Why India isn’t one of the Fragile Five

Lokeshwarri S K | Updated on November 19, 2014 Published on August 03, 2014



Lower CAD, improved forex reserves and quick policy response stand India in good stead

It has been quite a comedown for India since the turn of the decade. From being a part of the exalted group of the BRIC countries which were expected to lead global growth for the next 20 years, India has come to be called one of the ‘Fragile Five’ nations.

This state of affairs is a fallout of the turbulent summer of 2013. The Indian rupee was one of the worst affected in the rout. Other countries that witnessed similar outflows and a decline in their currencies − Turkey, Brazil, South Africa and Indonesia − were lumped with India to make up the Fragile Five. It is almost a year since those events. Does India still qualify as a fragile economy? The events of last week, with Argentina's default on its sovereign debt pulling the rupee lower, show that we are not immune to a global sell-off. Again, with experts predicting a period of heightened volatility in liquidity flows from the end of 2014 to the end of 2015, as the US starts hiking interest rates, will India once again be among the worst performers? To answer that, let us weigh some key metrics.

Current Account Deficit: All five countries in the Fragile Five sport current account deficits.

India’s CAD had hit a high of $31.9 billion in the December 2012 quarter, highlighting the precarious condition of the country’s external balance to foreign investors. This was a result of declining export growth and high imports of gold and crude oil.

The situation has been salvaged to a large extent by clamping down on gold imports through various ploys, including an import duty hike and restrictions on gold importers. An improvement in exports further helped narrow the deficit to $1.2 billion by the March 2014 quarter.

This is not too alarming. But with the Government easing some of the import curbs on gold, the CAD could increase again. The IMF pegging global economic growth lower for 2014 also means that exports are also not expected to gallop.

Forex Reserves: Foreign exchange reserves of Brazil, South Africa, Turkey and Indonesia recorded a drop in 2013. India, too, witnessed a similar trend. The consistently high CAD caused the reserves to decline from a high of $320 billion in October 2011 to $274 billion by June 2013. At this lowest point, the reserves were enough to service just six months of imports.

The action by the RBI since last September to bring in dollars through the FCNR(B)-cum swap scheme has resulted in the country receiving around $34 billion in the last quarter of 2013. The RBI has also been purchasing dollars in recent months. This has improved the reserves to $320 billion.

Policy response: The RBI’s move on interest rates had a large role to play in helping stabilise the rupee and external flows. Foreign investors in bonds are very sensitive to the difference in the real interest rates between the country of their residence and countries where they invest. The RBI went on a rate hike spree between September 2013 and January 2014, raising the repo rate from 7.25 to 8 per cent in this period.

The yield on India’s 10-year G-Sec, after adjusting the CPI, stands at 1.2 per cent. That makes it just good enough for foreign investors to stay put. Corresponding yields of the other Fragile Five countries range from 5.2 per cent for Brazil to -0.5 per cent for Turkey.

The RBI has also taken other measures to ensure that foreign investors invest for the long term. It has banned investment in treasury bills and Government bonds with maturity of less than one year.

It has also increased the ceiling for foreign investments in Government bonds through the auction route from $20 billion to $25 billion.

Nature of FPI flows: A study done by Bank of America Merrill Lynch on portfolio flows into various emerging markets revealed an interesting trend. Equity flows into India were three times the inflows into debt. In Brazil, the equity inflows were almost equal to bond purchases and in Indonesia, they were almost double. Since investors in equities take a bet on economic growth and company profits as opposed to currency movement and interest rates, these investors tend to be more long-term. The higher equity flows thus stand India in good stead.

To sum up, we have travelled some distance from the situation in September last year. The forex reserves are healthier and CAD is under check. But both could get out of control if there is a period of prolonged turbulence. The factor in India’s favour now is the improvement in sentiment due to quick policy response by the Government.

The risk of speculators targeting the rupee is almost negligible now.

We will totter along with the rest of the countries if there is a global risk-off, but we are not among the most fragile.

Published on August 03, 2014
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