Quote:Finance Minister Pranab Mukherjee on Thursday warned the international community that there is danger of a currency war if the ongoing economic crisis deepens.



Such a currency war can be avoided through dialogue and not through competitive devaluations, Mr. Mukherjee stressed at a crowded press conference of Finance Ministers of BRICS nations Brazil, Russia, India, China and South Africa at the headquarters of the International Monetary Fund here.



“Yes, if the crisis deepens further and there is greater volatility in financial flows, there is an increased risk of this (currency war) happening,” Mr. Mukherjee said in response to a question.



“But our view is that if such tensions arise, it should be eased through the dialogue and not through competitive devaluations,” he said.



Mr. Mukherjee pointed out the currencies used in BRICS countries should be widely appreciated and should be taken into account while determining the ingredients of special drawing rights (SDR) maintained by the IMF, as these nations’ contributions to global output and the economy is increasingly substantially.



“But we are not suggesting right now, because there are many other factors which ought to be taken into account, including free convertibility and other things which are not uniform, but the importance of these currencies has increased,” Mr. Mukherjee said in response to a question.

Quote:



The Indian government’s response to the market collapse that followed the U.S. debt standoff and subsequent Standard and Poor’s downgrade was predictable. While acknowledging that India was impacted, the effort was to play down the likely intensity of that impact. “Our institutions are strong and [we] are prepared to address any concern that may arise on account of the present situation,” Finance Minister Pranab Mukherjee reportedly stated. He also promised that the government “will fast track the implementation of the pending reforms and keep a close eye on international developments.”



That response misses the point. The problem is not that India is not adequately reformed, but that past reforms have resulted in its integration through flows of finance with global capital. This makes the perceptions and behaviour of global capital, whether stimulated by India’s fundamentals or not, of importance to the country. And unlike China, a lot of the reserves that insure the country against adverse global responses are not earned through current account surpluses, but are drawn from what foreign investors have delivered in the past. Keeping legacy capital satisfied is crucial for stability.



Put simply, independent of whether there would be a global slowdown that would impact India, the country is exposed and vulnerable to global financial uncertainty. So even when some of its fundamentals are ostensibly strong it is liable to be hit by weak investor sentiment. India is vulnerable because international finance may assess its so-called fundamentals very differently from the way they are assessed by the government.



Consider the issue that now captures financial market attention: public debt. The experience in Greece, Spain, Portugal and elsewhere suggests that finance capital is increasingly “intolerant” of what is perceived as excessive public debt. In some instances this may be understandable. International financial investors are substantially exposed to government bonds in some of those countries, and their governments seem increasingly incapable of meeting their debt service commitments. Sovereign default threatens investor solvency. What is not understandable is the austerity that finance demands in those countries. It not only triggers protest and social disruption. It also results in contraction of employment and incomes, and undermines the ability of governments to garner the revenues needed to pull themselves out of the crisis.



Trapped in its own ideological quagmire, finance now seems to have lost its bearings. The cause for concern about public debt in a particular context has been extended to an unthinking abhorrence of all debt. The standoff over public debt in the US was not because the US government was over-indebted relative to its GDP. There are many other OECD countries from Greece to Germany that have a higher public debt to GDP ratio than the US. And even to the extent that debt has risen sharply in recent times in the US, it is largely the result of the failure of finance. The huge stimulus and bail-out package adopted by the US government to deal with the crisis delivered by irresponsible financial agents in 2008 took the net public debt to GDP ratio in the U.S. from 42.6 in 2007 to 72.4 per cent in 2011.



Financial interests benefited from that package and also bought into that debt using the near-interest free liquidity provided by the Federal Reserve. In the process they increased their exposure to sovereign debt in the US and elsewhere. But now that they are overcome by fears of sovereign default, they want a “correction”. So even in the U.S. they have not merely backed the irresponsible Republican refusal to accept a routine hike in the debt ceiling cap, but have through discredited rating agency Standard & Poor’s delivered an irresponsible first time downgrade of U.S. debt. That has been enough to trigger the turmoil in world markets.



It is in that background that we should view reports of S&P’s statement that fiscal capacities in Asian emerging markets, including India, have shrunk relative to 2008. This, it has argued, would mean that in the event of a second global slowdown: “The implications for sovereign creditworthiness in Asia-Pacific would likely be more negative than previously experienced, and a larger number of negative ratings actions would follow.”



This is more of a threat than an analysis. But if a wrong downgrade can make a difference to US markets and interest rates, so can it for India’s. The real difficulty is one that emerges from an analysis by Cornell economist Easwar Prasad in the Financial Times. That analysis suggests that though India’s gross public debt to GDP ratio declined from 75.8 per cent to 66.2 per cent between 2007 and 2011, it still is among the highest in the region. India’s 66.2 per cent level compares with Malaysia’s 55.1, Pakistan’s 54.1, Philippines’ 47, Thailand’s 43.7, Indonesia’s 25.4 and China’s 16.5.



So if S&P needs a target to declare that some governments in the Asia-Pacific are excessively indebted, then India is in the firing line. It is no doubt true that a number of factors make Indian public debt less of a problem than in many other contexts. To start with, much of public debt in India is denominated in Indian rupees and is owed to resident agents and therefore is unlikely to be adversely affected by uncertainty in international debt and currency markets. Secondly, within the country public debt is largely held by the banking system dominated by public sector banks. They are subject to government influence and are unlikely to respond to developments in ways that make bond prices and yields extremely volatile. Given these circumstances, public debt is not a potential trigger for a crisis and in any case should not worry private financial interests.



But that is unlikely to satisfy the likes of S&P. India has been a favoured target of foreign finance. And if it does not satisfy its requirements, it can fall out of favour. In its search for new investment targets, global finance has viewed with interest debt markets in countries like India. And in any debt market, what better instrument than relatively risk-free government securities. So, anything that muddies that potential market would disturb finance capital. India may be put on alert and even downgraded. The fact that, at the moment, publicly owned banks largely hold government paper is inadequate insurance.



Besides, there are other reasons why international finance would resent excessive debt-financed spending by governments. One is that given the monetarist mindset that characterises finance, such autonomous debt-financed public expenditure is seen as potentially inflationary. Since inflation erodes the real value of financial assets, it is anathema and, therefore, so is deficit-financed spending. The other is that when rising debt increases the interest burden in the budget and restricts the manoeuvrability of the government, it may push for a reduction interest rates. Private financial interests do not favour such intervention in financial markets. They, therefore, seek to address the problem at its source.



For reasons such as these, international finance is strongly opposed to the build up of public debt as a result of large and rising fiscal deficits. It is no doubt true that even if institutions like S&P flag India’s public debt as excessive, it may not lead to a fall in bond prices and an immediate rise in interest rates. But, it may signal, however erroneously, the overall unreliability of Indian markets and encourage the exit of financial investors from markets other than debt. This perhaps partly explains the current volatility in the equity market.



The issue is not whether India is directly coupled with global bond markets. It is whether India is financially integrated enough for any adverse assessment by sections of international finance to destabilise its markets. That much India’s reform has indeed achieved. So when irresponsible ratings by a rogue agency create instability, the response should not be a pledge to undertake further “reform”. Rather, it should be to rethink which facets of reform have increased India’s vulnerability and how.

Quote:The markets are swaying to the ripple effect of developments across the globe. The domestic economy, growth and inflation numbers are struggling to cope with the consequences of wars, turmoil and economic crisis of nations miles away.



After the American subprime crisis that began with the bursting of the US housing bubble, the Euro zone crisis is the next big cause of concern for global economies. The US subprime mortgage crisis saw rise in sub-prime mortgage defaults and foreclosures. This resulted in a decline in securities backed by mortgages . The current Euro zone crisis threatens to impact economies of even nations with a robust domestic growth.



The severe debt crisis in Euro zone nations could spill over, affecting the financial health of developed economies and impeding the economic recovery of developing nations. The soaring international oil price has added fuel to the fire.



How will the Euro zone crisis impact India?



Capital flows into the economy and exports are likely to take a beating. Foreign institutional investor (FII) investment pattern is marked with high volatility. A sudden surge in investment pattern is as detrimental as an unannounced withdrawal. A surge in FII investments will lead to increased inflationary pressures and building of an asset bubble that could burst anytime.



India is grappling with high inflation and the central bank has raised the key interest rates a dozen times in the past year and a half. Now, the possibility of Greek debt default affecting the European banking and financial sectors is very real. The crisis is expected to spill over to the other European nations that otherwise appear economically stable.



While Greece has embarked on austerity measures, the bailout package from the European Union and IMF funds is expected to help it navigate out of its crisis. However, a rapidly shrinking Greek economy needs a fresh lease of life. But if Greece is only the beginning, then the Euro zone crisis could avalanche into larger trouble.



The quantum of impact of Euro zone crisis on markets here is yet to be measured. A slump in domestic industrial growth, unaddressed agricultural woes, rising interest rates and escalating fuel costs have compounded the global factors. A series of scandals emerging from under the carpet have diluted the faith of foreign investors.



The market volatility has compounded with the concerns of small investors. Sectors across the board including auto, oil and gas, metal, FMCG and healthcare took a beating. Concerns are the current European financial crisis will curb economic growth. The risk associated with otherwise favorite sectors such as banking has increased.



Investors have to study global trends before investing in the unpredictable stock markets today. Have a long-term perspective when taking investment decisions.