Rising Risks

India, alongside Indonesia, was the Asian country hit hardest by massive capital outflows this summer. Several factors fuelled this capital flight, including the country’s external vulnerability (current account deficit of 4.7% of GDP in fiscal year 2012/13), fragile public finances (budget deficit of 7.2% of GDP for all levels of government), tepid growth (5%) and sluggish growth prospects. Despite the strong upturn in external vulnerability, the risks of a balance of payments crisis still seem manageable, even though they are on the rise. A risk factor to watch is the deterioration in the quality of bank assets, eroded by the economic slowdown.

Greater external vulnerability
Along with Indonesia, India is the Asian country hit hardest by sudden capital outflows this summer, triggered by the deterioration of its macroeconomic fundamentals. For fiscal year 2012/13 as a whole, the current account deficit swelled to USD80bn (4.7% of GDP), a USD10bn increase in one year (+0.6 points of GDP). It also became much harder to finance the current account deficit because it was only 22% covered by foreign direct investment (FDI). As a result, India is increasingly dependent on volatile capital to assure its external financing. In fiscal year 2012/13, the country still had sufficient capital inflows to cover its external financing needs. This is no longer the case given the decline in foreign reserves. In the first five months of fiscal year 2013/14, foreign reserves shrank by more than USD8bn (excluding gold and IMF special drawing rights).

Even so, the risks of a balance of payments crisis still seem manageable. At the end of August, India still had USD250bn in foreign reserves, 2.7 times its short-term financing needs (current account deficit + repayment of medium and long-term debt), which amount toUSD92bn. Even if we add USD108bn in short-term external debt, India still has sufficient reserves to cover all the country’s commitments for the next year. Nonetheless, the country’s external vulnerability has increased significantly since 2009, and this trend is likely to continue.

Changes in external debt must also be monitored closely. Although it accounts for less than 21% of GDP, external debt increased 13% in a year, the equivalent of 3.5 points of GDP. Corporate debt accounts for 62% of total debt, while government and financial institutions each account for 19%.

The debt structure is becoming more risky as well. Short-term debt now accounts for 25% of total debt, compared to 19% in March 2009. As a result, the share of concessional debt has dropped to 12% from nearly 19% four years earlier. Fortunately, the share of hard currency debt has tended to decline. More than 23% of debt is denominated in rupees, compared to barely 15% in 2009. Dollar-denominated debt accounts for 56.8% of the total. Clearly, India is less sensitive to the depreciation of its currency against the dollar than it was four years ago, but it faces higher refinancing risks.

BY Johanna MELKA

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