The new year has brought with it reminders of existing risks to the Indian economy. Global markets stumbled across all asset categories—equities, bonds, currencies and commodities—in the first week (January 5th and 6th) of 2015. The markets are, in a sense, signalling that most of the risks to the Indian economy in the new year are likely to emerge from across the borders.
Two events precipitated the meltdown. One, plunging oil prices have triggered apprehensions that the global economic recession is more deep-seated than expected earlier. That eroded stock prices of major oil companies across the world, creating a ripple effect embracing all sectors. Second, on-going elections in Greece have thrown up a rather curious development—the left-leaning Syriza party is expected to win the end-January elections.
Party leader Alexis Tsipras has publicly promised that if Syriza comes to power, he will reverse reforms, end the austerity programme and renegotiate the debt Greece owes to European Union, International Monetary Fund and private banks. In short, if fulfilled, these promises could lead to Greece’s exit from the eurozone, thereby repricing the debt higher and significantly denting balance sheets of all lenders.
Both these developments startled the markets. India’s two benchmark stock indices—Sensex and Nifty-50—lost 855 and 251 points respectively on one single day (Tuesday, January 6), though both recovered some ground subsequently. But, the development does highlight the fragility of the markets and vulnerability of India’s economy to external developments.
This is all the more ironic when viewed from some nascent improvements being noticed in the domestic economy. The growth outlook has improved significantly. Inflation—measured through both wholesale and consumer prices—has abated considerably. The only exception is industrial production, which is still languishing and shows no signs of any buoyancy.
The Reserve Bank of India’s December 2014 edition of its Financial Stability Report outlined the external risks somewhat prophetically: “…low risk premia may lead to accumulation of vulnerabilities, and sudden and sharp overshooting in markets cannot be ruled out…portfolio flows to emerging markets and developing economies have been robust, increasing the risk of reversals on possible adverse growth or financial market shocks, thus necessitating greater alertness.”
The same report highlights that portfolio investors from the U.S. have the highest share of equity market inflows into India, and rank second in debt market inflows. This fact serves to underline the enhanced risk Indian markets face when the U.S. Federal Reserve increases interest rates some time later this year. Whenever that happens, it will be mostly U.S. portfolio investments that will head for the exit first. Given that they have the largest market share, their departure will have the maximum impact on the dollar-rupee exchange rate and the current account deficit.
It is, therefore, obvious that the Indian economy faces its most serious challenge from external sources. As previous Gateway House articles have insisted, the government and the RBI need an alternate strategy, which includes fixing the economy’s structural defects and ensuring an augmented flow of foreign direct investment into manufacturing and services. And, this needs to be addressed urgently because global crises are typically not so considerate.
Rajrishi Singhal is Senior Geoeconomics Fellow, Gateway House. He has been a senior business journalist, and Executive Editor, The Economic Times, and served as Head, Policy and Research, at a private sector bank, before shifting to consultancy and policy analysis.
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