BREMAINS OF THE DAY

Modi’s first full-blown crisis requires clarity of thought, steadiness of purpose

68 mark but recovered some ground to close at 67.9600 to the dollar, partly on Reserve Bank of India (RBI) intervention. Governor Raghuram Rajan reassured the markets redemption of $26 billion worth of FCNR(B) deposits, starting in September this year, would not be a worrisome event.

Economists at Bank of America wrote recently they expect banks should be able to fund $10 billion of outflows in September. “If Brexit stalls capital flows, we expect the RBI to roll over the FCNR(B) scheme,” they noted. The governor observed on Friday it might be premature to talk about a new rollover facility.

While India’s reserves, in the week to June 17, stood at $363.83 billion, an all-time high, there is some bunching up of forex repayments by banks and companies towards the end of the year.

India, experts said, could not escape the contagion effect even though its macroeconomic fundamentals are better than those of its peer economies. Portfolio flows could taper off with foreign investors moving money to safe havens. So far in 2016, foreign portfolio investors (FPIs) have bought equities worth $2.8 billion compared with $3.2 billion in 2015. FPIs have sold rupee bonds worth $1.84 billion in 2016 so far; in 2015 they bought bonds worth $7.56 billion.

Although falling prices of commodities, especially crude oil, will be a big positive, a global slowdown could mean that exports — which have fallen 18 months in a row till May — could remain weak. Moreover foreign direct investment could be impacted.

This may or may not be a Lehman moment, the truth is that we simply don’t know how the chips will fall, except to say that the signs are not good. There is the immediate fallout of the referendum—which is different from the actual Brexit that is at least two years away—in terms of the cataclysmic shock across currency, bond and stock markets globally. This requires central banks, including in India, to be ready to defend their currencies and pump in liquidity in the short run and find ways to ensure a currency crisis does not trigger a corporate debt crisis. In the medium-term, there are larger spillover effects that are difficult to predict, except to say the vote is a vote against economics—the economic rationale demanded that the UK stay on in the EU—and one in favour of a more closed world with less migration and less trade. Deglobalisation is too strong a term, but even before the Brexit vote, the world was seeing more barriers coming up and trade slowing down. Combine this with a global growth scenario that gets gloomier by the day—just look at how the IMF and the Fed seem to be tempering their forecasts each time around—and the picture isn’t a pretty one. If the UK wants out, will others in Europe follow suit and, if they do, what happens to banks who are left carrying the can—so much of the PIIGS debt is owned by banks in other countries like Germany—and does this then turn into a banking crisis? The possibilities are many, but with interest rates already negative in many areas, central banks are less equipped than they were at the time of Lehman.

Atsuchmoments,itiscommontotalkof Indiabeinganoasisof calm and of how, once the immediate turmoil is dealt with, more money will flow into the country; lower-for-longer commodity prices will boost the economyandcountertheimpactof exportsgrowthpossiblygoingback into negative territory if the eurozone growth plummets further as is expected. It also helps that, over the past two years, India’s ‘basic balances’ have improved—that is, FDI flows have been large enough to finance the current account deficit, making the country that much less vulnerable to volatile FII flows. That, however, assumes nothing slips out of control—FDI flows can slow down and dollar strengthening can lead to exit of existing capital; a banking problem in Europe will have its impact on banking capital flows into India … The uncertainty makes this prime minister Narendra Modi’s biggest economic test, with a mix of known unknowns and unknown unknowns. Some responses to this will be copybook, such as trying to attract more funds fromtheNRIcommunity,possiblywithapartial currency guarantee as was done when, three years ago, it looked as if the rupee would touch 70 to the dollar—announcing a new RBI Governor, with an inspiring track record, should be a priority since inflation controlwillbecriticalif debtinflowsaretobe sustained.Ithashelpedthat,from8.9months in FY15, RBI has managed to increase forex reserves to 10.9 in FY16.

While trying to attract FII flows is important, it is FDI flows that are going to be critical, and just projecting last year’s flows may not be a great idea since a lot of the flows were related to e-commerce which has lost some of its shine. India’s approach to FDI has tended to be incremental—even now, the opening up of single-brand retail has caveats like ‘cutting-edge’ and ‘state-of-the-art’. A precious two years, similarly, were lost in raising natural gas prices, as a result of which large amounts of forex that could have come in, did not; the illadvised rush towards net neutrality continues to keep telecom investors edgy and the lack of clarity over how to deal with an Ola or an Uber’s operations is another case in point. The short point is that the government has to be fast and alert to problems—that the retrospective tax cases still linger remains a deterrent.

In the ultimate analysis, boosting India’s growth is critical to staving off the Brexit-induced crisis and, despite all the government’s explanations, considerable doubt over the GDP numbers persists—even without the Brexit-induced tur moil in Europe, it is pretty clear the days of export-driven growth are over. With India Inc in terrible shape, cleaning up of its books as well as that of banks, becomes even more urgent, as does the government stepping up public sector investment in infrastructure in a bigger way. Though sections of thegovernmentareinfavourof usingRBIequitytofundthecleaning up of banks, this is probably a bad idea since it will mean selling off some reserves when strengthening them is the best way to keep the currency from plummeting. A better idea would be to issue government bonds to recapitalise banks—this doesn’t affect the fisc, except to the extent of interest payments in future years. Looking at ways to rebalance trade away from the slower-growth OECD into more vibrant Asia is another avenue that requires serious attention.

Large FDI flows inure India to volatile FIIs, but sustaining that needs a lot more reform and higher growth, cleaning bank books & hiking govt infra spend