... who is the most vulnerable of us all?
Given how volatile global currencies and markets have been in response to the US taper talk since May last year—the rupee fell from 55.47 to the dollar on May 22 when the US first talked of the taper, all the way down to 68.83 on August 28—it is not surprising that the IMF’s Global Financial Stability Report (GFSR) should be so focussed on the risks to global growth. At one level, things are a lot better. The average fiscal deficit of advanced economies has halved from the peak of the crisis and is now around 3.5% of GDP. In the case of the US, much less so for Europe, the amount of balance sheet repair has been large, suggesting future growth will be more stable—between 2009 and 2013, US households reduced their debt by 16.3% of GDP (1.8% for the euro area) and financial institutions by 35.6% (7.5% for the euro area). So, though corporate and bank stress is a big factor in Europe, the biggest rise in stress—since the last GFSR, in October last year—in the traditional diamond metric lies in emerging markets. With non-bank financial institutions doubling as a source of financing in China—since 2010, they have risen to 30-40% of GDP—the lack of an orderly deleveraging of the shadow banking system is obviously a key risk.
Quantifying the impact of that, however, is difficult since it is not clear at what pace it will unravel, and how much the Chinese government is able to contain will be critical. The GFSR, however, points out that, thanks to the various QEs in the US primarily, developing countries—including India—got around $480 billion more of inflows in 2013 than they would have got based on simple extrapolation of the 2002-07 trends. If even a part of this returns to the US due to higher interest rates there, the impact is potentially huge. Worse, IMF argues the BRICs have reached the last stage of the credit cycle, marked by deteriorating asset quality, increased leverage and peaking asset prices. India is better off than the other BRICs as both government and household debt-to-GDP levels are off their 2008 peaks, but corporate India remains very vulnerable to currency and interest rate shocks—the net debt-to-ebitda levels rose from 2.75 to 3.25 between 2008 and 2012. A 30% depreciation, when applied to India Inc’s forex debt, based on the natural hedges that firms have, the GFSR estimates will result in around 22% of ebitda getting wiped out. For select firms, the impact could be disastrous—even a 5% depreciation, BoFAML had estimated some months ago, could result in a 50% hit to EPS for select Indian firms. If all goes well—and there is no doubt India is better prepared today—India will not be impacted as much as it was when $12.56 billion flowed out between June and August last year and the rupee fell from 56.5 in May to 66.6 in August. But were the next government to be unstable, if its policies didn’t enthuse investors, or if interest rates in the US rise faster than expected, there could be large bouts of volatility ahead. This is still not the time for the faint-hearted.