Risk rising along with stocks in
India By Jephraim P Gundzik
India's benchmark BSE-30 equity index
scaled record heights early this month, surpassing
the crucial 10,000-point barrier. Heavy inflow of
foreign portfolio investment, which amounted to
nearly US$11 billion in 2005, has been crucial for
the equity market's current bull run and has
pushed India's stock of total foreign portfolio
investment above $40 billion.
In contrast
to foreign direct investment, foreign portfolio
investment is short-term in nature. In other
words, should conditions that
encouraged the inflow of
foreign portfolio investment deteriorate or
reverse, this investment can be expected also to
reverse course. Combined with other short-term
foreign capital inflows over the past three years,
India's total stock of short-term foreign capital
is estimated to be more than $50 billion.
The primary factors that have enticed this
enormous inflow of short-term foreign capital over
the past three years have been political stability
and strong economic growth. Considering the
pouring of increasingly large sums of money into
India over the past six months, it's easy to
extrapolate that foreign investors believe this
stability and strong growth will persist far into
the future.
However, should India's
political environment destabilize and economic
growth weaken, foreign investors are very likely
to take their money and run. With more than $50
billion of short-term foreign capital, the scale
of such capital flight could prompt a sharp
exchange-rate depreciation, a strong equity-market
correction and a significant decline in
foreign-exchange reserves.
Political
fragility The government's continued
viability depends on the Left Front's
parliamentary support. The Left Front has become
increasingly critical of the government's
policies. Disputes between the left and the
governing United Progressive Alliance have erupted
over foreign direct investment in India's retail
and financial sectors, the privatization of
profitable state-owned enterprises, and the UPA's
drive to modify the Industrial Disputes Act.
In late September, the Left Front
organized an enormous nationwide strike to
highlight its dissatisfaction with the UPA
government's economic policies. More acrimony has
exploded over the government's close relations
with the United States. After India's vote with
the US against Iran in the International Atomic
Energy Agency (IAEA) in late September, the Left
Front went ballistic. It accused the government of
Prime Minister Manmohan Singh of casting off
India's traditionally non-aligned status to curry
the favor of Washington.
In November the
Left Front, in cooperation with the Samajwadi
Party, organized several mass rallies across India
demanding that the government support Iran in the
IAEA rather than the US. Also that month, the left
organized massive demonstrations in West Bengal
protesting joint India-US military exercises.
The fickleness of Washington's favor was
demonstrated last month when the US ambassador to
New Delhi, David Mulford, publicly warned the
government that India's nuclear-energy deal with
Washington would "die" in the US Congress if India
did not support the United States against Iran in
this month's IAEA vote. Once again, the issue of
India's relations with the US and Iran touched off
a storm of protests in India, led by the Left
Front.
The Left Front again demonstrated
its power of mass mobilization during the recent
airport strike. This strike eventually forced the
government to guarantee the jobs of striking
airport employees. The left is distancing itself
from the policies of the Manmohan Singh
government, paving the way for the withdrawal of
its support for the UPA in the Lok Sabha
(literally House of the People, the lower house of
parliament). This withdrawal could happen shortly
after the Kerala and West Bengal state elections
in May.
Insurgency
woes Political and social instability are
also likely to be attenuated this year by the
escalation of India's Islamist and Naxal
insurgencies. After a lull over the past 18
months, the Islamist insurgency in Kashmir will
probably regain significant traction in the months
ahead.
The powerful earthquakes that
struck the region around Kashmir have given
Pakistan's Islamist organizations an opportunity
to strengthen their footholds. This, combined with
the return of Pakistani and Kashmir-based foreign
fighters from Iraq, is likely to breathe new life
into India's Islamist insurgency, as demonstrated
by the Islamist attack in Bangalore late last
year.
The Naxal insurgency has already
been intensifying over the past 12 months. In
November the Naxalites carried out their largest
ever attack, in Bihar state. More than 1,000
militants attacked the Jehanabad police station,
freeing more than 300 prisoners. In addition to
killing several police officers, these militants
executed many members of a private militia known
as the Ranvir Sena, set up by wealthy landowners.
According to the Home Ministry, the Naxalites
perpetrated more than 2,000 violent attacks last
year, killing nearly 800 people.
The surge
in Naxalite activity in 2005 can be attributed to
two factors: the joining in October 2004 of two
Naxalite organizations to form the Communist Party
of India (Maoist), and the linking of this
organization with Nepal's Maoist insurgents. The
recent escalation of Nepal's Maoist insurgency can
be expected to fuel India's Naxal insurgency this
year.
India's deteriorating political and
social conditions will weigh heavily on domestic
investment. Increasing costs, declining profits
and the poor condition of the country's
infrastructure are already undermining investment.
This bodes ill for the growth of the industrial
sector. India's coveted service sector is
vulnerable to weakening private consumption
growth. Deteriorating conditions in the
agricultural sector, which accounts for nearly 65%
of employment in India, poses a significant threat
to the growth of private consumption and services.
The economy also faces significant risks
arising from much higher international oil prices
and the impact of higher energy prices on Indian
inflation and global economic growth. The
escalating conflict between Tehran and the West
could easily lead to an Iranian oil-export embargo
or even a US military strike on Iran.
With
the balance between global oil supply and demand
exceedingly thin, any reduction in Iran's oil
exports could send international oil prices well
above $100 per barrel. This would push US
inflation and interest rates rapidly higher,
prompting sharp deceleration in global economic
growth. India's exports and its economy would
suffer greatly in such a scenario. History has
shown that 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.
Jephraim P Gundzik is president
of Condor Advisers Inc, which provides country
risk analysis to individuals and institutions
globally. Please visit www.condoradvisers.com
for further information.
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2006 Asia Times Online Ltd. All rights reserved.
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