Standing ‘country risk’ on its head

Much has been written about the rupee’s apparently never-ending fall. As the currency tests new lows on almost a daily basis, with the current account deficit — the gap between foreign currency-denominated outflows and inflows — widening. The Government is now talking about desperate measures like entering into rupee trade arrangements with nations willing to swap their currency for ours.

Desperate times call for desperate measures, one supposes. But such moves are, at best, temporary solutions, band-aids slapped on to staunch a mortal wound. The real reason for the rupee’s sustained fall is that the market does not see any near-term possibility of foreign currency flows being reversed. India’s demand for dollars, to pay for everything from consumer goods to oil and gas to weapons and aircraft, far outstrips the inflow of dollars coming in from investors into India.

The turmoil unleashed by the US Federal Reserves planned tapering off of its bond buying programme has suddenly made US gilts a far more lucrative — and safer —investment option than equities and corporate debt in troubled emerging markets like India.

LOSS OF CONFIDENCE

The fall would still have not been as steep if the market saw other flows replacing the Foreign Institutional Investor (FII) money currently exiting the stock markets. If Foreign Direct Investment (FDI) in setting up or acquiring businesses in India looked like it was going to take off — after all, there is that oft-repeated number of $1 trillion needed just in the infrastructure space over the next few years — then the rupee’s value would not have slid as sharply as it has. But, thanks to that omnibus phrase, ‘policy paralysis’ — used to club together everything from the Government’s politically dictated inability to bite the bullet on serious reforms, to the unending bureaucratic delays, legal and other hurdles as well as outright corruption — any sharp upsurge in FDI appears a forlorn hope.

So if there is going to be no game changing increase in either FDI or FII inflows, and with India’s economy continuing to grow — even if it is at 5 per cent – there is going to be no demand compression for dollars and the rupee will continue to fall.

The reluctance of foreign investors to buy into a by now increasingly tarnished India Growth Story is understandable. A revenue starved government, one, moreover, which was hell bent on pursuing its massive social spending agenda even at the expense of economic logic and ground reality did nothing to help the cause.

In fact, a series of acts of omission and commission — from passing a hugely disliked retroactive tax amendment to going after multinational companies for alleged tax evasion to failing to walk the talk on liberalisation, even to the extent of getting member states of the Indian federation to buy into its vision — have only made the situation worse. To top it all, there were even hints of the one phrase guaranteed to drive away any potential foreign investor — capital controls. Of course, this was swiftly denied, but the damage had been done.

So, it is no surprise that India is no longer a hot destination for international investment money. The ‘country risk’, to use investment parlance, has gone up a little too much for comfort for such investors.

INFRASTRUCTURE SPENDS

There is, of course, an alternative solution. India could tug its growth rate up by the bootstraps by stepping up investments itself. If the Government, as well as India Inc’s not inconsiderable resources were to be applied to targeting key deficiencies in the infrastructure sector, the resultant growth acceleration could help change the rest of the world’s collective mind.

But that is not happening. According to a study done by industry body Assocham last month, proposed investments by both overseas and domestic businesses together fell a staggering 75 per cent in 2012-13. From a level of 2,828 proposals worth Rs 6 lakh crore the previous year, the number of proposals shrank to 697 worth Rs 1.4 lakh crore in fiscal 2012-13 (which ended in March), the study found. Since then, the fall has only accelerated.

And a good part of this decline was contributed by the sharp fall in domestic investment proposals. India Inc is behaving exactly like its foreign counterpart when it comes to investing in India. It is not that they do not have the money — as of the end of the last financial year, just the top 500 companies had a cash and liquid investments stockpile of over Rs 9.3 lakh crore — enough to build nearly 80,000 km of 4-lane highways of National Highway standard!

What money they are investing is increasingly being invested abroad. FDI by Indian companies in fiscal 2012-13 more than doubled to $44 billion and the trend shows no signs of abating. As late as June, Indian companies invested over $1.7 billion. India is now the world’s 25th largest investor in overseas markets. This money is not going into just developed markets, but some of the least developed economies in the world. “Although China has garnered a reputation for hoovering up opportunities across Asia, Africa and Latin America, India has led the way among the BRICs for the past few years as the leading source of foreign direct investment to least developed countries, with $4.2 billion in 2012 against China’s $2.8 billion,” wrote risk analysis major Control Risk’s Jean Devlin in a recent report.

Anything from 30-50 per cent revenues for India’s 50 largest companies reflected in the NSE’s Nifty Index now comes from abroad, even though exports account for less than a fifth of the economy.

What this means is that when it comes to investments in India by Indian companies, the traditional perception of investment risk has been stood on its head. Logically, the ‘country risk’ for an Indian investor contemplating a potential investment in his home country should be zero. After all, who better than an Indian to accurately assess the market potential and understand policy risk? And then, there would be the added advantage of having a zero currency risk, since any rupee-denominated investment would not be hit by exchange rate fluctuations.

SOARING RISK

But this logic goes out of the window when market forecasts are sent crashing by an unexpected slowdown, or cost estimates mangled by rising inflation. Country risk shoots up when stated policy is either not implemented or reversed for whatever reason, and currency risk soars when the Rupee’s value goes into free fall.

Understandably, Indian companies now find Vietnam and Eritrea better bets than India.

This is the real price we are paying for policy paralysis and failure of governance. The growing presence of Indian companies in global markets is not a reflection of India’s growing clout in the world economic order, as the spinmeisters would have us believe. It is more a vote of no-confidence in the vision of India that might-have-been.

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