In terms of resilience in domestic market conditions, our economy fares quite well. India has a high market capitalisation to GDP ratio of 68.60%. An economy with a high market capitalisation like ours has less effect on asset prices from capital outflows. Moreover, Indian equity market has a high 54.63% turnover, a measure of the value of shares traded vis--vis average market capitalisation. With a relatively high turn-over, capital outflows tend to not have much effect on asset prices.
According to IMF, our dependence on foreign funding is low as compared to other countries. The foreign ownership of domestic equities as a per cent of GDP is only 7% and is the second lowest after China (3.19%). Korea, Australia, Canada and South Africa have a much higher dependence on foreign funding which exposes their equity markets to larger volatility. Our external debt is the third lowest at 20.90%. Even though our short term debt as a percentage of total external debt is the second highest at 27.13% after Turkey (36.89%), we need to keep in mind that the denominator, external debt, is itself low (20.90%) as compared to that of countries like Turkey (42.70%). A lower short-term debt entails less risk of funding shortages in case of capital outflows.
However, not everything is hunky dory. In terms of policy room, we do not have much manoeuvrability either in fiscal policy or in monetary policy. In fact, we have the lowest fiscal flexibility in terms of achieving our stated debt targets. With inflation higher than 6% and a negative output gap of -0.91%, we do not have much monetary policy room either. RBI has been fighting the twin battle of arresting growth slide and controlling inflation for long and doesnt have much flexibility left.
Some of the other measures where we fare badly are trade balance, foreign exchange (Fx) reserves, room for Fx adjustment, bank capital and non-performing loans (NPLs). Our trade balance as a percentage of GDP is the lowest at -7.63% among the 13 countries. Our Fx reserves is also one of lowest at less than 6 months worth of imports. China has the highest Fx reserves enough to cover more than one-and-a-half years of imports. Smaller Fx reserves indicate less room for intervention in currency markets to dampen potential excessive depreciation, like the way the rupee experienced in the last quarter. Our banking sector too isnt very healthy as compared to other countries which adds to the vulnerabilities in the economy. Bank capital is one of the lowest at just 6.9% of total assets and our banking sector has one of the highest NPLs at 3.1%.
The redeeming aspect is that on some of the measures like output gap, inflation, trade balance, achieving debt targets, bank capital or NPLs, the problems are mostly internal and our economy is insulated from outside shocks like that from UMP. We do have things to worry about but the only consolation is that they are less worrisome than some of the other countries.
Global rating agencies would do well to go through the IMF policy paper carefully. Among the 13 countries surveyed, India has the second lowest rating (BBB-) with a negative outlook. Even a one notch downgrade would take our rating to junk status. Countries like Thailand, Mexico, Brazil, Poland and South Africa have better sovereign rating than us but fare worse in the IMF study. As sovereign rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad, the IMF study seems to corroborate what the Indian government has been saying for long that rating agencies outlook on India is unfortunate. Unfortunate rating notwithstanding, I hope the IMF report whets investor appetite for India.
The author, formerly with JPMorganChases Global Capital Markets, trains finance professionals on derivatives and risk management