Time has run out Mr. Vajpayee

By Prem Shankar Jha

The country is once again on the brink of a foreign exchange crisis. The trigger is a shock to the global financial system delivered by an event that could not possibly have been foreseen - the terrorist attack on the U.S. But its effect on the Indian economy will be to speed up dramatically, a descent into crisis that was already on the cards.

The resemblance between the scenario that is unfolding today and the foreign exchange crisis of 1990-91 is uncanny. In 1990, the government was already living way beyond its means, and using short term international borrowing to do so. In a less spectacular manner, it has been doing exactly the same during the last ten years. Not once during this time has India recorded a balance of payments surplus. Instead, it has financed its external deficits by borrowing. While the payments deficit has not been spectacular in any year, the total has mounted. That is what our much-vaunted foreign exchange reserves happen to be, an accumulation of foreign borrowing. And the bulk of the liabilities incurred have once again been short term.

On March 31 this year, $38.1 billion of India's $42.2 billion of foreign exchange reserves consisted of trade credits, short term official debt, foreign institutional investor portfolio investment and non-resident Indian deposits, collectively described by the Centre for Monitoring Indian Economy (CMIE) as ``vulnerable liabilities". The first two have to be paid and reborrowed constantly. The latter two could start withdrawing from the country in a matter of weeks. This is not the whole story. The Reserve Bank of India also holds almost $10 billion of very short-term NRI deposits, which mature in less than a year.

Although these are not counted as reserves, that is an accounting sleight of hand. Any sudden outflow in these will bring unbearable pressure on the rupee just as surely as a fall in NRI deposits or withdrawal of portfolio investment.

The trigger for a foreign exchange crisis could be the impending withdrawal of funds from the share market by foreign investors. A business daily has reported that four major portfolio investors with $8 billion or more of shareholdings are reducing their stakes in India.

These and other investors began trimming their investments after Moody's and Standard and Poor's lowered India's credit rating, but the World Trade Center disaster will greatly accelerate the pullout. The reason has little to do with India: when the Dow Jones opens later today share prices are bound to fall in the U.S. At the same time, insurance companies and mutual fund managers the world over are going to face the largest simultaneous life insurance claim in history.

The effect will be not unlike a sudden run on the bank. To meet it they will have to sell shares, and in the face of falling share and bond prices at home, the first to go will be their portfolios in emerging markets.In anticipation of this selling pressure, the rupee has already begun to decline. From around 46.70 to the dollar before `black Tuesday' it is now edging towards Rs. 48. The markets too are bracing for the Sensex to fall as far as 2500.

What this will do to the 20 million Unit Trust of India shareholders stuck with the US-64 shares does not bear thinking about. What that will do in turn to the stability and prospects of the NDA Government, however, is all too predictable.As it is, exporters have been holding their earnings back in foreign accounts in anticipation of a devaluation for some time. It will not take much more to trigger a full scale withdrawal of foreign investors from the Indian market.

The Union Government is fully aware of the danger that looms ahead. But its response so far shows that it does not have the faintest clue of what to do. About the only sensible thing it has so far is that it will not raise interest rates to shore up the exchange rate as it has done repeatedly since January 1998, at industry's cost.

Other than that, its confusion is reflected by the spate of `liberalisation' measures it intends to announce in the next few days. Prominent among these is the removal of the 49 per cent ceiling on foreign investment in Indian companies and a raising of the 5 per cent ceiling on creeping annual acquisition of shares in a company by foreigners. Both assume that there are people out there wanting to buy shares in Indian companies. They make no sense whatever when there are no buyers and investors are bent upon turning their existing shareholdings into cash.

The crisis can be avoided. In six months, most of the world financial markets will have absorbed the shock and a new equilibrium will have been established. If the Indian market is looking sound then the money will start flowing back.

Thus what India needs is measures that prevent an immediate flight from the share market by not just foreign but also domestic investors, and the immediate announcement of policy changes that will convince all investors that India is at last taking the hard decisions that are needed to cut the fiscal deficit, increase public and private investment, and shore up the balance of payments.

The first can be done in a number of ways but all of them require the government to throwing the International Monetary Fund's neo- liberal economic rule book out of the window and start buying shares aggressively to stabilise their prices. Since it will not be buying shares for short term speculation, it cannot in any case lose money so long as it invests in companies whose bottom line of profitability is sound.

The second requires Mr. Vajpayee to announce immediately, the `harsh economic measures' that he promised in his televised address to the nation. He has made no secret of the fact that most of them will have to do with reducing government subsidies and reducing the fiscal deficit.

Anything he announces to achieve this end will come as music to the ears of all investors in India, both Indian and foreign. But whatever measures he proposes to take must be announced now. A delay of even a week could prove fatal. Efforts to fine-tune or soften the impact of these measures, that are likely to delay their announcement and implementation, must be resisted at any cost. In the final analysis, the impact of any action depends as much on its timing as its content.

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