'India flush on forex'

Fiscal deficit, if handled strategically, can bring foreign capital flooding into India, writes Dr Bhaskar Dasgupta.

Babble in the Indian Markets
After Saddam was caught over the weekend, the Sensex moved smartly upwards on sustained foreign buying behaviour and closed more than 1 per cent up, the highest in 44 months and the purchases keep on going on Tuesday as well.

Wednesday saw more of the same with the index touching 5285 after investors piled into automobile, cement and oil stocks. Thursday saw a slight increase of about 36 points after signs of profit taking but Friday saw the market powering up by 86 points to close the week at 5541, a 4 year high. Well, the foreign exchange reserves have now become a centurion, with the reserves crossing the $100 billion mark mainly coming from foreign investment inflows, trade flows and revaluation gains on the dollar's weakness against global currencies.

This also allows India to pre-pay its foreign debt as shown by indications that India will pay back $1.3 billion to the Asian Development Bank and about $2 billion more to other countries. As we have mentioned before, a dramatic rise in the reserves is evidence that the RBI is trying to keep the value of the rupee stable. A fluctuating rupee causes problems for importers and exporters who are unable to manage their cash flows. As most of our exports are currently priced in dollars, an appreciating rise in the rupee will hurt the exports as it will make the exports dearer.

This has had another beneficial impact with Standard & Poor's revising India's long-term foreign currency rating from 'negative' to 'stable' because of improving external finances, but the local currency outlook is still negative. This is mainly because of the huge fiscal deficit that is sucking the lifeblood out of the country. This revision of the foreign currency rating means that Indian firms, wanting to raise capital from international capital markets, can raise money more cheaply. As the S&P press release said, "Foreign exchange reserves should equal about 490 per cent of India's gross external financing gap (current account deficit plus amortisation and short-term debt) in '03, compared with 90 per cent or so in similarly rated countries. This is a major supporting factor for the sovereign ratings on India".

Talking about FDI, private banking shares such as IDBI, UTI Bank, etc. moved rapidly up after Finance Minister Jaswant Singh told Parliament on Tuesday that the government has taken an in-principle decision to raise the foreign direct investment limit for this category of banks. Foreign banks are currently only allowed to operate as branches but now they can operate as a subsidiary where they can hold up to 74 per cent, and this will allow their business to expand much more easily. If one may recall, HSBC Bank has started going down this route by acquiring a state in India's UTI Bank and is planning to increase its holding dramatically. About time too, I must admit, our banking capital is woefully low and this additional capital will definitely help.

The FDI level for this year has hit $7bn as of last Tuesday, the highest ever recorded. Most of the inflow is coming through the financial markets rather than actual investments in land, buildings and machinery, which could be a cause of concern, but hey, we take money where we get it. The good monsoon and industrial performance also helps with people predicting anything between 7-10 per cent growth rates. Investments in the equity markets is a far easier and better way to invest rather than run the gamut of the stinking and corrupt babu's and politicians by trying to setup a factory to manufacture prices. One thing to remember is that this is easy money, its easy come, and easy go. So let's temper our enthusiasm and happiness, ok?

Finally, another cheery note, the Supreme Court has finally told the government that anybody indulging in strikes and causing damage to public and private property should be treated stringently. About time, too. I do not know why people love to destroy things while trying to protest about their rights. I mean, how will burning up a state transport bus or smashing my scooter help you get your rights? You know what that makes you? It makes you a goonda, an ordinary criminal and a vandal who does not deserve pity or sympathy or even rights, you deserve to be locked up. I rather doubt that the government will manage to do much, after all, most of the political parties are full of these goonda's anyway, some wear white, some wear saffron and some wear red. Still, kudos' to the court!

Babble in the World Markets
The Saddam capture really did not reflect in the American markets on Monday with the markets actually declining (while oil prices declined as well). Tokyo, Germany and France, on the other hand, actually went on a rally on getting the news! Over the week, the American markets recovered, with new IPO's, the DOW powering up 2.4 per cent up on the week, while the NASDAQ kept quiet, with a bare 2 points up on the week. IPO's from Orbitz and China Life were the main movers in the week where we saw 10 IPO's launched.

You may recall that there were a total of 10 IPO's in the first 6 months of this year!, quite a turnaround, what? Europe was worrying about the rise in the value of the Euro but some good news about Gerhard Schroeder's reform package helped Germany close about 20 points up on the week. France dropped slightly over the week with concerns about the Executive life affair and the falling dollar keeping investors away from the market. The Footsie advanced about 70 points over the week, after good results and news from Cable and Wireless, BAE, BP and Shell.

Well, its getting worse and worse, the investment flows into the US failed to cover the US current account deficit for the second month running. In other words, there are more people selling US assets than people who are purchasing US assets, which means that the current account deficit is going to get deeper into the red for financing. This will have an impact on the dollar value and unfortunately, this could turn into a vicious circle, especially if the interest rates and inflation remain low. Once you factor in the abysmally low level of saving of the US consumer and rampant spending on credit, this is something which the treasury and the Federal Reserve people have to consider trying to resolve.

I know I have slated the German grand poo bah's before for not taking sufficient notice and care of the German economy but I have to admit that I am pleasantly surprised at how Gerhard Schroeder managed to get the red, blue, green and other assorted shaded political parties to agree on the Reform 2020 proposal. In short, the economic reforms include tax, social security and labour market reforms. These include basic social security reforms such as unemployed people have to take up whatever job is offered instead of only selecting jobs above a certain wage level. Still, this should help in reducing the painfully high degree of structurally unemployed in the system. People won't realise it but the famed social inclusiveness model of post-war Germany is creaking at the edges.

Obviously, beggars cannot be choosers did not apply before and this has been rectified. But there will be one problem which will show up in 2005, the financing required to fund the tax cuts will make sure that Germany's budget deficit will remain stubbornly above the 3 per cent budget deficit limit of the EU.

Talking about the EU, the 6 richest nations, UK, Germany, Netherlands, Sweden, France and Austria have called for the freezing of the EU budget to 1.1 per cent of the Gross National Income of the EU. Currently, it's more like 1.24 per cent. The main problem will be faced by the poorer nations such as Spain, Portugal, Greece and Poland, whose structural adjustment funds are going to be cut if this proposal is going to be accepted. Needless to say, the EU commission reacted very sharply to this proposal and set up a big moan at this proposal. It may be recalled that Germany was rather miffed at Spain and Poland for not allowing the European constitution to be accepted weekend before last, and threatened vaguely at financial penalties and of creating a separate inner core of a 2 speed Europe.

A fascinating factoid came to my desk. Did you know that the French spend more time watching TV rather than doing effective work per day? The figures are about 3 hours for TV and about 2.25 hours for work. Interesting, eh?

Japan seems to be playing it safe with plans to keep on issuing bonds to sustain recovery. 3 times in the past many years, Japan's nascent recovery was choked off by external events or monetary tightening of some shape or form. They are not taking any chances this time and will keep on flooding the economy with cheap money. This will, of course, keep the massive fiscal deficit alive but in my opinion, keeping the easy money coming will be a better option. Japan has structural issues with a very tough and difficult solution set. Till Japan actually get some political gumption (see the example of Germany above), it will have to keep on trying to paper over its horrible economic infrastructure with easy money.

Some years back, when Daimler Benz of Germany merged with Chrysler of the USA, the chairmen, CEO and big shareholders did not even read the deal documents before signing on the dotted line. This amazing state of affairs doesn't stop here, the members of the supervisory board of Daimler Benz, makers of the world famous Mercedes Benz cars, did not even the deal
documents before giving their approval over the phone. Kirk Kerkorian, one of the biggest shareholders in Chrysler, is suing the company for $1.2 billion claiming that the German company paid too little for the American car company. One wonders at their competence and I would have guessed that this does explain why the combined DaimlerChrysler company is suffering.

Top management have no clue!

For people who haven't read Bjorn Lomborg's The Sceptical Environmentalist, this is a word of advise, get hold of a copy and check it out. Lomborg's arguments against the foam-speckled, wild-eyed environmentalists are absolutely stunning, backed up with through statistical analysis and drives at least 20 stakes through the most commonly held theories about global warming, deforestation, climate change, recycling and a whole host of other issues. Well, this book did not make him popular at all, to the extent that the Danish Research Agency said some time back that the book was clearly contrary to the standards of good scientific practise and he has been physically attacked by the above mentioned foamy people. Well, the Danish Science Ministry overturned the decision of the Danish Research Agency and said, the charge was basically wrong, the worthy members of the agency failed to provide any evidence to support their claims. Simple pettiness and massive childish behaviour, eh?

Now that's fuzzy environmental math for you, no wonder these environmentalists come at the bottom end of the trustworthy scale as the PEW report said.

Finally, an interesting proposal came from Brazilian President Lula who proposed that the G20 countries form their own free trade block. It's a pretty powerful idea, as some of the countries include Argentina, Bolivia, Brazil, Chile, China, Cuba, Egypt, India, Indonesia, Mexico, Nigeria, Pakistan, the Philippines, Paraguay, South Africa, Tanzania, Venezuela and Zimbabwe. These form a big block already and can well come up with a big trade block of their own. While it will be difficult to push through, I can see some very big advantages to this bloc coming up in a trade pact.

If one looks at the countries involved, they have good technology, textile, agricultural and services uniqueness and can really increase their trade with each other. I know the rich countries are the biggest paymasters, but once this bloc forms, the EU and America's will be forced to deal with a market which contains up to 60 per cent of the world's population!

Go for it, I say! Actually, check out this document if you can, the EU is complaining about India's anti-dumping efforts on some products. It made me smile, it did. The EU complaining about bad procedures is so fantastically amazing, specially coming from a block which has made bad procedures an art form.

(Dr Bhaskar Dasgupta writes a weekly Monday round-up on markets and indicators. He holds a Doctorate in Finance and Artificial Intelligence from Manchester Business School and works in London in diverse capacities in the banking sector.)