Views | Indian capex depends on state of global economy

The prospect of Greece exiting the eurozone, the currency union of 17 countries, is being talked more openly now, after its leaders have failed to form a government a week after the recent parliamentary elections.

Last Sunday, 70% of Greece’s electorate rejected the budget cutbacks required under a joint European Union/IMF bailout by favoring the parties opposing the bailout. This could possibly result in Greece defaulting and eventually exiting the eurozone. There is fear that this could lead to financial contagion, wherein a Greek exit from the common European currency might have a domino effect and trigger other troubled eurozone countries to do the same.

This could result in prolonged risk aversion which could further drag down the growth of India. The latest Index of Industrial Production (IIP) data brings no joy either; it says factory output contracted by 3.5% in March. This brings the 2011-12 factory output growth to 2.8%, closer to the 2.5%which in 2008-09, the year when Lehman crisis unfolded.

How the troubles of advanced economies would be a threat to India was discussed by the International Monetary Fund (IMF) in its India 2012 Article IV report. Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with member countries, usually every year, and publishes a staff report.

Though IMF feels the external downside scenario generates a growth shock comparable to the global financial crisis, it says as India is less open then other emerging economies and is less exposed to global supply chain disruptions than many other Asian economies; hence the impact is unlikely to be large.

IMF staff’s calculations show that a 1% decline in global domestic demand (weighted by countries’ trade with India) is associated with a 0.6% decline in Indian exports, which is countered by declining imports, as happened during after the Lehman crisis.

The real impact is likely to be on investment, which has become highly correlated with the global cycle.

Through financial channels such as external commercial borrowing and equity markets, corporate investment has seen increased integration globally. According to IMF, the stock of external borrowings by Indian companies is now around 4% of gross domestic product (GDP), and total holdings of debt securities amount to 2.3% of GDP. Foreigners also own around 11% of the market capitalization and a significantly larger share of the free float (public shareholding).

Increasing uncertainty in Eurozone has only spooked global investors. This can create volatility in capital flows and have an impact on the equity market and the rupee, which has already fallen around 21% since August 2011. Financing new projects and rollover of existing debt is only going to get more complicated and difficult in coming days further impacting the growth negatively. There is a need for government to increase the pace of its structural reforms and government decision making, especially in the area of energy, which is also hurting growth.