The Entrepreneur

“Fundamentally strong” is the phrase most often used to describe the Indian economy in this period of global financial crisis. Why then have these fundamentals, been unable to prevent the Sensex from falling below 9000 mark, or the dollar from crossing the 50-rupee mark?

The free-fall of the Sensex can largely be attributed to the withdrawal of money by Foreign Institutional Investor (FII’s). Last year, the total inflow by FII’s was $17bn. This year, the outflow presently stands at $10bn. This outflow has more to do with crippling foreign banks than the Indian economy. The market is falling because these foreign banks are in dire need of money. Take Morgan Stanley for example; they emptied out their entire portfolio of Rs 2200cr in two days.

Consider SBI, India’s leading financial conglomerate; it has beaten all projections and posted a 40% growth in its quarterly profits. Even in the case of ICICI, the bank’s Indian operations posted a profit growth of 42%. However, ICICI showed an overall 27% decline due to its overseas subsidiaries. Credit for the comparative insulation of Indian banks, from the financial crisis, must be given to Dr. Manmohan Singh and his team. While framing the deregulation policies in the 90’s, they made sure that banks remain sufficiently regulated.

Foreign banks are also largely responsible for the fall of the rupee. Large foreign banks have been withdrawing money in rupees from the Indian market, and taking it to the US market in dollars, in order to sort out their own crisis. With the exception of the Chinese Yuan and Japanese Yen, most international currencies have weakened against the US dollar. The Yen and Yuan have grown stronger due to unwinding carry trade, where people borrowed in cheap yen to invest in other high yielding assets. This sudden new found strength in the dollar isn’t going to last long as its cause isn’t fundamentally good enough for it to remain so.

Today, India is not as insulated from the rest of the world as it was in the late-90s. Cross-border transactions contribute significantly to India’s present economy. The Indian IT industry, more so the BPO industry, will probably be the worst hit in the following six to nine months. This hit will last until someone fills the void created by Lehman Brothers, Bear Stearns, and other foreign banks coping with bankruptcy. The real test of the Indian economy’s strong foundation will be its GDP growth rate; tosee if it can achieve the projected 7.5%. (Bank to BPO contribution) While none of the economic parameters show any cause for  concern, the regulators need to make sure things remain that way. Crashing markets is the first stage of any financial crisis. This will not have a significant long-term effect. Although it is unlikely that India will reach the second stage, where non-financial firms get affected, poor regulation can push the country to that stage. Otherwise, we can look forward to a healthy long term economic growth.

Similar Posts:

• Making Sense of the Financial Crisis
• Does Inflation spell doom for India’s entrepreneurship boom?

This entry was posted Tuesday, December 9th, 2008 at 11:18 pm and is filed under 25th November 2008, Finance. You can leave a response, or trackback from your own site.