India will be worse than China

When I listed my Ten Surprises for 2012 in January I predicted that China would have a hard landing, defined as quarterly growth below 5% annualised by the end of this year. But I also said that India would be worse than China. And it is this combination that makes me more concerned about the global growth slowdown in emerging markets than the crisis in Europe. This is a big, big story but no one is talking about it because Europe is sucking up all of the air.

The crisis in Europe is a known unknown meaning we know that there is a problem and the outcome is unpredictable. I see the slowdowns elsewhere in the globe as being unknown unknowns in that not only is the outcome unpredictable but the problem is relatively overlooked. The problems in China have had the most exposure. But the reality is that growth is slowing right across the emerging markets with India being the most worrying spot given the size of its economy.

Today Reuters has an article out entitled "India faces mass default and restructuring as devaluation looms". The gist of the article is that imbalances in the Indian economy are enormous and that they will come to a head in the form of private sector deleveraging and defaults. I see this as a huge issue that few macro analysts are talking about openly.

Reuters writes:

India’s mounting economic and political woes are prompting market players to raise the specter of a Greek-style crisis in Asia’s third largest economy.

This is not simply idle speculation. Last Friday, the rupee crashed to an all-time low against the dollar of 54.9 and it was stuck most of Tuesday at the psychologically significant Rs55/USD level, where the currency is seen as having no obvious technical support. And the implications of a rupee collapse would be immense.

"It could go to stratospheric levels against the dollar and it looks to me as if the Indian government is aiming at a de facto devaluation in an effort to prop up flagging economic growth. And you then have to worry about all the unpleasant boxes such an action would inevitably tick, such as straining further the country’s already strained balance of payments as well as bringing on an almighty wave of inflationary pressure," said a credit analyst at a ratings agency in Singapore.

He added that a spike in the rupee would strain the cashflow of corporates and banks as they struggled to service dollar-denominated debt and that the odds of a widespread Indian debt restructuring would be low.

In his opinion the market will determine the rupee’s level, with a formal devaluation seen as unlikely given the consequent need for interest rates to be pushed significantly higher to contain capital flight and counter toxic inflation levels.

This scenario was seen in the UK in 1992 when the country exited the ERM and the government pushed short term interest rates up to 15% from 10%, spending billions of pounds of reserves to defend the currency in the process.

When S&P cut India’s sovereign rating to BBB- in April, this was their concern. S&P believed that India’s large fiscal and current account deficits combined with political dysfunction to worsen the macro outlook for India.  Below are a few points to highlight in the worsening Indian macro situation:

• High government debt. According to Moody’s, India’s public debt, which is 70% of GDP, has prevented the country from getting an investment-grade rating. S&P is actually cutting India’s outlook.
• High current account deficits. India’s current account deficit was the worst in eight years in the fiscal year 2012 ended March. According to government forecasts, the deficit will be 4% of GDP, up from 2.6% last fiscal year. Moreover, India’s exports in March fell 5.7%, the first fall since 2009, as demand in the US and Europe dried up.
• Weak industrial production numbers. The most recent industrial production reading from India was for March 2012. Industrial production fell 3.5% year-on-year against expectations for a 1.7% gain. This is the second weakest reading since March 2009. You can forget about decoupling here.
• Still fighting spectre of stagflation. April wholesale inflation crept up to 7.23% from 6.89% in March. This was the highest reading since last November. On a three month annualised basis, wholesale inflation is now running at near 14%. That definitely restricts the RBI’s ability to lower rates to counteract the deceleration in economic growth.
• Currency depreciation causing headaches. The Reserve Bank of India spent more than $20 billion intervening to support the rupee between September and March. They have also forced corporate repatriations, demonstrating CB concern about the currency and the huge amount of USD debt on Indian corporate balance sheets. The RBI is now requiring Indian corporations to repatriate 50% of their overseas earnings. This number could be adjusted higher.
• Capital outflows. The biggest risk now may be the faster levels of equity sales by foreign investors. Brown Brothers Harriman’s FX team says that if the current trend picks up, the RBI would not be willing or able to stop INR weakness.

Bottom line: India’s economy is weakening at a startling pace. There is zero chance they can provide support to the global economy where weakness in Europe is the biggest macro concern. More likely, they will be dragged down further by trade flows. i expect growth to continue to decelerate.