Wake up and smell the crisis

India’s top officials are whistling past the graveyard in maintaining that the global financial crisis has a minimal impact on the economy, writes NC Mohan.

India’s top officials are whistling past the graveyard in maintaining that the global financial crisis has a minimal impact on the economy. Doubtless, they are trying to keep us cheerful under these difficult circumstances. But domestic stock markets are hitting record lows on adverse global cues. Foreign institutional investors (FIIs) are pulling out billions of dollars. The rupee is weakening. Is there, then, any warrant for their spin that India will remain unscathed by the worst economic turmoil since the 1930s?

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These officials, however, are quick to clarify that the impact is only indirect. Pointing out that the India’s financial system is stable, they admit that if the rest of the world gets disturbed, there are bound to be spillover effects here. Interest rates will firm up. Inflows of foreign direct (FDI) and portfolio investments will be affected. So, too, will the export of goods. But none of this is expected to disturb the economy’s rapid pace of expansion of 8 per cent this year and 9 per cent in 2009-10.

Prime Minister Manmohan Singh was candid in saying that “we live in an interdependent world and the fate of all countries is related to the international financial system.” Our value markets are open to the world, and, if they are affected, this will affect our capacity to finance our development, he said, adding that if the financial crisis causes a recession in the main economies, this will compromise our exports. The truth is that the dreaded R-word is a reality in much of the developed world.

Capital inflows into the country are beginning to flag. The latest balance of payments data, in fact, indicate that they fell to $13.2 billion during April-June 2008 as against $17.3 billion during the same period last year. This is because of net FII outflows of $4.2 billion compared with net inflows of $7.4 billion in the corresponding quarter of 2007-08. As such, investors need liquidity, they have so far taken out $9.2 billion since January 2008. Our stock market indices have nose-dived as a result.

The disturbing prospect is for such inflows to further diminish this year to $71 billion as against record highs of $108 billion in 2007-08. Although such levels are more than adequate to finance the current account deficit (that is the broadest measure of the country’s trade with the rest of the world), they will definitely impact India Inc’s efforts to raise resources for investments. These trends also imply a much lower accretion to our foreign exchange reserves than the handsome build-up of $92.2 billion in 2007-08.

However, it is not Deep Fish’s contention that all is gloom and doom on India’s balance of payments front. Although strains are showing, a silver lining has been the bullish outlook on net FDI inflows that rose to $10.1 billion during April-June 2008, up from $2.6 billion in April-June 2007. While there is greater volatility in FII investment behaviour, thanks to the global financial meltdown, FDI inflows are more long-term in nature and basically represent a vote of confidence in India’s economy.

But can such inflows keep pouring in when developed countries sink deeper into recession? Any slowing down will be bad news indeed for India’s effort to sustain its growth trajectory of 8-9 per cent per annum. Unlike China, India’s growth is not FDI-driven but it needs a massive $99 billion per annum during 2007-2012 to build its infrastructure like roads, ports, airports, telecom and power. Without such facilities, it is most unlikely that the country can continue to expand like it did in the last five years.

The bad news is that actual FDI inflows are only a trickle in financing our infrastructure. From April-2000 to February 2008, such investments amounted to only $1.3 billion per annum in building roads, ports, telecom, railways and airports, according to United Nation’s Conference on Trade and Development (Unctad) latest World Investment Report. The present global woes will only compound India’s difficulty in attracting more such investments, except for nuclear power facilities with the passage of the Indo-US nuclear deal and cooperation with France and Russia.

While capital inflows, thus, are bound to take a hit, matters should not be worsened by rolling out a redder carpet than necessary to attract them. The last thing India needs at this juncture is another Enron scandal. As a rising power, there is a need for greater strategic intent in leveraging FDI in infrastructure. The recent instance of providing 2G spectrum at throwaway prices instead of auctioning it hardly enthuses confidence in the UPA government’s ability to take the right decisions in telecom infrastructure.

The terms of the big-ticket deal from South Korea to build a 12 million-tonne steel plant in Orissa is another case in point. India, no doubt, badly requires more steel for its fast-growing economy. But is there is a need for providing massive subsidies to Pohang Iron and Steel Company? To be sure, there are also serious policy issues to be resolved at the state government level on handing over one-third of Orissa’s iron ore supplies, raising the question whether the deal’s costs far outweigh the benefits, Enron-style.

The upshot is there is no need for a race to the bottom to attract capital inflows in a difficult international environment. India must leverage the strengths of its strong fundamentals. But it is probable that its growth will nevertheless weaken to 7.5 per cent or less, thanks to recessionary conditions in the world.

Interestingly, even this is considered an outstanding achievement by our official spin meisters as it is happening in the worst year for the global economy since the 1930s.