What The Govt Needs To Do To Save The Indian Economy From Crashing Like China’s

Posted on August 27, 2015 in Business and Economy

By Sreekanth Narayan:

The People’s Bank of China (PBC) recently devalued Yuan to as low as 4% against the dollar, creating a ruckus in the global financial markets. Other eastern countries such as Vietnam have followed suit by devaluing their currency, as China accounts for a significant portion of their exports. Stock markets crashed world over, from the west to the east, as investors started pulling out of equities, shifting to safe havens like bonds and gold.

stock market economy


China, which accounts for 15% of the world economy, has been slowing down over the last three years and the government has been unable to boost domestic consumption. The Shanghai Composite Index has fallen 22% in the last four trading sessions causing world-wide panic, and gains worth $8 trillion have been erased from the global markets. The Chinese government is aggressively pursuing devaluation, rate cuts and tactics like allowing the $548 billion pension funds to invest in stocks to prop up the markets, albeit unsuccessfully. The media is also silent on the recent crash and all these incidents convey a single message – China is no more the growth story it once was. Debt fuelled spending has put the country in an irreparable state and short term recovery looks uncertain.

Ever since the market crash, intellectuals have been debating over whether this is a ‘Déjà vu’ of the 1997 Asian financial crisis. While that might certainly be an overstatement, one thing is aptly clear – the Indian economy is very much safeguarded by strong macroeconomic factors. With commodity prices falling and the RBI sitting atop a huge pile of Forex reserves of $355 billion, there is very less probability of a downturn in India. Volatility in the Bombay Stock Exchange Sensex, including the biggest fall of 5.94% on August 24th, is primarily due to over exposure of the markets to hot money from the Foreign Institutional Investors (FIIs). Retail investors and Domestic Institutional Investors (DIIs) are only a small part of the Indian stock markets. This dollar outflow has made the rupee fall to its lowest level since August 2013.

Both the Government and Raghuram Rajan, the RBI governor, have not intervened yet to pull the rupee back to 63-64 levels, which indicate confidence. Or does it? Is the government afraid that investors who are already vexed due to the retrospective Minimum Alternate Tax and the inability to push reforms in the Parliament, especially the GST (Goods and Services Tax) and Land Acquisition Bills, would further turn away from the Indian stock markets? Making press releases to merely calm the investors would not put the markets back on track. The disinvestment of 10% stake in Indian Oil Corporation (IOC) saw very less participation from retail investors. 90% of the stake was bought by LIC. And the IPOs such as Navkar Corp which are currently going on are oversubscribed by a mere 0.36 times, even on the final day. This shows how panicky the investors are at the moment.

So the main question is this – what could be done to cheer the investors? There is a widespread clamour for a rate cut of 50 bps or rather the investors are demanding a ‘Rajan Put’, a phrase coined after Alan Greenspan, former chairman of the federal reserve, kept cutting rates aggressively during 1997-2003, which in fact was responsible for creating various bubbles such as the dotcom bubble and the housing price bubble. The problem with the rate cut is that, though it might cheer the investors temporarily, the effects will not be felt immediately. The previous 75 bps rate cut has not fully translated to lower lending rates by the banks. The US 10-year treasury yields are at a 4 month low, and though the chances of a sudden Fed rate hike is currently off the table, it cannot be totally discarded from the picture. One has to appreciate Rajan for being very conservative vis-à-vis rate cuts. Though the inflation declined to 3.78% in July, the meteorological departments have been predicting a 10% monsoon deficit. Any further rate cuts should account for prospective rate hikes by the Fed this year and the volatility in food prices.

The onus lies on the government to usher in reforms. The three main areas of contention are land acquisition, GST and labour laws. With the monsoon session being totally unproductive, the NDA government is vouching for a special session to be held in September to pass these bills. An opposition that is hell bent on blocking all major reforms puts the burden of resolving the deadlock on the government, and it has to the handled in a well thought-out manner. Joint sessions are probably be only way these amendments could be passed, as the NDA government lacks a majority in the upper house. With the Bihar elections lurking around the corner, how the opposition could be handled to push these bills would be a real acid test for the government.