India may have to exit the league of 14 countries with a $1 trillion market capitalisation.
Most pathetic is the rupee. It has seen a 28 per cent slide in two years — the sharpest drop since India pledged its gold with IMF in 1991. In 1991-92, the rupee had lost 37 per cent, obliging India to beg and secure an emergency loan of $2.2 billion from IMF to finance its oil imports. But for that the country had to pledge 67 tonnes of its gold as collateral. The rupee’s depreciated value has knocked out a good part of stock valuations. India’s stocks capitalisation today stands at $1.004 trillion; just four months ago, it was $1.209 trillion. The erosion works out to 17 per cent in dollar terms.
India is already out of the top ten nations with the most foreign exchange reserves. As recently as in May, India was 10th with reserves of $288 billion. These have since dropped to $277 billion. But Singapore and Germany have moved up despite their own problems.
As for the lot of the aam aadmi, the less said the better. Sustained double-digit inflation in food prices and high interest rates are eating into their savings, forcing them to put off investments, purchases and even to pare kitchen budgets. Onions selling at Rs 100 a kg and tomato at Rs 60 a kg are enough to bring tears to their eyes. Jobs are not being created; worse, more people are losing their jobs.
We seem to be already at the bottom of the pit. But apparently, the pit can get deeper. In other words, a financial emergency may be in the offing? Only Chidambaram knows why we should believe otherwise.