Indian Prime Minister Manmohan Singh’s speech and aggressive dollar selling have pulled the rupee back from its lowest point in four years, but underlying weaknesses in the Indian economy are causing investors to pull even more hard currency out of India. With the beginning of Fed tapering in the near future, India could struggle to finance the short-term debt that now makes up a quarter of its total external debt.
Rise in India’s current account deficit
Investors’ main worry is that India’s current account deficit has grown sharply over the last few years and its fiscal deficit, which will increase again after decreasing for a few years, is going towards subsidies more than capital investments.
India’s Prime Minister on economic strategy
“We need to ensure the fundamentals of the economy remain strong so that India continues to grow at a healthy rate for many years to come,” Singh said in his speech. Manoj Kumar and Frank Jack Daniel at Reuters report that the Prime Minister is working with other emerging markets to take some concerted action, but with elections around the corner, analysts worry that they won’t see the kinds of reform necessary to bring in foreign investment.
“With India’s next national election fast approaching (it is scheduled to be held somewhere around May 2014), political compulsions seem to have clearly pushed economic imperatives to the back seat,” says Societe Generale’s Kunal Kundu, with a particularly bearish stance on India. “The recent passage of the exchequer-draining Food Security Bill in the lower house (most likely to be confirmed by the upper house) and the virtual free-fall of the rupee is symptomatic of the ills plaguing the Indian economy – unrestrained fiscal deficit and the concomitant current account deficit.”
India forced to invest more
We should expect these problems to be exacerbated in the near future when India is forced to devote even more of its budget to interest. It’s not just that India’s total debt has grown, but also more than a quarter of that debt is short-term (44 percent if you include residual maturity) compared to just 5 percent ten years ago. Interest rates have already ticked up just on speculation of tapering starting soon; once it arrives they could go up by anywhere from 3 to 8 percent, making all that short-term debt even more expensive to refinance.