Is India Vulnerable Or Resilient?

So far, 2008 has been an extremely challenging year. The deterioration in the global macro-environment and consequent rise in risk aversion and spreads has resulted in increasing volatility across all asset classes.
 
India too has not been immune to global developments with the equity markets down 16% from their peaks, bond yields edging closer to 8% from 7.5% levels earlier , and the currency depreciating by 3% to Rs40.5/US$ levels.
 
And, as we have explained in an earlier note
1, during times of volatility, it is countries with high twin deficits that are viewed as most susceptible to changes in global risk appetite.
 
India’s CAD to widen to near 1991 levels:
Oil prices at record highs and the fact that India imports close to 70% of its crude oil requirement, coupled with a slowdown in export growth to 14% levels from 20%+ seen earlier, will likely result in the trade deficit widening to US$115bn.
 
As a result, despite buoyant invisibles (software exports and remittances), India’s CAD would widen to US$36.7bn or 2.8% of GDP, up from 1.2% of GDP in FY08. A deceleration in capital flows in the current environment poses further risks to the external account.
 
Off balance sheet items hide the true fiscal picture:
 
India’s fiscal situation, which had been a steadily improving trend, appears to have taken a turn for the worse. While the ‘printed’ number is targeting a combined fiscal deficit of under 6% of GDP for FY09, given the various off-balance sheet items, the true deficit would trend close to 8%. India’s high deficit leaves limited fiscal space for policy maneuvers and at times is a deterrent for capital inflows.
 
India: Resilient or Vulnerable? Analyzing the Evidence
 
So, how vulnerable is India? Following the methodology adopted by our CEEMEA economics team in a series of notes
2, we assess India’s external vulnerability by measuring its dependence on capital inflows by using a ratio of the CAD and external debt amortization divided by the existing stock of FX reserves.
 
Besides the dependence on capital flows, it is also important to try and measure the speed at which money can go out. Coupling our previous analysis of key parameters to these variables, we re-visit the issue of India’s external vulnerability.
 
In terms of dependence on capital flows, India fares pretty well compared to most economies running current account deficits. Moreover, if one looks at possible outflows, cumulative portfolio flows since FY91 are US$64bn, with the current market value of FII holdings estimated at US$258bn.
 
Taking into account non-resident Indian deposits - the other element besides FII flows commonly defined as ‘hot money’, we believe the current level of forex reserves will be able to offset volatility in the interest rate and rupee markets.

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