India in a self-engineered financial crisis?

Larry Elliott of The Guardian writes in his post, "India's financial woes are rapidly approaching the critical stage. The rupee has depreciated by 44% in the past two years and hit a record low against the US dollar on Monday. The stock market is plunging, bond yields are nudging 10% and capital is flooding out of the country."

At the time of writing Rupee breached 64.5/$

Yesterday, Ruchir Sharma along-with Dr. Pranay Roy and Arun Shouri dissected Indian economy in a talk show in NDTV's news channel. Ruchir and his team at Morgan stanley put together few charts to show where India stands today. I have extracted the data from video and

FDI flow shrunk to half in 5 years. Official data
can be found here

While Forex Reserve stagnated, CAD ballooned.
FM said that CAD will be contained to $70bn

ballooning short-term debt a disturbing aspect

put them in charts here. Since, May, 2013, FII are pulling money from both equity and bond market. Ruchir's chart showed that FII drew out around $12 billion since May, $2 billion from equity and $10 billion from debt. The tipping point as everyone seem to be pointing to is Ben Bernanke's announcement about "tapering" Quantitative Easing which in plain word means, from September, US will slowly reduce pumping money in the market in response to US financial recovery. As soon as the announcement came, foreign money [not locked in capital investment] started moving back to US putting huge pressure on Indian currency. But the fact is Indian currency is  losing ground since last year, may not be as fast as it is losing between May and August. Indian Government did not appear to figure out the right move for the whole of the last year barring usual discourse of "Fundamentals are Strong". As GDP slowed, Current Account Deficit and fiscal deficit both ballooned while foreign exchange reserve started coming down slowly.

India did really bad compared to other EE

Contrast this with China which is still an export-surplus economy and still growing faster than India. While India's financial policies are tentative at best, China maintains firm grip on the value of Yuan. Ruchir showed that top 10 Indian companies have expanded their debt 6 times. The direct effect from that is, as he pointed out, some of the companies do not have enough cash flow to take care of interest payment. It is interesting to note that these corporate debtors have taken loans mostly from Indian banks and as an effect, banks' Non-Performing Assets have expanded a lot. CBI director made a statement yesterday that they are investigating NPA with various banks and asked

Indian Companies are adding their share of debt

respective CVOs [Chief Vigilance Officers] to assist them with the data. So why are these relevant? Well that is the point Ruchir is making. He is saying India is actually in financial crisis and a large part of that has to be attributed to ill-decisions or confusing financial policies that Government owns. In other words, this crisis rather than an effect of global slow-down, is largely self-engineered.
You can watch the video here

What Ruchir explained in the hour-long session is summarized by Larry quite well. He wrote, "In a sense, this is a classic case of deja vu, a revisiting of the Asian crisis of 1997-98 that acted as an unheeded warning sign of what was in store for the global economy a decade later. An emerging economy exhibiting strong growth attracts the attention of foreign investors. Inward investment comes in together with hot money flows that circumvent capital controls. Capital inflows push up the exchange rate, making imports cheaper and exports dearer.

Widening FD and CAD signal the crisis

The trade deficit balloons, growth slows, deep-seated structural flaws become more prominent and the hot money leaves."
How does India get out of this mess? Well, here things become less convincing. Investor's confidence has to be reinstated and that Bloomberg suggests, can only happen after the election! CAD has to be brought down to manageable 2% of GDP but that requires cutting down subsidies to corporates and energy prices and probably in food subsidies too. That is not going to happen before next election. Forex reserve may not be enough if the rupee continues its downward journey and India may have to go back to IMF again.
         Now one thing we must remember is that Economics as an applied body of knowledge is not an exact science, neither the economists can claim to accurately predict future given a circumstance. Things are messy because there are many competing interests and themes that are involved when one talks about country's economy. Dynamics between these competing chain of events are never clearly understood. So it become news when a prediction actually turns out to be true. Success of prediction is an exception rather than a rule, here. So, India's economy can collapse and go back by 5 years or circumstances may change and that could propel India to adopt right path. Indian FM spoke this afternoon and told that structural changes are being undertaken by the Govt. He assured that CAD and FD will be contained and growth will start by next quarter. While the market believes in his intent, it is not sure how those will be done and till people see any tangible results from Govt. policy changes, market sentiments are likely to remain the same and rupee will continue with its down-slide.
Either way, we have little options other than preparing ourselves for another gloomy decade of Indian economy. Journey will not be easy, weak economy opens political fissures, slows down country's growth, expands the rich-poor divide more, which in turn can lead to more social violence. But the silverline is that India has gone through worse phases in past. As one retired DRDO scientist told me once, fact that India still continues to exist as a country and a nation even after all the misadventures of its political masters and bureaucratic misdirections from its executives, proves beyond doubt [to him] that India is a holy land!
So let's hope that holiness of India will help us to sail through this time.

Mounting global debt and the way further

[cntd from previous post]
It does not appear that there is an easy way out.  During 1945-47 when US gross debt crossed the GDP figure they went for large-scale infrastructure development across the country. That in turn spurred sustained growth of economy which finally brought down the Debt/GDP ratio to 32% and made US a technology super-power. The question is what will they do this time? What will Europe do? Looking at the austerity measures of  Govt of UK and US, it seems that they are not sure. They are trying to restrain their expenses, cutting down their public expenditure in order to bring their overall deficit and hoping that somehow once they are in control of the expenses, the economy will slowly recover. People argue that it is slower path and recovery is not guranteed in the long run.
Harvard thinktank suggests that US should invest in innovation in a big way. HBR article argues that it was competition that was the hallmark of US growth. It is the high-tech sector that over the last few decades created the edge and competitiveness of US economy. They, however, showed that in the high-tech sector US trade-deficit drastically went up [ as much as 53% by 2007] since 2000. Outsourcing manufacturing for high tech goods to Asian countries [China, Taiwan, Malayasia] has ridden them of crucial ability to innovate and get better against their competition with better and advanced products. If they must get their economy back to normal, they must focus all their energy together in nurturing competition and innovation. They brought the concept of Commons, the valley of technology workers, which in actual sense, created the ability of the industry to compete and come up with better products. They believed that over the years in the name of focusing on core competency, US companies created a void in the skill requirement that drive innovation and with the depleted requirement, technical resources migrated to different areas. That in turn made these companies lose their ability to innovate. Coming years will tell if US Govt accepted the Harvard line or they chose different plan but as of now, experts in US believe that US is heading towards slower recovery path even with new stimulus package from Fed. For record, here is the Fed Reserve Bank Chairman, Ben Bernanke's latest speech at Jackson Hole.
Eurozone's problem is little deeper, there is lot of gaussian noise in the system without the emergence of any clear direction. With many soverign countries, each at different junctures and assessment of the problem, it is even a question whether Euro monetary model will survive this crisis.
    With the developed countries struggling to take their economies out of red, it is obvious that onus to drive the growth of world economy squarely falls on the shoulders of developing countries, particularly, China, Brazil and India. But are these countries really ready to lift this heavy burden? China and India both have been experiencing high inflation for last one year. Both of late have projected slower growth rate this year. For the first quarter of 2011-2012, India clocked 7.7% overall GDP growth compoared to 9.1% from last year. RBI incidentally downgraded growth projection for Indian economy to 8% from earlier projection of 8.5% for this year and next. RBI also said that inflation is likely to remain above 7% for next 12 months riding on high global inflation. China and Brazil also are facing high inflation overall. Added to that is the pain of corruption in high institutions in these countries.
Dan Rodrick, an expert from Harvard said that India and China must incentivize Innovation if they want to achieve robust economic growth during the next decade. India and China, both for instance are promoting renewable energy sector but what we are seeing today is more of adoption of technologies developed in developed countries compared to developing new technologies. Fact is traditionally [and till date] these countries have been technology adopters rather than technology creators. So it would be a challenge for these countries to create a path for technology innovation. What happens if these countries fail to create ecosystem that foster technology innovation?
There is a substantial risk of these countries becoming the growth market for developed countries. With slow growth of their economies, there are chances that both US and Eurozone will coerce the developing countries to allow open access to the markets of these countries [which the BRIC has resisted this far]. Last time this happened, the countries like India and China were collonies to British empire and industries in UK grew at the expense of the home-grown Cottage Industries in both these countries. If that kind of market access happens again, India and China will retrace their path in the history, though in a new format. IP protection will be the weapon in the new turf.
As an Indian I only can hope that Indian industry leaders come together and convince the Government to create incentive schemes for creating technology innovations and adopt the path themselves even if it means higher short-term profitability risks for them.