Economic Highlights

New Delhi, 7 October 2011

US-Euro Crisis

INDIA HIT IN CURRENCY WAR

By Shivaji Sarkar

 The US-Euro crisis is severely hitting the Asian and Indian economy. The latest jolt to the State Bank of India of downgrading by Moody indicates a grim scenario. It has not only shaken confidence in the banking system but also in the stock market.

This is not an isolated incident. Banks in India have been facing a crisis for some time with their non-performing assets (NPA), i.e. losses, rising, a fall in credit offtake and repayments affected. But the US-Euro crisis has a greater impact on the currencies. The Rupee, Korean Wan, Brazil’s Rial, Russian Rouble, Polish Zolti and South Africa Rand are losing their strength against the dollar. This is what Fed Reserve Chairman Ben Bernanke’s “operation twist” is doing to the world economy.

Brazilian Finance Minister G Matenga says a “currency war” is being waged and there is an overflow of the dollar to wreck the strength of other currencies. Indeed, India has started feeling it. The Rupee has slid to around Rs 50 to a dollar. It could have slid further had not the RBI intervened. Till July 27 one dollar used to cost Rs 43.85.

Since then not only the rupee but all other currencies are facing severe pressure. Countries such as Korea, Turkey, Thailand, South Africa, Brazil along with India are perturbed at the sudden rise in the demand for the dollar. Observers in these countries had anticipated that the US dollar would not be able to regain strength. However, the US Fed Reserve policy has changed all that.

Clearly, the bankers are finding the situation untenable and met on October 4 in Mumbai. They called upon the RBI to ease the interest rate regime. Chief Executive of Indian Banks Association K Ramakrishnan states that bankers want a pause to rate hikes. While the credit growth during this period was of 20.1 per cent or by Rs 31,490 crore, it is not reassuring. It was mostly due to disbursals of outstanding credit order by the petroleum, coal and nuclear sectors.

Unfortunately, emerging economies are unable to match the US operation twist. Even a year ago these economies were supposed to be the global engine. They had growth, flow of money towards share market and other investments. They were seeing investments at the cost of withdrawals in due to the weakening the US dollar and Euro. Their currencies were strengthening, sometimes causing worries in these countries. Their added advantage was the large flow of investments as interest rates were rising in many of these countries.

Indeed, the US googly has upset all that. The US Fed unlike many other economies has not increased interest rates. It has also not called a stop to spending and its policy of strengthening the bond market has given a severe shock to emerging nations such as India. The Global Emerging Market index has lost 18 per cent in September, the highest since the 2008 Lehman Brothers crisis.

The US Citibank believes that 40 per cent of it is contributed by the falling currencies in these countries as there is large selling in the share market of these economies. Since the Fed Reserve operation twist foreign investors retracted investment worth $ 220,000 in India alone.

The bond market is equally seeing the crisis. Investments in bonds of companies were coming largely from European banks. Now they are withdrawing their investments. Even the Chinese and East European corporate bond bazaars are in a tizzy.

Until this new crisis, India, Brazil, Russia and Korea were supposed to have three security rings as it was believed that the US-Euro crisis was more a touch and go affair. The first was growth, which was the greatest strength of these countries. The second was an attractive share market, wherein the investors were investing in these countries with loans available on low interest. This was providing stability in the currency market and was the third security ring.

Today all the three rings are dissipating and growth is gradually coming down. It may go down to 6.5 per cent this year, much less than the revised 7.8 per cent target. Fitch Ratings had revised downward growth projection of the Indian economy to 7.5 per cent. Next year these economies may further slow down to 6.1 per cent. Whether we like it or not the slowdown is a reality.

Investors are on a flight from these share markets adding to the weakening of currencies such as the rupee. And there is no denying that countries like India are facing severe inflation. This means a further fall in currency value, weakening the rupee shall further fuel inflation. Worse, it does not stop here. A weak rupee makes petroleum, mineral and other imports expensive. A larger dollar flow is upsetting many economic calculations. However, a weak currency should raise hopes for higher exports, but this is difficult as global demand is slackening.

All this may further lead to another difficult scenario. As investors withdraw their investments in dollar and export market remains weak, the forex reserves may come down and add to other problems.

In a scenario like this Moody’s downgrading of SBI indicates another danger. Its deterioration of NPAs is due to very high exposure to infrastructure companies. These borrowers are facing severe problems in the form of high infrastructure exposure, high interest rates and implementation delays in the wake of the slowing economy leaving more scope for rise in NPAs. A bounce back by the SBI does not seem to be easy particularly when a further fall may not be unlikely.

Given the above, the SBI has led the fall of other banking stocks – the ICICI Bank, HDFC Bank, Axis Bank and Yes Bank at the stock market. The big question arises: Is the malaise spreading?

The SBI is awaiting Government funding for bailing it out of the crisis. While this may be welcome for the SBI, it affects Government finances and reserves and may lead to larger borrowings. This is critical. It is certain to increase fiscal deficit, something that may cause further anxiety as not much money is left with banks for credit purposes squeezed by the high interest rates and NPAs. Would that further cause another slowdown?

Candidly, not unlikely, unless the RBI comes with a policy to match the googly of the US Fed Reserve. It is a difficult proposition. The US Fed Reserve has still the backing of a strong political system despite many crises being faced by the US economy. The RBI decision to throw a googly would have political repercussion. It needs the consent of the Government, which in a critical geo-political situation would not be easy. ---INFA

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