This piece was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.
Continuing stress in the US banking system following the collapse of three mid-size banks, while several others seek liquidity support, had prompted Goldman Sachs to forecast that the Federal Reserve might pause its relentless interest rate hikes to attack inflation. But the Fed on Thursday chose to raise the benchmark interest rate by another 25 basis points, clearly signalling that inflation control remains its top priority and maintaining market and financial stability was secondary.
A week earlier, the European Central Bank also aggressively raised the interest rate by 50 basis points against the backdrop of the collapse of Credit Suisse Bank and its imminent takeover by UBS Bank. Larry Summers hailed the decision to aggressively raise interest rates on the ground that financial market imperatives can’t be allowed to dominate the larger objective of taming inflation. Even Fed chairman Jerome Powell suggested that the stress in the financial system can’t be allowed to dictate the essentials of monetary policy.
This means the stress in the banking system, caused largely by the scale and speed of interest rate hikes by the Fed over the last one year, will be allowed to play itself out and it will remain secondary to inflation targeting for now.
This has implications for global capital flows in the medium term and is bound to impact emerging economies like India. The era of cheap money is over and world economies will have to adjust to it. There will be no more scope for borrowing at nearly zero interest from Western or Japanese markets to invest in emerging economies like India for higher returns. This arbitrage game is over.
So most experts agree that Indian stock markets will remain tepid during 2023 and the first half of 2024, as India prepares for general elections. If stock markets remain stagnant, the political economy ceases to afford politicians and big business the opportunity to generate extra funds in a rising market. In a rising interest rate regime globally, money creating more money becomes a more challenging proposition.
There are other ways in which India’s economy will have to brace itself as global money becomes more and more expensive. Through weaker trade and capital flows, India’s economy will be impacted as the global recession (hopefully mild) plays out.
With the tightening of global money as interest rates rise 5-6 percentage points, accompanied by continued stress in the Western financial system, many large Indian corporates with heavy borrowings from abroad will become vulnerable as the time comes for refinancing their borrowings from abroad at much higher rates. Big Indian infrastructure builders like the Adanis, Jindals, Vedanta, Bharti Airtel and the Birlas will be particularly vulnerable when they seek refinancing of their foreign debt.
Already, Indian businessmen have begun suggesting that the Reserve Bank of India need not raise interest rates at the pace and scale followed by the Federal Reserve. There is also a suggestion that India can partially decouple from the global financial tightening. Past experience has shown that that such decoupling does not work.
The bulk of funding of India’s infrastructure, which the Modi government seeks to boost, has to come from foreign savings. India does not have capital on the scale it needs to boost its infrastructure. There’s a reason why 70% of Adani Group’s total borrowings of $30 billion is from abroad. Indian banks or capital markets can’t possibly generate funds of that order.
Similarly, other large infrastructure projects also have to depend heavily on foreign borrowings. This will be the biggest challenge for India amid the global tightening of money combined with a deepening stress in the global banking system.