(SA) Recovery in Economy: How Indian Economy Would Fare With The Large Fiscal Deficit by the End of Year 2009?

Is the 35% to 70% rally in a global stock market showing the recovery in the global economy or it is just a bear market rally? But its clear, this rally cannot be justified why? Lets start read the whole review. Even before the World Bank prediction, VMW have already made a bleak outlook for the global economy.
 
Click here to get India's State-wise GDP Data.

Recovery in EconomySince Mar, 2009 – equity markets has rallied by more than 30% from their Mar ’09 lows. What we could expect from this? Is it showing the recovery in the global economy or it is just a bear market rally or it is just giving some hope of recovery in the global economy? Whatever the recent trends in the global financial markets are developing, but the situation is still unclear. Economies are still struggling, investors are still losing their wealth, banks and financial companies are still losing their profits, credit market are still nervy, people are still very anxious about their job prospect, consumers are still shunning from the spending, companies are still losing their markets, and there are lot of other problems, which are revolving around us. Everyone is questioning about the economic prospect. For how long, this recession will last? When we should see the time of better prospect which we had witnessed before this crisis? 

Do you believe, the economy is now going to settling down or at least set to recover from here? Hmm…Yes, but not at a full pace. Since the crisis has embarked, banks and financial institutions have lost more than $700 billion in total losses, and it is not very easy for them to recover from this huge massive trouble in a very short period of time. Banks and FIs are striving to sustain their business in these tough times. Financial condition of the banks however is still not in a good shape and their bad assets in a balance sheet are still a major setback for them to recuperate from this. However, the government authorities and central bank around the world are taking adequate measures to heal the bank’s pain to put these banks back on the growth track. 

What are the Problems/Challenges, Indian Economy is facing? 

  • Disparity between Wholesale Price Index (WPI) and Consumer Price Index (CPI)
  • Higher Fiscal Deficit
  • Balance of Payments
  • Falling Exports
  • Rising Government Borrowings
  • Global Economic Challenges
  • Economic Reforms
  • Final Budget

We’ll discuss these points in detail latter… 

Liquidity Situation: Then & Now 

Exhibit 1: India's Call Money Rate between Jun '08 and Mar '09

Exhibit 1: India's Call Money Rate between Jun '08 and Mar '09

 

Now, let’s talk about the Indian economy and its financial system. Indian Government is persistently putting pressure on the Indian Banks to reduce interest rates to the important sectors like Real Estate and Infrastructure. The liquidity situation in the country was very fickle and lot of apprehension in the call money market when the global recession was at a peak during Sep, 2008 followed by the collapse of Wall Street investment bank Lehman Brothers Holdings Incorporated.  At that time, banks even unable to lend to each other, resulted call rates jumped up to 20% (See Exhibit 1 for the reference). However, the liquidity is now at a comfortable levels and call rates lingering around 3% and 4% and even falls below 3% in May ’09. If the Indian economy has an adequate amount of liquidity in the system, so why banks and financial institutions are still dis-inclining to lend? 

Firstly, this crisis proved to be the disastrous one especially for the international banks. Indian banks are still far better than the foreign banks. In India, banks have only saw decline in their revenue growth and profits and in some cases mark to market losses (largely known by MTM losses), however the foreign banks have lost almost trillions of dollars in the last 6 quarters and still struggling to do their business as usual. So, here the reason could be the lack of confidence. Secondly, the higher cost of credit. In India, the banks are largely depend on the time deposits (also known as Fixed Deposits or Term Deposits) for the primary source of funds to lend in which they have to offer more than 7% interest rate to the depositors. The cheaper source of credit to the banks is Current Account and Savings Account deposits (also known as Checking Account). Generally banks offer 3.5% to 4% interest rates on Savings Account and nil on Current Account. That is the reason – banks are now focusing on to reduce the cost burden. 

Stimulus Package Announcement? To refuel the growth in the export oriented industries, newly elected government should consider announcing Stimulus Package for the export industry such as Textiles, Gems & Jewelers, Steel and other industries which are vastly depend on the exports and to focus on the lower cost of credit to revive the infrastructure, Real Estate sector and Auto Sector. 

Indian economy as a whole 

India's CPI and WPI Comparison for Year 2008.

India's CPI and WPI Comparison for Year 2008.

 

Earlier, we’ve mentioned some important points which are specifically have certain influence on the Indian Economy. Out of those, one the most prominent is the variance between the WPI and CPI which actually making difficult for the RBI to take stance. Since the change in base year in Wholesale Price Index (WPI), inflation has steeply fallen from over 10% to almost zero within 6 months and interestingly, CPI has not been affected that much and still at over 8%. This is going to be a troublesome for the Reserve Bank of India while considering any change in its monetary policy. RBI should consider CPI numbers while taking any appropriate decision on the interest rates. Overall the inflation rate has created confusion for the RBI, that is the reason, the Indian Ministry of Statistics and Planning Implementation (MosPI) is going to launch CPI next year. 

US Dollar Trivializing and Euro Gaining Fiat Currency Status? Now, the another important developments since last year is rising Fiscal Deficit. This is not a single problem in the Indian Economy alone, actually many economies around world are facing the same kind of threat. US and UK probably would face the de-rating of their Bond/debt from the credit rating organizations. What would probably going to happen? Of course US Dollar may witness significant reduction in its value against the major currencies as the biggest creditors – China, Japan will sell US Treasury en-masse. The world’s fastest developing nations like India, China, Russia, Brazil are the biggest holder of US Dollars and may consider to revise their dependence on the US Dollar and in that case, US Dollar would lost its status as a Fiat currency (or universal currency) and will see the huge depreciation. 

Countering Tax Evasion is the Solution to the Soaring Deficits? With the Governments facing rising budget deficits while combating the economic crisis, tax authorities around the world have agreed on a plan to encourage tax compliance and counter tax evasion specially focusing on the banks, financial institutions, wealthy individuals and offshore investments. US, which have announced trillions of dollars of bailout packages to protect its economy is going to face significant rise in Debt to GDP ratio, perhaps would excess the 100% mark. The bailout packages, which cost nearly $5 Trillion to the American Taxpayers, will have to endure this strain possibly for the next decade. But the Indian economy in particular, which largely depends on the foreign inflows (FDI or FII) should check the rising fiscal deficit in order to maintain its sovereign rating. 

Higher Inflation prospect? Lets check the Indian Government’s borrowing in the last four quarters of the financial year 2008-09.


The given below table shows the borrowings of the Indian Government in the last four quarters of FY2008-09. The amount shown is in Crores (Ten Million) of Indian Rupees.

 

Year 2008        
Public Debt Q4 Q3 Q2 Q1
         
Internal Debt        
Market Loans 1,200,576.00 1,170,756.00 1,137,203.00 1,104,553.00
91 Day Treasury Bills 69,892.00 51,501.00 52,250.00 30,371.00
14 Day Treasury Bills 56,043.00 41,080.00 48,770.00 68,630.00
Other Debts 569,211.00 598,777.00 603,577.00 576,946.00
         
  1,895,722 1,862,114 1,841,800 1,780,500
         
External Debt 258,194.00 237,352.00 220,902.00 210,083.00
Other Liabilities 520,148.00 471,147.00 479,719.00 483,490.00
         
Total Public Debt of India 2,674,064 2,570,613 2,542,421 2,474,073
% age of Annual GDP 53.75% 51.67% 51.11% 49.73%
         
 The above table may not be accessible clearly. Please follow the link to access the full length We really apologize for the inconvenience caused to you. 

As you can see from the above table which shows the Indian Government Debt, which is continuously rising. The upward trend in the Debt to GDP Ratio is actually showing the signs of concern. This would ruin the country’s credit rating and makes credit expensive to all of us. Moreover, the rise in issue of Bonds to the central bank would force them to print more money and infuse that money into the economy which could lead to rise in stock of money. Currently India’s stock of money (M1) stood at $261.49 Billion in compare to $253.06 Billion in Mar 2009. Rise in money supply means higher headline inflation. 

After the elections, there is a rise in optimism among the investors and businesses. There are lot of tasks which are pending to the new government. Prime Minister Manmohan Singh, which is also known as a Architect of the Indian Economy by opening up the Indian Economy since 1990s and the business leaders are expecting the same from the PM and his cabinet as they have a liberty to announce the favorable reforms for the Indian economy and to open up the Foreign Direct Investments (FDI) route in the sectors like Banks, Insurance, Retail, Infrastructure, Power and other sectors. After this, government should also need to focus on larger gap in Balance of Payment. Higher Current Account (CA) deficit is largely caused by the falling exports. As the Indian Economy is facing lot of challenges from the global economic downturn, so far the federal government had announced the two stimulus packages for the sector to enhance the potential of the export industry to survive in the challenging time and to boost the domestic demand and the industry is expecting the another stimulus package as the condition of the global economy is still looking uncertain. 

Economy in Rest of Year 2009 

Not easy to answer! When the year 2009 was approaching after bloody ending of 2008, economist around the world were expected that the economy should continue to contract and even sharper than expected. Central banks around the world have slashed their interest rates further in order to fuel the economic growth engine and even the crucial G-20 summit in London also proved as a sturdy solution for this global mess. Global equity markets have regained their strength and recovered by more than 30% from their Mar ’09 lows. That is the strong thumbs up from the investors in response to the global authority. But economies like US, UK, Germany, France, Japan and other developed economies are still contracting and seeing the worst economic data in more than a decade. US economy in particular, will take at least five years to recover from the massive amount of losses that has damaged the country’s financial system badly. Now the trillions of dollars of bailout package has been announced in response to this crisis and this will probably swell to multi trillion dollars in amount in the next few years and indeed will convert into a huge deficit for the country, which will be inherited to the newer generation of the country. Indian economy is also facing the same challenge, and this threat must be contain for a fresh start of the global economy by following the determination of the G-20 Summit which was held in London, UK. 

So overall, the situation is sill in a very bad shape and the recovery in the global market is not showing the real picture. The rise in consumer confidence, business sentiment, and the perception about the particular economy would take some time to revive. 

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Economy in Crisis: Global Markets Loses Extended to $50 Trillion, South Asia Can Weather Economic Crisis.

Asian Development Bank study says, there is further room for interest rate cut is available in India and need to diversify their economies to reduce the impact of global financial crisis and larger Gov’t deficits.

Asian Development Bank's Headquarters in Manila, the Phillippines.

Asian Development Bank's Headquarters in Manila, the Phillippines.

According to the new study by the ADB, the Global financial markets losses have reached $50 trillion (Rs.2.5 Quadrillion or Rs.2.5 followed by 14 zeroes) mark. Losses on financial assets in Developing Asia in 2008 totaled $9.8 trillion. The total measure of losses includes reduction in value in Equity and bond markets including those backed by mortgages  and other assets and depriciation of many currencies against the US Dollar, however it does not includes the derivative products like Credit Default Swaps (CDS). According to data available with the VMW, the total outstanding of principle amount of CDS equals to $50 trillion alone, and  it will further instensify the total losses. Study shows the recovery can only now be contemplate for the late 2009 or early 2010. Data provide close connection between the economy and markets, therefore, the emerging economies are in mid of the crisis and the next 12 to 18 months are very crucial.

The good news is that, the South Asia (including Indian Subcontinent – India, Sri Lanka, Afghanistan, Pakistan, Bangladesh, Nepal, Bhutan and Maldives) Economies can weather the current Economic downturn by taking both short term and long term measures to stimulate the domestic demand and their economies.

The number of short term measures have been taken to cushion the impact of this crisis. In India, the Government has already announced the three Economic Stimulus Packages to stimulate the economy. Particularly in India and Sri Lanka, there is enough room available for more rate cuts. It means, the expectations from the central bank to brace the economy is still alive. Government could also consider incentives to encourage overseas workers to remit money home, they should also discuss currency swap arrangements and other measures to keep their financial systems stable.

However, in the long term, South Asian nations need to reduce their fiscal deficits, diversify their economies, step up infrastructure investment and boost intra-regional trade to take up the slack of lower demand from G7 nations.

Source: Asian Development Bank and VMW.

Reason Of Economic Disaster: An Explosion of World Financial Assets!

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The current credit crunch has added new urgency to discussions about redesigning the rules of the game for global capital markets. Clearly, risk management has lagged behind innovation in the financial system, and existing regulatory frameworks and institutions need to be updated to keep pace. National governments are clearly still important to the world financial system, but their ability to unilaterally manage and regulate financial activity is diminishing. Instead, as global capital markets grow, they are dispersing financial power. The United States remains the world’s biggest economy and home to the largest financial markets, but the influence of Europe, China, and the Middle East (among others) now extends globally. Investment of trade surpluses by Asian countries and of petrodollars by oil exporters has pumped liquidity into global capital markets, lowered interest rates in developed countries, fueled a new wave of leveraged financial activity, and propped up struggling Wall Street investment banks.

All this has happened as the world’s capital markets have undergone an extraordinary transformation. The value of the world’s financial assets—including equities, private and public debt, and bank deposits—has soared from $12 trillion in 1980 to $195 trillion in 2007. In fact, those assets have grown faster than the world economy. This phenomenon is called as Financial Deepening. In 1980, the total value of global financial assets was roughly equal to world GDP; by the end of 2007, world financial depth, or the ratio of assets to GDP, was 356%. Today, one-third of owners of government bonds, one-fourth of equities owners, and one-fifth of people who own private debt securities are not from the country where the assets were issued. Even the individual investor who buys only U.S. stocks on U.S. exchanges is paying prices determined in global markets.

Pension and insurance funds continue to be the major private investors, but other private and public players are increasing in importance. Hedge funds, private equity funds, central banks, sovereign wealth funds, government investment corporations, and government controlled companies all with different investment goals and strategies are now prominent on the global landscape. The recent crisis has highlighted the weaknesses of systems that regulate some actors but not others and that have no international reach. At a minimum, this patchwork approach encourages investors to operate in the realms with the fewest restrictions a race to the regulatory bottom.

Policy makers need to grasp how much financial activity is taking place outside traditional publicly traded and regulated markets and to ensure adequate oversight. Several Western banks and other companies have recapitalized in 2008 not by selling shares or debt on public exchanges but by seeking large cash infusions from private investors. As debt markets froze up, banks unloaded lots of loans by selling them to private equity firms. And while the credit crisis cooled the leveraged buyout boom of early 2007, many private equity firms have adapted in 2008 by acquiring stakes in public companies.

Deeper financial markets, though unruly and unpredictable, have many benefits. They can provide broader access to capital for borrowers, increase opportunities for sharing risk, and spur economic growth. Of course, market turmoil can also cause great disruptions, such as the currency crises that led to devastating recessions in Asia during the late 1990s and shortly thereafter in Argentina not to mention the U.S. subprime mortgage debacle, which continues to unfold. As policy makers look ahead, their goal should be to enable the world to enjoy the benefits of evolving global capital markets while managing the risks more effectively. But success depends on updating our thinking, not just our rules.

 Source: McKinsey & Company and HBR.