Why Greek crisis didn't affect Indian economy

Fortified with a foreign exchange war chest of $355 billion, India is in its strongest position ever since the 2008 global financial collapse to withstand any fallout of external shocks such as the Greek debt crisis. The rupee has remained stable and it has been largely business as usual at the country's stock markets in the wake of the current happenings in the European Union.

Given the small size of the Greek economy and the insignificant level of Indian exports that it absorbs, the direct impact of the financial crisis in Greece is expected to be negligible on Asia's third largest and fastest growing economy.

Instability

However, if "Grexit'' leads to any instability in the euro, which would hit the European Union, this could lead to an outflow of foreign funds from India's capital markets that would have the potential of weakening the rupee and sending stock prices into a tailspin.

The European Union also accounts for 19 per cent of India's exports and any further slowdown in the bigger economies of the region such as Germany, France and Italy would adversely impact the overseas demand of Indian goods.

India's merchandise exports have already contracted for six months in a row and had shrunk by over 20 per cent in May this year. This declining trend is a worrying sign as goods exports account for a sizeable 16 per cent of India's two trillion dollar-economy.

The Modi government's strategy to boost manufacturing and export-led growth to create high-quality jobs for lakhs of youngsters graduating from the country's universities every year would also be affected by the slowdown. The target to almost double goods and services exports to $900 billion in the next four years would become that much more difficult to achieve. In 2010 and 2012, the Eurozone's debt problems had shaken global stock markets and had sparked fears of a wider contagion reminiscent of the 2008 financial collapse. Of course, the crisis had resolved itself but was not without its costs in terms of denting economic growth and investor sentiments.

However, the present situation is different from 2010 when Greek debt was held mostly by private creditors. Since then international banks and foreign investors have sold Greek bonds which are now held mainly by government agencies and the European Central Bank (ECB). Eurozone countries have also set up a 500 billion euro crisis-resolution fund to check any adverse fallout for other euro member states.

The EU is also better prepared to tackle the situation since it has not come as a sudden surprise. As far as India is concerned, the comfortable $355 billion foreign exchange cushion provides the country with sufficient funds to meet its current account deficit (CAD). This is broadly the amount by which the country's foreign exchange earnings through the export of goods and services fall short of its import bill. The foreign exchange reserves can also be used by the RBI to strengthen the rupee against any short-term volatility. This could happen, for instance, if some foreign investors suddenly decide to pull out of the stock markets. The RBI has the firepower to pump in dollars into the market to check any weakening of the rupee.

Strength

However, much of the current strength of India's external balance stems from the fact that international crude prices came down from a phenomenal $109 per barrel in June last year to $46.59 in January this year.

Although crude prices have firmed up since then and are currently hovering at around $57-$60 a barrel, analysts expect the upside to be limited due to the excess supply in the market. India imports close to 80 per cent of its crude requirement which accounts for one-third of the country's total imports. So any drop in crude prices leads to a huge saving. Similarly, the prices of commodities such as coal, gold and edible oil which are also imported in large quantities have come down contributing to the decline in the import bill.

Fundamentals

Thus although exports have been shrinking the trade deficit and current account deficit have come down because of the decline in the country's import bill. The CAD narrowed to a one-year-low of 0.2 per cent of GDP in the January-March quarter this year.

Although global crude prices have gained in recent months, analysts are of the view that the upside potential is limited as there is an excess supply in the market.

The steady flow of foreign capital into equity and debt instruments in the Indian stock markets is another major source of foreign exchange and helps to prop up the reserves. In fact when crude oil prices had risen to over $100 a barrel last year and the CAD had shot up to over two per cent of GDP, the country had become critically dependent on this hot money to pay for its imports.

Figures compiled by market regulator SEBI show that during the last 12 months foreign portfolio investors have invested a net amount of Rs 2,10,458 crore in Indian stocks and bonds. The investments in government bonds have already touched the $30 billion ceiling fixed by the RBI for foreign investors. The Centre indicated last week that it plans to raise this cap after reviewing the situation every six months to meet the needs of the expanding economy.

However, in the long run, the country would need to work harder to give a fillip to exports in order to generate more jobs as well as have a more dependable source of foreign exchange which would strengthen the fundamentals of the economy.