Chidambaram to Woo U.S. Money in Race to Finance Record Deficit

By the end of this month, Indian Finance Minister Palaniappan Chidambaram will have completed a tour of the world’s biggest financial centers as he seeks investors for Asia’s No. 3 economy. He has no time to lose.

The steepest foreign-direct-investment drop in more than a decade has increased India’s reliance on more volatile stock and bond inflows to plug a record current-account deficit. Such a shift is exposing the economy to disruption and currency swings if short-term investors pull out, according to central bank Governor Duvvuri Subbarao.

Chidambaram, due to meet pension and sovereign-wealth funds in a tour of U.S. and Canadian cities starting April 15, is striving to boost demand for Indian assets after similar trips to Hong Kong, Singapore and Europe earlier this year. The government estimates growth has slowed to a decade low as foreign direct investment slid 20 percent to $30.8 billion in the April-to-January period, set for the biggest 12-month fall since the fiscal year through March 2002.

“Financing the current-account deficit is a challenge, particularly if recent signs of reduced global risk appetite develop further,” said Richard Iley, the chief economist for Asia at BNP Paribas SA in Hong Kong. The imbalance in the widest measure of trade along with stubborn inflation leave the Reserve Bank of India little room for more interest-rate cuts to boost expansion, he said.

Deficit Swells

India’s current-account deficit swelled to $32.6 billion in the quarter ended Dec. 31, or 6.7 percent of gross domestic product, stoked by gold and oil imports and subdued exports. The shortfall has weighed on the rupee, which has depreciated 5.6 percent against the dollar in the past year, the second-biggest decline in a basket of 11 Asian currencies tracked by Bloomberg, behind the yen. It gained 0.1 percent to 54.525.

Chidambaram, a Harvard Business School graduate and third-time finance minister, has already criss-crossed two continents and five cities in less than three months to pitch India as an investment destination. In January, the 67-year-old politician flew to Hong Kong on an Air India overnight flight to meet investors the next morning, abandoning his trademark starched white shirt and veshti, a traditional Tamil attire draped like a sarong, for a suit and tie for his engagements.

The minister, who oversaw a record expansion as finance chief from 2004 to 2008, took on the task of reviving an economy hampered by elevated inflation, infrastructure shortfalls, a slumping rupee and the threat of a credit-rating downgrade to junk status when he regained the job last year.

1991 Crisis

He is under pressure to prevent a recurrence of the 1991 financing crisis, which prompted India to pledge gold as collateral for a loan from the International Monetary Fund after foreign reserves slid. The country devalued the rupee then, tackled government monopolies, cut tax rates and let foreign companies take majority stakes in sectors including automobiles and pharmaceuticals to rescue the economy.

The present-day current-account deficit has led the nation to change policies since September by easing curbs and levies on capital inflows. Subbarao said this month the imbalance in the widest measure of trade isn’t “sustainable,” exceeds the desired level of 2.5 percent of GDP and is “worrying” as it comes amid slowing economic growth.

The shortfall is estimated at about 5 percent of GDP in the year ended March 31, 2013, according to Prime Minister Manmohan Singh. Reliance on more volatile stock and bond inflows to finance a deficit estimated at $93 billion in 2012-13 is growing, according to Deutsche Bank AG.

Temperamental Flows

“Growing reliance on temperamental flows will keep the economy vulnerable to bouts of shifts in risk sentiment and keep the rupee under pressure,” said Radhika Rao, a Singapore-based economist at DBS Group Holdings Ltd. “The other worry is moderating foreign-exchange reserves and declining import cover,” which has halved to seven months from the peak of 15 months in 2002-04, she said.

India’s short-term debt, including investments in government bonds and trade credits, made up 24.4 percent of total external debt at the end of Dec. 31, 2012, the biggest proportion since at least the financial year through March 1991, according to government data. The ratio was 22.6 percent in the 2011-12 annual period.

Foreign portfolio investment rose to $8.6 billion in the three months to Dec. 31, compared with $1.8 billion a year earlier, according to RBI estimates. FDI in the same period fell to $2.5 billion from $5 billion. External commercial borrowings by companies rose to $3.1 billion from net repayments a year earlier.

FDI Falls

In contrast, foreign direct investment declined to $30.8 billion in the ten months through January from $38.3 billion in the same period a year earlier, according to government data, without taking into account any revisions to previously reported numbers.

To stem the decline, Chidambaram has cut a levy on overseas corporate debt, reduced energy subsidies and allowed more foreign investment in industries including aviation and retail. India in January raised a limit on foreign investment in bonds by $10 billion to $75 billion.

India’s bond risk has fallen since mid-September, when the government began unveiling policies to jumpstart growth. The cost to insure the debt of State Bank of India, considered a proxy for the sovereign by some investors, for five years against non-payment using credit-default swaps has declined 64 basis points since Sept. 13 to 205, according to data provider CMA, which is owned by McGraw-Hill Cos.

Lot at Stake

The yield on the benchmark 10-year government bonds has slid 28 basis points, or 0.28 percentage point, to 7.9 percent in the same period.

Chidambaram kicks off his roadshow in Toronto with a meeting with pension funds on April 15 followed by investors and sovereign wealth funds in Boston and New York later next week. Chidambaram traveled to Singapore, Hong Kong, Frankfurt and London in January, promising investors fiscal prudence ahead of his Feb. 28 budget. He also visited Japan this month.

“There’s a lot at stake since the pitch to get investments has to be credible and no doubt the minister has a good story to sell,” said N.R. Bhanumurthy, an economist at the National Institute of Public Finance and Policy in New Delhi. “The visit comes at a time when there is a crisis of confidence in most emerging markets, not just India.”

Before it's here, it's on the Bloomberg Terminal.