Today, Indians are outraged by soaring gasoline and diesel prices. Opposition parties are demanding further duty cuts from the central government while the prime minister wants states to cut their fuel taxes. Neither side dares spread the bad news that even today’s prices are unsustainably low and will go much higher. Currently, fuel prices are tied to a crude price of $105 per barrel. As the war in Ukraine continues – and no end in sight – the price will rise to at least $130 a barrel.
I predicted in these columns in January that the stock market would crash in 2022. When the markets have fallen for the past six weeks, friends have praised me for my omniscience. No, I told them, what has happened so far is not a crash, just a modest fix. The crash will come later in the year and will drive the markets much lower. I am a bear.
Most readers have little idea of the magnitude of the next global debt crisis. India is well equipped to weather the financial typhoon. Its foreign exchange reserves stand at a comfortable $630 billion and its current account deficit (CAD) is manageable at 3% of GDP. Foreign investors have withdrawn billions from the stock and bond markets. But domestic investors continued to invest, supporting the market and preventing a meltdown. Obviously, many more countries will fall before the crisis hits India. But it will come.
The coming crash may not be as bad as the Asian financial crisis of 1997. But it could be as bad or worse than the Taper Tantrum of 2013, when the rupee crashed from ₹55 to ₹67 for a dollar. At that time, India had a high CAD of over 4% of GDP and modest foreign exchange reserves. Raghuram Rajan as the new Governor of the Reserve Bank of India (RBI) has devised a scheme for foreigners to use Non Resident Indians (NRIs) as proxies to invest over $30 billion at a rate of high interest and at a guaranteed exchange rate. Maybe a similar strategy will save the day this time too. But India will be dented, if not beaten down.
India’s weakest point is its budget deficit. In India, most people have stopped caring. After all, countries around the world were able for years to record unprecedented deficits with minimal inflation after the 2008 crisis. With the disappearance of Covid, India had hoped for runaway economic growth this year. Revenues have been buoyant in 2021-22 and are expected to be buoyant this year as well.
Nevertheless, the combined budget deficit of the Center and the States was budgeted at 11% of GDP. By international standards, this is horribly high. The situation will worsen as the war in Ukraine drags on, slowing growth and revenues, even as demands for oil tax cuts increase. A widening budget deficit may at some point trigger a market crash.
Double the draw
Modern monetary theory has become popular in recent years. This suggests that governments can print money forever without serious inflation. But now that inflation has climbed to 8.5% in the United States and 7.5% in the Eurozone, inflation can no longer be ignored. Central banks will have to tighten money.
The US Fed will aim for a “soft landing”, hoping to compress demand without causing a crash. But history shows that attempts at a soft landing often prove difficult and produce a recession. This will produce a worst case scenario – a global recession superimposed on a third world debt crisis.
The world experienced a glut of savings in the 2010s. Thus, global money flowed into all risky countries and companies in search of higher returns. Historical borrowing standards have been discontinued. China has become an aggressive new lender, lending more than Western donors and international institutions combined. Private equity (PE) and venture capital (VC) funds have poured billions of dollars into third world startups. In this mad rush for loans, the weaknesses of dozens of developing countries have been ignored. People have simply forgotten that almost 75 countries have gone bankrupt, repeatedly since the 1980s. The bubble has now burst.
The World Bank estimates that 74 developing countries must repay $35 billion to public and private lenders in 2022, up 45% from the 2020 figure. Their coffers had already been emptied by Covid. The G20 debt service suspension initiative launched in April 2020 aimed to defer $20 billion in debt service from 73 developing countries in 2020. This measure has been extended until the end of 2021.
Actual debt relief amounted to just $12.7 billion at the end of 2021. These countries now need a massive bailout package that highlights the risks across all emerging markets. This will have consequences for India.