Illustration by Stephen Cheetham

How Global Headwinds Are Slowing Indian Growth

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Dec. 19 (Bloomberg) -- India hasn’t been spared the effects of the recession and the recent slowing of global growth.

Weak Chinese imports in particular have had a distinctly negative impact on suppliers such as South Korea, Taiwan, Indonesia, Australia and Brazil. In the 2010-2011 fiscal year, India’s trade gap with China jumped to $28 billion, its largest shortfall with a trading partner.

India wants to shift its exports to China to value-added products such as pharmaceuticals from raw materials such as copper and iron ore, which account for about half the total.

Another headwind was the weak monsoon this year. About 60 percent of Indian farmland depends on monsoon rainfall, which was 7 percent less than long-run averages. In reaction, farmers planted fewer summer crops. They also pumped more water from wells because reservoirs were depleted. That, in turn, required more spending on diesel fuel. The added costs, plus the anticipated poor harvests, are squeezing farmers’ discretionary spending.

Adding to those external detriments to economic growth, India’s leaders recently have introduced a number of policy measures that, though they may be politically necessary, discourage domestic and foreign investment.

Retroactive Taxation

Early this year, the government proposed taxes on transactions in which Indian assets were transferred between foreign entities, to be applied retroactively. The proposal would override an Indian Supreme Court decision in January that U.K. mobile-phone company Vodafone Group Plc isn’t liable for more than $2 billion in taxes on a 2007 deal it made to enter the Indian market.

Another proposal would establish an anti-tax-avoidance policy that investors worry would allow the government to tax investments in India conducted from offshore tax havens such as Mauritius.

The plan puts the responsibility on investors, many of them foreigners, to prove that they didn’t structure corporate deals to avoid taxes. About $692 million in foreign capital left the Indian stock market in the three days after that proposal was announced.

Another deterrent to foreign direct investment is the recent proposal to extend pharmaceutical price controls to 60 percent of the 348 drugs that the government considers “essential” from the current 20 percent.

The price restrictions would extend beyond generics to patented drugs for the first time. This is a response to the government’s concern about the two-thirds of Indians who lack health insurance and the fact that Indians pay 70 percent of their health-care costs out of pocket.

Then there is the recent rash of scandals involving government officials, especially “Coalgate,” in which companies -- some controlled by senior members of the ruling Congress Party -- illegally acquired coal block mining licenses between 2008 and 2011. India’s Federal Auditor reported that the government lost as much as $33 billion by allocating licenses without transparent auctions.

The global economic headwinds and the bad economic policy decisions have had significant negative consequences for India. The mushrooming foreign trade and current-account deficits are serious concerns, because the foreign funds required to finance the shortfalls have largely dried up.

The trade deficit grew 56 percent, to $185 billion, in the 2011-2012 fiscal year, compared with the previous year, as oil and gold import prices rose. The trade and current-account deficits, about 4 percent of gross domestic product, are significantly driven by oil imports, and global crude oil prices are likely to remain high. India imports about three-fourths of its petroleum consumption.

Equity Troubles

When it comes to foreign investment, private-equity companies poured into India-oriented funds from 2005 to 2007, when the Indian stock market was booming. Now the private-equity investors are having trouble raising money for India funds because of the fiscal and current-account deficits, slowing growth and uncertain outlook for stocks.

Returns on Indian-oriented private equity funds have been poor in recent years, and a decline in initial public offerings makes it difficult for investors to profit. In 2011, private-equity companies sold stakes worth $3 billion via Indian IPOs or through mergers and acquisitions, down from $7 billion in 2010.

With the high trade and current-account deficits and foreign money abandoning India, it isn’t surprising that the rupee has lost strength. The weak currency creates difficulties for Indian companies with foreign-currency bonds as well as for foreign investors in Indian debt.

In the boom years from 2005 to 2007, when Indian real GDP was growing at an 8 percent annual rate and the stock market jumped, the rupee was strong, reaching a record 40 rupees per dollar; today, the dollar trades at about 54.5 rupees. As a result, Indian companies sold huge quantities of bonds to foreigners.

The Reserve Bank of India has attempted to support the rupee by encouraging foreign purchases of government bonds, hoping that investors would be attracted by yields of more than 8 percent, exceeding even those for the debt of Spain and Italy.

Foreign investors are often only interested in India bonds, however, if they can hedge their currency exposure, but the RBI has also made it more difficult for traders to bet against the rupee with futures contracts.

The central bank has attempted to attract money from offshore Indians by offering them higher interest rates on bank deposits in India. In addition, in May, it forced foreign-exchange earners to convert 50 percent of their foreign currency holdings to rupees. None of these actions has produced lasting support for the beleaguered currency.

Export Obstacles

The weak rupee does make Indian goods cheaper abroad. The effect is limited, however, because exports account for only 16 percent of India’s GDP, compared with 26 percent for China. Furthermore, the costs of exporting goods in India are more than twice as high as in China and exceed even those in the U.S. and the U.K. For India, the lack of infrastructure and prevalence of graft increase costs and impede trade.

In April, Standard & Poor’s reduced its outlook on India’s long-term debt to negative and warned of a possible credit downgrade. S&P pointed to political gridlock and said there was a one-in-three chance of a downgrade from BBB-, the lowest investment grade, to junk, over the next two years “if the external position continues to deteriorate, growth prospects diminish, or progress in fiscal reforms remain slow in a weakened political setting.”

Moody’s Investors Service and Fitch Ratings didn’t join S&P in its negative outlook, though they rated India at the lowest investment grade, just above junk.

With a subdued global economy, investment-depressing government policy and declining foreign direct investment, private corporate capital spending in India has been on the decline. It has fallen from 14 percent of GDP before the financial crisis of 2008 to 10 percent in the 2011 fiscal year, and even more in recent quarters.

In the past, growth in capital formation in India correlated well with global GDP growth. Recently, however, it has dropped below zero while global GDP growth is running at about 4.5 percent year-over-year.

This trend suggests structural problems such as an inhospitable government policy. The World Bank’s Doing Business Rankings consistently put India behind the other BRIC nations -- Brazil, Russia and China. According to the World Economic Forum, India’s global competitiveness fell to 56th place in 2011 from 49th in 2009.

Among other things, the downgrade reflected deteriorating transparency in government decision-making and the relative slow growth in infrastructure.

Slipping Growth

India’s real GDP grew 8.4 percent for both the 2010 and 2011 fiscal years. It slipped to 6.9 percent for the year ending March 31, 2012. In the second calendar quarter of this year, it grew only 5.5 percent from a year earlier, a low rate in a developing country that needs at least that much growth to accommodate the 13 million entrants to the labor force each year.

The International Monetary Fund predicts 4.9 percent real economic growth for 2012, lower than its July forecast of 6.1 percent and the lowest in a decade.

Industrial production is falling. The HSBC India Manufacturing Purchasing Managers Index remains above 50, indicating expansion, though at a slower pace. Compared with the other BRICs, in 2011, India had the highest inflation rate, the highest unemployment rate, the worst current-account balance and the worst budget balance as a percentage of GDP.

The stock market is often a good gauge of a nation’s economic and financial health, and the two-year slide in the Indian market indicates a sick patient.

Falling stock prices are no match for bank deposit rates of 8 percent to 9 percent and yields of more than 8 percent on government 10-year bonds. In response, the government is giving tax breaks to individual investors with less than 1 million rupees ($18,000) in annual income who invest as much as 50,000 rupees in stocks annually and hold the securities for at least three years.

In India, gold prices and purchases are also major indicators of economic well-being. Ornate necklaces, armlets, earrings, bangles, chains and finger rings are essential parts of a Hindu bride’s trousseau and are usually bought by her parents. The World Gold Council reports that 27 percent of global demand for gold jewelry and investment comes from India.

Nevertheless, gold purchases in India have fallen dramatically, with demand for jewelry down 30 percent in the first six months of this year compared with a year earlier, and investment demand is down by 45 percent.

Early this year, the Bombay Bullion Association forecast a 20 percent drop in gold imports because of the weakening rupee. It revised its projection to a 40 percent drop after the weak monsoon and the widespread closing of jewelry stores for 21 days to protest higher domestic taxes on gold jewelry and gold imports.

The situation is so dire that the government was forced to rescind the tax increase on gold jewelry.

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the third in a five-part series. Read Part 1 and Part 2.)

To contact the writer of this article: A. Gary Shilling at

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