The economic tailwinds provided by low oil prices, a weak dollar, low interest rates, easy financial conditions and a relatively benign geopolitical environment have begun to reverse for emerging markets. And none seems more exposed than India.
The rupee has depreciated by almost 4% against the dollar since the Reserve Bank of India last met in April to set monetary policy, bringing an unwelcome rise in inflation. At the same time, the fiscal deficits of both central and state governments are expected to widen. At a moment when the cost of capital in the country is far higher than elsewhere in Asia, the unhappy likelihood is that the central bank will be forced to raise interest rates, if not at its June meeting then in August.
A higher cost of capital is the last thing that India needs. Whole swathes of the economy are in distress, from banking to steel, and from mining to telecommunications. Capacity utilization is low, so few companies see the need to undertake new investment. A new bankruptcy regime should speed recoveries for the banks and trigger a new credit cycle. Sadly, however, higher interest rates and flaws in the process will likely mean more bankruptcies and a disappointingly slow speed of resolution.
There is so little risk capital in the country that new-economy companies in India are generally owned by American technology giants or startups that have Indian faces but foreign capital -- notably from China's Alibaba and Tencent, Japan's SoftBank, or U.S. companies such as Walmart, which has just put $16 billion into Flipkart, an Indian e-commerce company.
In retrospect it seems clear that India has mostly wasted the years of cheap worldwide capital that followed the introduction of unconventional monetary policies in the developed world after the 2008 global financial crisis. The country should have gotten its infrastructure act together using borrowed money, which was far less costly yesterday than it will be tomorrow.
Moreover, as world trade slowly recovered in the wake of the crisis, India barely saw an improvement in its export performance. The country has few international competitive advantages other than in its awesome human capital, which no country should wish to export.
Many of India's neighbors in South and Southeast Asia, such as Bangladesh and Vietnam, have been able to attract investment as multinational money that would once have gone to China looks for alternative destinations in the face of rising wages and other costs in the Middle Kingdom. But not India.
There are few people in the country who will be more distressed by the prospect of higher interest rates than Prime Minister Narendra Modi, whose first term in office expires in May 2019.
To ensure the overwhelming victory he seeks at the polls, Modi plans to push up crop subsidies to override declining terms-of-trade for farmers, expand programs which forgive farm loans, and accelerate schemes to build affordable housing in cities whose populations have been swollen by rural migrants looking for jobs. These initiatives will worsen fiscal deficits, widen the already troublesome current account deficit and put further pressure on the rupee.
Some of these policies are desperately needed, notably the push for more affordable housing. India must create 1 million jobs a month to absorb its young population into the workforce. Yet in the last five years it has created fewer than 5 million -- a twelfth of the required number. China, with its aging demographics, created 10 million jobs in the first 10 months of 2017 alone -- twice as many as India managed in half a decade. Construction jobs are perfect for unskilled laborers coming into the cities from rural areas, and demand for affordable housing far exceeds supply, leading to shanty towns on the edge of every city and every factory.
But many other items on the agenda are deeply flawed, reflecting an unfortunate protectionist bent in New Delhi. For example, the capital is choking on toxic air, and the country desperately needs to clean up its urban environment by reducing its dependence on thermal power. The cost of renewable energy had dropped to a level where it was beginning to become economically viable relative to coal-fired plants. In January, however, Modi announced plans for a 70% tariff on imports of Chinese solar panels.
The idea is to protect Indian manufacturers of solar generating equipment from foreign competition. But the low cost of China's solar panels is what makes Indian solar power economically attractive. Making such panels is capital intensive and requires relatively few employees. It is just the sort of industry, in other words, which makes no sense in India, with its high cost of capital and its urgent need to find jobs for its unemployed. The measure is currently held up by legal challenges.
New Delhi's attitude to Chinese capital is depressingly similar. When KKR, a U.S. private equity group, tried to sell 100% of an Indian pharmaceutical company to Fosun, a Chinese conglomerate, the prime minister blocked the transaction. Since sales of stakes up to 74% do not require the blessing of the government, the transfer of a majority interest went through anyway. But the deal sent a clear message that Chinese capital is not welcome in India.
Meanwhile, India faces strengthening economic headwinds. "Our baseline inflation forecast [for the first quarter of 2019] already stands above 5%, and the risks are skewed firmly to the upside," economists at JPMorgan in Mumbai noted recently. "All this simply increases our conviction that monetary tightening will come later this year. We now expect the RBI to raise rates by 25 basis points at the August review." (A basis point is 1 hundredth of a percentage point.)
Against this background, it is urgently necessary for New Delhi to recognize that trade and investment protectionism is contrary to the country's interests, even if the goods and capital it requires come from China. With so little risk capital of its own, and the cost going up, India does not have the luxury of being choosy.
Henny Sender is the Financial Times' chief correspondent for international finance, based in Hong Kong, and contributes occasional columns to the Nikkei Asian Review. She has extensive experience of covering international finance.