Two influential business lobbies on Thursday asked the government and the Reserve Bank of India (RBI) to inject huge amounts of liquidity into the economy.
Let’s keep aside for the moment the question of whether this is the right time to slash interest rates. The very fact that the Confederation of Indian Industry (CII) and the Federation of Indian Chambers of Commerce and Industry (Ficci) have seen signs of a credit crunch is cause for worry. This flies in the face of the general assumption that companies are not finding it hard to finance their working capital and capital spending.
The action plans put out by CII and Ficci suggest that the global financial crunch will not leave us untouched.
True, India is unlikely to see bank insolvencies of the type that the US and Europe are announcing every week. That is what the authorities focus on when they try to soothe nerves. But we have a large current account deficit that is being funded by volatile flows — into the capital market and of short-term debt. We have often said in these columns that India will be vulnerable to global financial storms because of this.
That belief is being tested right now. The brutal sell-off in the stock market by foreign investors has pushed down the rupee and RBI’s subsequent support for the domestic currency has sucked too much liquidity out of the local money market.
That’s as far as rupee funding goes. The International Monetary Fund says in its new Global Financial Stability Report that onshore dollar funding costs in India — that are implied in currency forwards and cross-currency swaps — have spiked as well. The three-month implied cost of dollar borrowing exceeds 8%.
Most large companies are likely to be affected by the shrinkage in the market for emerging market corporate debt. Issuance there has dropped from $88 billion in the first three quarters of 2007 to $40 billion in the same period of 2008. Some banks such as ICICI Bank have also been big borrowers in the overseas short-term commercial paper market.
The drop in external finance and the fall in share prices could lead to financing strains on both the equity and debt sides. Most corporate balance sheets are still strong but we cannot ignore the stress points either.
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