Gyrations
Of Indian Stock Market Point To Future Economic Instability
By Parwini Zora and
Kranti Kumara
11 July 2006
World
Socialist Web
The wild fluctuations in Indian
share prices over the past two months point to the increasing power
foreign finance capital is exerting over Indian equity markets and indirectly
the Indian economy.
After reaching an all-time
high of 12,761 on May 11, the Bombay Stock Exchange (BSE) Sensitive
Index (SENSEX), fell back sharply. By June 14, it had fallen some 30
percent, closing at 8,929—a loss of around $250 billion in a market
whose total capitalisation is estimated at between $800 and $900 billion.
In the past three weeks,
share prices have risen in fits and starts. On Thursday, the Sensex
closed at 10,768 points, meaning share values have recovered about half
of the losses they incurred between mid-May and mid-June.
Prior to this May’s
stock market plunge, India’s business houses, political elite
and corporate media were holding up the more than doubling in the value
of India’s premier stock market since May 2004 as proof of the
“take-off” of India’s economy.
Much, if not most, of this
increase was due to the inflow of equity investments from Foreign Institutional
Investors (FIIs) such as investment banks and hedge funds. A large portion
of this investment came from the small Indian Ocean island and tax haven
of Mauritius, where FIIs have set up paper companies that masquerade
as Mauritius-based firms so they can take advantage of the double taxation
treaty between Mauritius and India and escape paying taxes on their
investment gains.
The biggest decline in the
Sensex occurred May 22, when it plunged 1,111.70 points or more than
10 percent, triggering an automatic hour halt in trading. According
to stock analysts, much of the fall on that and preceding days was due
to sustained selling by FIIs, especially hedge funds. Such funds are
notorious for borrowing massive amounts for speculative investments,
which makes them vulnerable to margin calls (a demand for cash by lenders
due to falling asset prices).
Following the May 22 plunge,
Indian Finance Minister Chidambaram tried to exude calm: “There
was certain nervousness in the market. My message to retail investors
is to stay invested. FIIs are here to stay. There is no reason to panic....
[B]anks will provide money to those who want to provide margin calls.”
Fearing that stock market
losses might trigger a rash of suicides among ruined small investors,
police in several cities, including Mumbai and Ahmedabad, were instructed
to closely watch bridges and railway lines. Such suicides did occur
in the 1990s when a speculative stock bubble burst.
According to estimates made
in mid-June, the stock market sell-off has nearly halved the net foreign
equity investment in India for this year to about $2.7 billion. By contrast,
in 2005 there was a net inflow of foreign investment in Indian equities
of $10 billion and in 2004 of $8.6 billion.
The share sell-off and associated
withdrawal of foreign funds from India affected the exchange rate of
the rupee. The rupee declined to a three-year low against the US dollar
of Rs 46.57, but recovered somewhat after the Reserve Bank of India
increased two key interest rates by 0.25 percent.
Ironically, the May 22 stock
market plunge coincided with the second anniversary of the coming to
power of the Congress Party-led United Progressive Alliance (UPA) government.
During the campaign for the 2004 elections, the Congress made a calibrated
appeal to popular anger over mounting economic insecurity and social
inequality, while the Bharatiya Janata Party (BJP)-led National Democratic
Alliance, reflecting the mood in the corporate elite and the most privileged
sections of the middle class, sought re-election under the slogan “India
shining.”
Predictably, the Congress-led
UPA, while continuing to spout pro-poor rhetoric, has pursued the same
neo-liberal agenda as the BJP, seeking to make India a centre of cheap-labour
IT engineering, business-processing, research, and manufacturing for
the world market.
The dismantling of barriers
to foreign investment in banking, retail and other sectors and government
plans to gut restrictions on the layoff of workers and plant closures
and divert state funds from income support and public services to developing
energy and communication infrastructure have made India a magnet for
foreign capital, helping fuel a quickening in the country’s growth
rate.
But the 7 percent-plus annual
increases in GDP and sizeable per capita income increases of recent
years have not translated into any improvement in the socio-economic
well-being of the vast majority of Indians. On the contrary, the dismantling
of India’s nationally regulated economy, the associated cuts in
social spending, including agricultural price supports, and the diversion
of state investment away from agriculture towards the infrastructure
projects wanted by Indian and foreign capital have produced mounting
unemployment in the cities and severe distress in the countryside. According
to a recent World Bank report, 35 percent of India’s population
live on less than a dollar a day.
Moreover, the claims of the
corporate and political elite that India is on the fast track to becoming
a world economic power are based on decades-long extrapolations of current
growth rates.
By virtually any measure,
and in all but a few sectors, India’s economy remains small and
backward. Although home to more than 15 percent of the world’s
population, India accounts for barely 1 percent of total world trade.
Just as importantly, the
claims of India’s irresistible rise ignore fundamental problems
and imbalances in both the Indian and world economies.
The dilapidated state of
India’s infrastructure is increasingly cited by the information
technology sector, a niche in which India has emerged as a significant
global player, as a barrier to further investments.
Many economists estimate
that for India to achieve an annual growth rate of 8.5 percent, it will
require a yearly capital inflow of $50-$60 billion. Even this sum could
be an underestimate, as Prime Minister Manmohan Singh told the 39th
Annual Meeting of the Board of Governors of Asian Development Bank on
May 5 that India’s infrastructure requires an investment of more
than $150 billion in the next few years.
With a view to attracting
foreign infrastructure investment, the UPA, like the government before
it, is planning to turn over key resources, like water, and key economic
sectors, like power generation, to partial or even complete private
sector control and ownership.
Yet, most of the foreign
capital that India has attracted in recent years has been in the form
of foreign institutional investment, rather than foreign direct investment.
(In 2005, the ratio was 60 to 40 percent.) While the FII inflow has
enabled Indian companies to raise additional capital through new share
offerings or by raising loans based on the increase in their valuation,
FII investments are by definition highly liquid, as financial institutions
are in the business of profiting from short-term variations in share
and currency values.
India’s dependence
on FII forms a marked contrast with China and Brazil, where FII investment
accounted respectively for 26 percent and 30 percent of all foreign
investment in 2005.
Should India’s growth
rate slacken, foreign investors grow impatient with the pace of neo-liberal
reform, or international market conditions deteriorate, India could,
as the recent stock market gyrations have shown, be sideswiped by a
sudden withdrawal of FII and consequent rupee devaluation.
An article earlier this year
on the asiatimes.com web site noted that the India’s economy “faces
significant risks arising from much higher international oil prices
and the impact of higher energy prices on Indian inflation and global
economic growth” and warned these risks could lead to the withdrawal
of foreign funds from India’s equity markets.
“In the past,”
continued the article, “emerging-markets investment performance
that has lived by the accumulation of short-term foreign capital has
also died because of sudden foreign capital flight. And India is very
vulnerable to this syndrome.”
India is running a substantial
current account deficit. For the April-December 2005 period, the deficit
was $13.5 billion, more than double the $5.9 billion deficit incurred
in the corresponding period in 2004. The main reason for the increase
in the current account deficit was the ballooning of the trade deficit,
which totalled $39.6 billion for the nine months between April and December
2005.
On the fiscal front, both
the central and state governments in India are mired in debts with up
to 40 percent of revenue set aside for debt repayment. The huge debts
are a direct consequence of successive rounds of tax cuts for business
and the rich. With combined central and state government debt around
9 percent of GDP, international capital is insisting public spending
must be sharply reduced.
In the long run, a confluence
of factors beyond the control of the Indian elite could well bring about
an economic crisis similar to the one that devastated Southeast Asia
in 1997-1998.