Country Risk
Analysis: Indian economy
Last year I read
a report which said India’s economic growth is set to overtake China’s economic
growth in a couple of year. It also said that by 2050, China, America and India
are poised to be the three biggest economies. However the report listed these findings
subject to some caveats related to country risk analysis. I make an attempt
here to discuss these caveats and analyze their implications on the general
well being in
context of the Indian economy.
- How sound is the
fiscal/ monetary policy?
A persistent
ratio of Fiscal Deficit to GDP over 4% is viewed with concern. Countries with
ratio of debt to GDP of more than 70-80% of GDP are extremely vulnerable.
The central bank
needs to be commended for maintaining an independent monetary policy and taking
effective measures to balance growth with inflation. It’s the fiscal policy
which is leaving the economy barefooted. Currently the central bank is raising
rates in hope to rein inflation by squeezing money supply. But the inflation is
proving to be sticky and not responding quickly to monetary tightening. Part of
this can be blamed to lack of tandem in monetary and fiscal policy. Government
is spending more than its earnings and the spending is acting like a stimulus.
This stimulus is aiding growth and fueling inflation. Worst still the
government spending is increasing in non productive areas like subsidies and
populist social programs which lack metrics for performance and delivery
mechanism effectiveness measurement.
- What are the economic
growth prospects for the economy
The economic
growth prospects of India look so much like Virender Sehwag’s batting. One day the economy looks like its invincible
and portrays a healthy picture for future growth. The very next day, economy
starts looking vulnerable The long growth prospects of the economy looks very
optimistic. But after Lehman brothers and Euro crisis, who has seen long term.
Still the policy paralysis in a difficult environment has stalled the growth
momentum. The medium term growth prospects depend largely on external macros
and internal proactive policy.
- Is the currency
competitive and are the external accounts under control
A small current
account deficit on the order of 1-3% of GDP is probably sustainable, provided
that the economy is growing. The current and near term projections for current
account deficit is 2.7 % of GDP. Though there may be a spike in import bill on
account of depreciating Rupee, exports too may rise easing the burden on
current account deficit. The current account deficit is within reasonable
limits and is likely to be so in the medium and long term. But at the same
time, current account deficit poses the maximum risk to India’s economy. Any
substantial shift could lead to a run on the Rupee and the economy could come
under serious stress. Phasing out subsidies and an efficient tax system has
become indispensible.
- Is external debt
under control
India’s has a
current account deficit so it borrows money from abroad, or in other words
foreigners are net investors in the country. But the amount of money India has
borrowed in within bounds on a relative basis.
- Is liquidity
plentiful
By liquidity we
mean forex reserves in relation to trade flows and short term debt. An
important ratio is reserves divided by short term debt. A safe level is 200% while a risky level is under 100%. The
country is sitting on a reserve base which is roughly equal to short and medium
term external debt. This limits the ability of RBI to intervene in the forex
market to support the rupee in times of downward pressure of Rupee. Still the
situation is not as comfortable and as regards the forex reserves India is just
within its means.
- Is the political
situation supportive of the required policies
In India, as in
America, being in opposition means opposing every policy move of the ruling
party even if it means opposing your original stand. There is a talk of party paralysis in India
thanks to inaction of UPA. But there’s a lot of contribution of opposition
parties to this policy paralyses. Without getting into this debate, this factor
is the biggest contributor to country risk of India. In fact on a valuation
metric, political risk will have the highest beta.
Overall I would
like to wait for a couple more months before starting to under weigh India in
my global portfolio. The country risk premium is relatively high compared to other
emerging economies. The economy is facing strong headwinds from abroad and
tailwinds from within the country. Big steps need to be taken to ramp up the
GDP and its growth metrics.
