Country Risk Analysis: Indian Economy

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.

1. 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.

2. 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.

3. 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.

4. 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.

5. 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.

6. 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.