2011 began well for both America and India. The American stock market had closed 2010 with a 20% rally from the lows of August 2010. The American economy was expected to deliver reasonably good growth of about 3% in 2011. India was, of course, was riding the wave. The Indian Government forecast a growth of 9% in 2011 with a reasonable chance of double digit growth. The Indian stock market was enjoying a boom. Capital around the world was flowing into India and Indian companies were seen looking at or buying corporate assets in Europe & America. Prosperity was all around and Indian society was ebullient.
How did the year end? America still seems fine. The third quarter GDP came in around 2% and the fourth quarter look OK. The stock market closed unchanged for the year despite the massive crisis emanating from Europe. American corporations are in as good a shape as they have ever been. America’s Banking Sector, hard hit in 2008, is now the strongest in the world.
In contrast, India seems to have fallen off a cliff. The Indian stock market is down about 26% this year, one of the worst performances of any country in the world. India saw persistent high inflation all year. This forced the Reserve Bank of India to raise interest rates several times. The Indian economy has already slowed demonstrably.
India’s seemingly sudden fall from grace is evidenced by the precipitous drop in the Indian Rupee against the U.S. Dollar. The Rupee which traded around 43-44 fell in less than two months to 52-53, a 20% drop. This makes the Indian people about 20% poorer than they were just two months ago. This severely damages India’s fiscal condition because India virtually imports all the oil it needs and oil is priced in U.S. Dollars. It also creates severe problems for the Indian Corporations who purchased western assets or borrowed cheaply in U.S. Dollars. In turn, that causes real stress for India’s Banks, the principal lender to these foolhardy Indian corporations.
As 2011 ends, the financial conditions and economic outlook for America & India seem vastly different. America seems to have come out of its 2008 financial crisis and regained its primacy in the world. In contrast, India seems to have entered its own financial crisis, one potentially worse than America’s 2008 crisis.
What happened? Why did it happen? What does this say about the two societies? What lied ahead? In this article, we lay out our views.
So Similar, Yet So Different?
Most people think America and India are very different economies. Financial lingo places America in the DM or Developed Markets category and India in the EM or Emerging Markets category.
But the Indian economy is more akin to the American economy than to the other emerging market economies. The emerging market economies in Asia and in Latin America are primarily export machines that have built fiscal surpluses and large foreign exchange reserves.
In contrast, both American and Indian economy are driven by domestic consumer spending rather than exports. Both economies benefit from free movement of labor within the respective countries from less prosperous states to more prosperous states. Both economies run fiscal and current account deficits. Both therefore are dependent on import of foreign capital to sustain their growth. Both countries have competent Central Banks that operate semi-independently under twin mandates of price stability and economic growth.
If this is the case, why do financial markets treat America and India so differently? Or to put it simply:
- Why does money run out of India in every crisis and why does money run into America in every crisis?
Look back at America in 2008. At that time, it was a purely American crisis. The entire world recognized it as such. Lehman Brothers, a top tier U.S. Investment Bank, filed for Chapter 11 bankruptcy. The world’s largest insurance company, AIG, had to be bailed out with injection of over $80 billion in capital. The American banking system was in a deep and sorry mess.
Yet, even at the nadir of this American financial crisis, capital from all over the World ran, nay flooded into America. The U.S. Dollar rose in value against the Euro and the Emerging Market Currencies. And yes, the Indian Rupee fell to about 52 against the Dollar in 2008 even though India had no financial or banking problems.
In contrast, today’s Indian financial crisis is seemingly smaller and more contained than the American crisis of 2008. Yet, the Indian Rupee has fallen precipitously, fallen harder and lower than just about any other currency in the world, fallen below the 2008 low of about 52. Chartists now forecast a further fall to the 57-58 level against the U.S. Dollar.
So if the two economies are so similar, why do financial markets treat them so differently?
Difference Between Economics & Finance
This is not just nomenclature. These two disciplines are related but very different. Economics is a science while Finance is a technology. Every country in the world understands economics. It is taught in every university in the world. India has excellent economists. The Prime Minister of India, Dr. Manmohan Singh, is a noted economist. And so is Montek Singh Ahluwalia, the foremost economic bureaucrat in India. These two were the brain trust behind the Indian economic reforms launched in 1990.
Yet, these two noted economists and all their colleagues in India proved inadequate in preventing the recent collapse of the Indian Rupee. It seems that they didn’t even see the approach of this recent crisis. That may be because they completely misunderstood the true nature of America’s 2008 financial crisis.
Think back to the proud proclamation of Sonia Gandhi in 2008 & 2009:
- “It was my Mother-in-law Indira Gandhi who nationalized India’s Banks. That is what protected India from the global economic crisis”.
This was not just her boast. Every single economist in India and the entire Indian ‘elite’ believed that the American financial crisis of 2008 had demonstrated that the Indian economy was based on sounder economic footing and free of excesses evident in America’s freewheeling financial system.
So the Indian ‘elite’ concurred with Sonia Gandhi and the Indian Government poured economic stimulus into the Indian economy. This runaway spending together with large capital inflows triggered partly by U.S. Quantitative Easing (engineered by the U.S. Federal Reserve in the Autumn of 2010) created a credit bubble in India in 2011.
This bubble has now burst and we all see the result – massive flight of capital out of India, widening of fiscal and current account deficits, a weak, leveraged corporate sector and India’s nationalized banking sector clogged with poor quality loans.
The American crisis of 2008 was only a banking & financial crisis. The state of the U.S. Government and its Debt market was very sound. That is why the world’s capital rushed into America, to the safety of the U.S. Government Debt. This is why the U.S. Dollar strengthened despite the crisis in America’s banking sector.
In contrast, the Indian crisis of 2011 is much worse. It is a Government-Banking-Corporate crisis all rolled into one. Would you keep your risk capital in India during such a crisis? Of course not. This is why global capital rushed out of India in a financial stampede in November 2011.
The reality is that India’s financial ‘elite’ has never understood the difference between the science of Economics and the technology of Finance. An example might illustrate our meaning:
- Think back to a comment by an Indian General just before the 1991 Gulf War. The Iraqi Army of Saddam Hussein was trained by officers of the Indian Army. This General was quoted as saying that the Iraqis would give “a good account of themselves” in the war. We all know what happened. The Iraqi Army, the fourth largest in the world, was destroyed in a week. The “Shock & Awe” of American military technology converted the huge Iraqi Army into a helpless flock of sitting ducks.
The Indian economy was geared by and towards the science of Economics. The Indian Government, the Indian Banking Sector, the Indian corporate sector had never bothered to build up the financial infrastructure necessary to protect the Indian economy from a financial stampede. The result is what happened in November 2011, what usually happens to a system, a country that does not understand or use modern technology.
Finance as a Central Technology – Difference between America & India
Look at the Indian Government, the Indian Finance Ministry, Indian Financial Markets, Indian Academic Institutions. They are all staffed by Economists, Bureaucrats or Politicians. And none of these have any first hand knowledge, any real experience with financial markets.
In contrast, look at the American Government and its Treasury Department. These are staffed by veteran financial market players who have first hand experience in dealing with financial market panics and liquidations. America was very lucky to have Hank Paulson, ex-CEO of Goldman Sachs, as the Treasury Secretary in 2008. It was he who contained the fallout and rammed the massive TARP program through a Congress that had no clue about the scale or ramifications of the crisis. Today, America has Tim Geithner who managed the 1998 financial crisis and worked with Hank Paulson in October 2008 from his vantage position at the New York Fed.
There is a deep reservoir of financial technology expertise in America’s Wall Street and America’s Academic Institutions. Talent from this reservoir moves to and fro between America’s Government Institutions and Wall Street.
So America and India may have similar economies but their financial markets, their financial technologies are vastly different. This is true of military technologies as well. India’s military generals were stunned by the collapse of the Indian-trained Iraqi military in 1990. It was an important lesson and the Indian military used it to begin a slow but steady modernization drive that continues to this day.
We know that India’s financial generals are stunned by the sudden collapse of the Indian Rupee. We hope they learn the real lesson of this collapse. We hope they begin a slow and steady drive to modernize India’s credit and commodity markets with modern financial ‘technology’.
The United States of America is the world’s foremost leader in the Technology of Finance. This is why America’s Financial Markets are the deepest, most transparent, most liquid and most innovative in the world. This is why the world’s capital runs into America in every financial crisis.
Until India embraces and implements this technology, India’s financial markets will remain puny, illiquid and essentially powerless to protect India’s economy from any financial crisis. Until this changes, the world’s capital will continue to run out of India in every financial crisis.
A Silver Lining and Pure Luck?
Given the discussion above, our next statement might surprise readers. We suspect America’s financial leaders, Tim Geithner, Ben Bernanke and perhaps even President Obama, might be looking at India with a touch of envy. We believe they would just love it if the U.S. Dollar fell by about 10% from current levels. Instead, they watch with a degree of trepidation as the U.S. Dollar rises against other currencies.
They realize that India, all of a sudden, is far more competitive as a nation. The services of Indian information technology staff, the core of India’s technology exports, are now 20% cheaper than they were just two months ago. The Indian Rupee has not just fallen against the U.S. Dollar, it has also fallen against other emerging market currencies. As a result, India’s manufacturing products are now 10%-20% cheaper than Chinese, Malaysian, Indonesian and Vietnamese products than they were two months ago.
Since India is primarily a domestic consumption economy, the average Indian is relatively unaffected by the fall of the Rupee against foreign currencies. And if the price of Oil falls because of a global slowdown, then India’s inflation might go down and its balance of payments might improve despite the fall in the Rupee.
Indian economy has one advantage that most developed or EM economies don’t – huge, secular, unmet consumer demand for just about every product known to mankind. So once the world economy stabilizes, India will again become a magnet for foreign capital flows, an India that will be 20% cheaper to enter than it was in October 2011.
We see a world in which every major country will try to lower its currency to make itself more competitive. India will not have to try. By sheer dumb luck, India has already achieved in a free market manner what others will try to achieve via government policies. And so India might have the pole position when the race begins for the new growth phase.
This is the silver lining we see in today’s dark cloud that dominates India’s economic sky.
(This post originally appeared on Macro Viewpoints and has been republished with the approval of the author).