As the Asian markets await full details on the plot behind Wednesday’s terrorism in India’s principal business city of Mumbai (aka Bombay), 5-year credit default swap spreads for 5-year government-owned State Bank of India widened to around 465 basis points, the cost of buying one US dollar breached the critical 50-rupee threshold and Indian equity futures quotes were dominated by selling interest in the Far East (the Indian stock markets were closed today).
In leading a recent charge to return to India, particularly after a 55%-plus drop Indian equity indexes, major mutual fund managers like Mark Mobius of Templeton Asset Management and Devan Kaloo of Aberdeen Asset Managers have been insisting that India’s democratic traditions are strong enough to withstand terrorism. But the crisis in Mumbai today cannot simply be explained away by the proposition that periodic acts of terrorism have only a limited and temporary impact on the Indian corporate spectrum.
On the contrary, the entire post-independence Indian social fabric is being gradually undermined by terrorism, separatist insurgencies, farm protests and far-left communist movements. It may be argued that India’s failure, over five decades, to make profound structural changes within its economy has now placed the country on the verge of a significant, and highly unsavoury, political transition in 2009.
The 2008 price lows in India-specific Exchange-traded funds (EPI, IFN, IIF, INP and PIN) are being widely touted as attractive buying opportunities given India’s 8% GDP outlook. And India ETFs did indeed hold up well in New York trading on Wednesday. But even before the Mumbai terrorist attacks, default risk perceptions on India have been rising; 5-year CDS coverage for sovereign risk is being priced at 310 basis points, and in the 800-900 bps range for ICICI and other Indian banks. The US$/Indian rupee “hawala” rate, the rate at which tens of millions of dollars worth of rupees are transferred in and out of India via non-banking channels on a daily basis, is edging towards 53.25. And US$/Indian rupee 5-year currency swaps are being priced at a whopping 42%-factor in favour of the dollar.
In the briefest of terms, the fundamental incompatibility between pockets of wealth on one hand and rampant poverty on the other has been held in check by 50 years of political promises backed by a series of 5-year national plans. Today, depending upon whom you ask, between 65 and 80 percent of Indians live below the poverty line, if the poverty line is calculated against a basket of living essentials. So, while the failure to remedy agrarian poverty has finally created powerful protest movements, urban unrest (and discontent) is being effectively translated into vote banks by religious extremists. On all present indications, a well-knit coalition of religious radicals will be in control of the New Delhi parliament within the space of a few short months.
History tells us that a government under the control and direction of religious extremists is not necessarily unfriendly to private capital (e.g. Iran and Sudan). But, in the case of India, the ascendancy of right-wing Hindu entities will be no smooth business-friendly transition by any means, since it will be met by a sharp spike in separatist activity, by more militancy in the countryside and, most importantly, by a steady spate of deadly terrorism from indigenous or foreign Islamic radicals.
What all this means for consumer demand and corporate profits in the midst of a worsening global recession is certainly not an open question, as some analysts would like to believe. The fact is that bullish calls by Templeton and Aberdeen do not incorporate inherent political risk; for the record, medium-term or long-term political risk insurance contracts (as distinct from CDS-type insurance) for India are unavailable below 5.50% (per annum) today.
This writer’s call on India remains unchanged: sell on healthy India-ETF rallies from current levels, and short the Indian rupee.
