The Asian crisis that hit the Tiger economies in the late 1990’s missed India then. India was not exposed to international markets in the 1990’s and the fast growing Tiger economies of Hong Kong, Thailand, Indonesia, Philippines, South Korea and Malaysia that were exposed to global markets suffered when the bubble burst. The Asian crisis was all about countries taking up short term external debt to unsustainable proportions leading to a run on their currencies. The aftermath of the Asian crisis proved to be an extremely difficult period for Asian economies that saw them go into deep recession and it took them many years of reforms and hardship to come out of the crisis.
India is now suffering the same pain as its Asian counterparts suffered then. The scale and the reasons may differ but the pain of coming out of the issues is the same. India will have to undergo a period of restructuring in the coming years for the economy to strengthen. The restructuring period is going to be difficult for all concerned. However once the restructuring is over then the economy should get back on a more qualitative growth path.
India’s problems at present
The Indian Rupee (INR) reflects the market sentiment on the country. The INR is the worst performing currency amongst other Asian economies. Table 1 shows the performance of Asian currencies against the USD over a three year period.
Source: Yahoo Finance
The INR has depreciated by close to 16% over the last three years while all other currencies except the Indonesian Rupiah has appreciated. The INR depreciation is more to do with India’s problems than market sentiments towards Asian currencies. The reasons for the INR depreciation are largely due to the rising Current Account Deficit (CAD), rising vulnerability factors and rising fiscal deficit.
Current account deficit as a percentage of GDP has gone up from levels of 2.8% in 2009-10 to levels of 5.4% seen in the second quarter of 2012-13. CAD is expected at 4.6% for the full year 2012-13. Indian’s vulnerability to the external sector has gone up with short term external debt to total external debt ratio rising from levels of 13% seen in 2005 to 23% levels seen in end September 2012. Ratio of short term debt of residual maturity of one year and less to total debt is 43.7% as of September 2012 indicating that the country could face serious problems if there is a freeze in global financial markets. Import cover that measures the foreign exchange reserves to imports has declined from 14 months in 2005 to 7 months in 2012. India saw such low import cover levels in late 1990’s when the country’s foreign exchanges reserves were at extremely low levels.
India’s fiscal deficit as a percentage of GDP has gone up from levels of 3.9% seen in 2005 to levels of 5.9% seen in 2012. Fiscal deficit for 2013 is expected at 5.3% of GDP.
India’s competitiveness at the global stage is being eroded due to high property prices and rising wages. An IT outsourcing company setting up shop in India will be paying seven to ten times as much for space as a company would have paid ten years back while wages would have gone up by at least five to seven times. A manufacturer will be paying higher land prices, higher wages, higher transportation costs and will suffer power cuts, infrastructural bottlenecks, corruption and bureaucracy. In short it is expensive to outsource services or manufacturing to India.
India is facing rising inflation issues with CPI (Consumer Price Index) at 10.6% as of December 2012. The high CPI will push up wage costs further leading to further erosion of competitiveness of a country that depends on lower cost of skilled labour as opposed to other countries.
India has to set things right
India has no choice but to get down to hard economics. Deficits have to be cut, inflation has to be brought down, rampant property price speculation has to be curtailed, infrastructure has to be improved, corruption has to be brought down and bureaucracy has to be cut. These decisions are painful for the economy in the near term but in the long term it will help stabilize the economy and get it moving forward. It is a long hard grind ahead, similar to the grind Asian economies faced in the late 1990’s but it is definitely worth it.
Indian public has to brace themselves for tough conditions ahead.