More FDI, less foreign debt has to be India’s mantra
Though the IMF has lowered its 2014 US forecast quite dramatically from 2.8% in April to 1.7% now, the dangers of the spillover haven’t reduced; they have though changed in their nature. For one, though the US forecast has been lowered, the fact that the Fed is going ahead with an unchanged taper schedule means US interest rates are on their way up—the IMF’s latest External Sector Report (ESR) talks of 10-year US bond yields rising from 2.3% in 2013 to 2.7% in 2014—which means more investments could move away from emerging markets. There is then the volatility that will come from the dramatic change in the prospects of emerging markets—between January 2013 and now, 2014 GDP forecasts for emerging markets are down from 5.7% to 4.6%. This has its own positives as well as negatives. A one percentage point decline in emerging markets growth is normally assumed to result in a 6% fall in commodity prices—any increase in Russian tension could, though, change this completely. Any adverse shocks in emerging markets could also disrupt global supply chains which, in turn, would affect developed country production as well—since Russia entered Crimea in early March, palladium and nickel prices are up more than 10%. Another negative is the impact on global trade—between April 2013 and now, projections for global trade growth in 2014 are down from 5.3% to 4%.
The saving grace for India, as the IMF’s ESR points out, is that with the current account deficit (CAD) under control, the external situation looks a lot better for India; how the CAD will behave when GDP growth picks up, however, is something to keep a close watch on. While a CAD of 2-2.5% of GDP is financeable, as the IMF points out, what is worrying is the recent change in the composition of forex flows towards more debt and less FDI—debt flows in the form of NRI deposits, ECBs by corporates and more trade credit have increased. Even though FII flows are in themselves volatile, since the beginning of the year, while FIIs have invested $12 billion in equity, they have invested $13 billion in debt. The additional problem is that, should the rupee depreciate suddenly due to the dollar appreciating, India Inc looks a lot more vulnerable; more so given the amount of ECB that needs rolling over. In other words, still time to tread cautiously.