India Finds Support from Japan to Shore Up Liquidity Concerns in 2012

2011 will go down in history as a year filled with economic uncertainty, creating undercurrents of volatility that rocked financial markets both to and fro. For emerging economies, like India and its other “BRIC” brethren, a ”ripple” in Europe or North America can easily transform into a “tsunami-type” wave bent on destruction by the time it reaches domestic shores. Many experts are predicting a repeat performance in 2012. The time is now to build fortifications to withstand the onslaught to come.

Government officials for India and Japan have already been hard at work preparing for potential storms of an economic nature. Recent press releases confirm that a $15 billion currency arrangement has been reached, as well as agreement to work cooperatively on many projects that should benefit trade for both countries.

The currency swap deal will provide a liquidity backstop for the Indian government should the crisis in Europe put undue pressure on global credit sources in the year ahead. The latter cooperative effort will provide long-term stability by enabling more trade to pass easily to both Europe and Africa from Indian companies, as well as from the more than 800 Japanese entities with active operations in India.

The world today is interconnected by global commercial flows that are difficult to comprehend. When “ripples” occur in the commercial fabric, they can have major impacts on a country’s financial standing. The diagram below will help to reveal a few of these global interdependencies that must be accommodated when the equilibrium is disturbed:

Exchange-Traded Funds offer a wealth of pricing data that when compared can demonstrate how interconnected our global commerce engine is today. The “Blue” line is a proxy for the India stock market, whereas the “Red” and “Violet” lines represent Europe and the United States for the past twelve months. The “Green” line has been added to illustrate the trend of the Rupee as events transpired during the year.

A few conclusions that can be drawn from this data are:
  • Stocks tend to be more volatile than currencies;
  • Emerging economy stock markets tend to be more volatile than those for major economic powers. If a line had been inserted for Brazil, it would have behaved similarly to India, yet not nearly as steep a decline at the end of the year since it does not have an import/export trade imbalance as does India;
  • India was grappling with weaker demand from Europe during the first half of the year, but when the debt crisis in Europe escalated in the latter half, Indian stocks plummeted;
  • Falling stock values highlighted anticipated drops in exports, the primary reason for the Rupee depreciating nearly 15% in six months. The depreciating currency has also led to “capital flight” as investors have repatriated local investments.
 Prospects for 2012
The one positive signal at the end of 2011 was that the U.S. economy was beginning to stage a modest economic recovery, hopefully, strong enough to withstand further problems in the European sector. The challenge for Indian officials will be to manage its current growth objectives without depleting its balance of foreign currency reserves. The pact with Japan should provide a protective “cushion” in case debt markets tighten in the foreseeable future.

It is well known that India has many infrastructure projects on the drawing board that will attract foreign capital to its coffers. The population demographics are also favorably young with internal consumption on the rise, such that experts agree that the economy is poised for long-term growth. If short-term demands can be managed, long-term prosperity awaits.

About the author
Tom Cleveland is a writer and currency analyst for ForexTraders, an online resource for the foreign exchange market and currency news. He has over 30 years of experience in executive management, corporate governance and business development, having served as CFO for various Visa International entities from 1980 until his retirement in 1999.