Could we catch the American flu? The broad numbers would say it is highly likely. Of every Rs 100 India made in 2007-08, about Rs 30 were earned abroad by selling our wares and skills or by the proverbial Prodigal Son sending home a fat dollar cheque. And for the same Rs 100, foreigners lent us Rs 4 and bought another Rs 4.50 worth of Indian companies, banks and real estate. All this adds up to a fairly significant exposure to even the most pacific bug emanating from the US financial system. Yet the chances of India coming down with a full-blown viral attack seem remote.
Here’s why. India’s $1 trillion economy exported $158 billion of goods in the previous financial year, slightly under a third each to the US, the EU and China. In the event of the financial meltdown spreading to the broader US economy, the other two could hold out a while longer, particularly those guys across the Great Wall, who in the course of this year will become the biggest buyers of our stuff. And most of this ‘stuff’ is pretty basic: gems, tea, textiles — commodities, led by oil, which are traversing the upper reaches of the business cycle while the global capital market flounders. This year’s $200 billion merchandise export target looks a bit of a stretch under the circumstances.
When it comes to selling our skills though (the only one that matters being our ability to write code), the terrain looks decidedly tricky. Four out of every five of the $40 billion we earned as software exports last year came in from the US, half of which was for services rendered to American banks, brokerage houses and insurance companies. As more of these buckle, Indian software services exports look wobbly this year.
Finally, the Prodigal Son. It’s not love alone for the homestead that sees him sending across a staggering $42 billion. India still offers the best return on investment to its diaspora. Half a decade of the economy growing at about 9 per cent has spawned fabulous profits for India Inc. There’s no reason why this fact should escape the attention of the maid in Muscat or the doctor in Devon. As long as they have something to save, it makes sense for them to remit it back home.
What India earns from the world then is relatively inured, the immediate fallout of the sub-prime crisis in the US limited to software service exports. Not so with what the world invests in or lends India. In just over a week since Lehman Brothers and Merrill Lynch went belly up, portfolio investors have pulled $2 billion out of India. And the cheap foreign loans that were driving a turbo-charged economy have seized up.
Ever since the world recovered from the dotcom bust and found a new mantra —emerging markets — foreign investment, both direct and financial, has been chasing an India story that delivers profits in the region of 25 per cent a year. Beginning as a trickle, financial investors poured $29 billion into our bourses last year. The tide has since turned. Financial investors have sold $9 billion of Indian stock since the beginning of 2008 and with the curtains coming down on a hedonistic era of investment banking, we can safely expect more billions to move out at the click of a jumpy mouse.
Foreign direct investment, at $25 billion last year, drives in a slower lane where sudden U-turns are difficult. Left to itself, the Indian economy was heading for a slowdown, but hardly of an order that warrants a rethink by foreign companies planning to buy plants and set up offices here.
Indians are now saving and investing close to a third of their income. Nearly half this investment is being made by local companies, which borrowed $22 billion overseas last year. Typically, Indian companies wanting to expand operations in the recent past first sold some stock to an investor, mainly an investment bank, and then leveraged the sale to raise debt, preferably overseas, which works out far cheaper. This tap is now dry. With private equity running scared, the second-stage fund-raising through loans is no longer an option, as a clutch of late-comers discovered much to their chagrin earlier this year. Again, India Inc financed nearly all its foreign acquisitions through leveraged buyouts and the predators have to stay at home till last season’s fashion revives.
This scenario offers meagre policy options. There is precious little any government can do to keep hot money from flowing out. But it can very well open the doors wider for the dollars to flow in. In the short term, recently imposed restrictions on borrowing abroad by Indian companies may need to be lifted. Some already have, we should see more as the crisis plays out.
Given its relative stability, FDI is always more welcome than portfolio investment. Yet restrictions remain. A medium-term solution would require political will to dismantle the steeplechase that is our FDI policy today.
The proximate risks of the roiling global financial market are to the two principal scriptwriters of the India story: companies in general and the software industry in particular. If they were to lose their lustre, it could be a long wait for the next star to appear in the East.