In its time, the Indian finance ministry has done a lot of good things. Agreed, most of them were fortunate mistakes (sorry, too much Taleb on my brain), but they still did a reasonable job of opening up the economy, especially after the 1991 economic crisis.
In fact, you would think that with the current Prime Minister being a former RBI Governor and being the former Finance Minister with a PhD from Oxford, and with the current Finance Minister being a Harvard educated economist/lawyer, India’s economic and fiscal policies would be a little more sound.
Currently, the US economy is in a downturn. To top it off, the federal rate cut has created liquidity in the market that’s been driving the FIIs to invest some place. So, all the FIIs have taken to investing a lot in India. This is further helped by the fact that a lot of capital account control measures are being relaxed to help these chaps. While the RBI did make a good call on trying to control the rise of the Rupee against the US Dollar, it does not seem to be enough.
If anything, FII investment has shot up to an all-time high of USD 11 bn this year. Wow. Yay. Way to go. Kudos. Etc etc.
Now, India also happens to be one of the worst borrowers from the World Bank. In fact, India moved into the list of the top 10 borrowers at World Bank sometime back. Well, it is a developing nation and there are some problems (you know, corrupt politicians, poverty, disease, politicians whose kids probably really need that luxury car etc). Well, that’s fair enough and understandable, too.
But do they really need to be stupid enough to try and pay off these debts using money that the FIIs have invested in the economy? Just what do they think is going to happen the moment the US economy recovers? That’s right, they are just going to go back to investing in the US.
One of the things that hit the SE Asian economic crisis of the late 90s was the absolute lack of capital control that these countries demonstrated, that led to their economies crashing. India was fortunate enough to have a fairly strict and tightly controlled (oh, sorry, regulated) market economy then.
Today, the story is slightly different. What would happen when the FIIs pull back and all the money that’s in the economy goes out of it? While I wouldn’t go as far as some people to say that the economy is at a financial risk, it is still a scary thought.
At least in the case of China, they have tangible assets (i.e. manufacturing industries). India has a very weak manufacturing infrastructure and very little in the name of tangible assets. Unless we create new assets, the continued rise will shoot the price of existing assets through the roof. Secondly, in the event of a market crash, there would have been some tangible benefit derived out of the investments that would go back into the system, e.g. infrastructure and industries.
It is indeed a policy dilemma for India. I do not know what the solution is — but what I do know is that we’d better find a good way of absorbing all this investment into the system. Otherwise, when the investors pull out and the stock market starts going down (and oh yes it will, at some point or the other), it could leave the Indian economy in a bad shape.
(Today’s pessimistic armchair economic forecast inspired by Blues from around the world and an over-dose of RSS feeds.)
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