While India will face inevitable economic headwinds, it must have a protection plan for its people
Put on Your Seat Belts
The coronavirus and lockdown-induced recession have fuelled huge distress in India. A third connected problem has been the crash in stock markets. A fourth misfortune, an extension of the third, is now threatened by loan defaults by developing countries that could snowball into a further panicky exit of dollars from all emerging markets, including India.
The Sensex is already down from almost 40,000 to 27,000. Foreign portfolio investors (FPIs) today are the biggest shareholders of many Sensex companies. HDFC Bank and ICICI Bank are owned mainly by FPIs, even though they are called Indian banks. But in March alone, FPIs were net sellers of $16.5 billion of shares, against $9 billion in the entire 2008 crisis.
Is the crisis about to peak, and will we soon return on the path to normality? Wall Street analysts predict a sharp economic recovery from the current recession in the second half of 2020. Indian optimists hope that FPIs will soon come back and the Sensex will boom again. The optimists argue that bond yields are close to zero in advanced countries. So, global money will have to come back to countries like India, which promise higher yields since they will grow faster than the advanced countries.
Maybe, but those days may be a long way off. Markets yo-yo with alternate bouts of greed and fear. Some FPI money will doubtless come back for bottom-fishing. But the big risk is another round of massive FPI outflows as part of a panicky exit from all emerging markets induced by a series of defaults.
Lebanon has just defaulted for the first time ever. In the 1950s, it seemed the brightest economic star in Asia, but was then devastated by a civil war that still continues in a sort of equilibrium. Despite that, Lebanon never defaulted on its foreign debt — until now. Covid-19 has finally done what even civil war could not.
Argentina has defaulted too, on dollar debt subject to adjudication within the country. It has massive debts running into billions of dollars under international judicial jurisdiction, which presumably will suffer default too. Argentina enjoyed a spell of fast growth in the 2000s that enabled it to look so creditworthy that in 2017, it could actually sell 100-year dollar bonds to global buyers. Today, it is comprehensively bust.
Venezuela cannot pay its debts, but is a special case since it has been the target of US sanctions. Ecuador is also on the verge of default. Venezuela and Ecuador are oil exporters, and the collapse of the price of oil from $65 a barrel a few months ago to under $30 a barrel today means their main source of tax revenue and foreign exchange has evaporated. The same story is going to be repeated in other oil-exporting countries, and can devastate smaller exporters in Africa. Mexico, a major oil exporter, has seen its currency sink 20% this year.
The world is in a deep recession and could take over a year to revive to pre-crisis levels. The virus has hit Asian countries whose exports depend on global value chains and have suffered from China’s lockdowns. But a bigger problem has been a fall in all commodity prices, which are the staple exports of many developing countries. These are suffering a double whammy of a crash in exports even as dollars are yanked out of their economies by panicky FPIs. India and China are net commodity importers, and will gain from declining prices. But most developing countries will suffer.
Just a few years ago, Brics — Brazil, Russia, India, China and South Africa — were touted as the next major global powers. They even set up a Brics Bank to finance global projects. Of the five members, three — Brazil, Russia and South Africa — have seen their currencies sink 20% in recent weeks. They will want to borrow rather than lend through the Brics Bank.
Defaults by emerging markets are set to snowball. United Nations Conference on Trade and Development (Unctad) has just come out with a report saying developing countries urgently need debt cancellation of $1 trillion this year; another clean gift of $1trillion through a new issue of special drawing rights by the International Monetary Fund (IMF); and an additional $500 million from rich countries as a new sort of Marshall Aid. Alas, even the richest countries are focusing on reviving their own stricken economies.
India is in a relatively good position to withstanding the hurricane about to strike defaulting and other emerging markets. Its current account deficit is very low and may go to zero because of the crash in oil prices (which may, however, be offset partly by a decline in remittances from the Gulf). Inflation is under control, save for vegetable prices. The fiscal deficit is going to shoot up, but that is happening across the world and is not causing inflation.
RBI will monetise most of the fiscal deficit, so interest rates will not shoot up and the financial sector should have enough liquidity. But not even all this will give India immunity. Prepare for stormy days ahead.