Borrow Long to Lend Short

India is an emerging market economy privileged with a current account and budget deficit. The country imports more than it exports and its government spends more than it taxes. Unfortunately for India the rupee is not the reserve currency of the world nor is oil priced in it.

The Reserve Bank of India understands that for India to pay its oil bill it has to import capital to do so. For a banker borrowing long to lend short is welcome provided there are interested suppliers of capital. Too little capital investment will put the country back on the World Bank respirator. Too much capital investment will inflate assets beyond the living standard of the average, impoverished farmer.

Fortunately for India the world believes the country will have GDP growth of between 7-9% for the next three years, Stephen Roach, Chairman, Morgan Stanley Asia, and that inflation and deficits are of no concern. Ok.

Then tax collection should be of no concern either. Direct tax collection from business and individuals has been flat through November of this year despite the Government claiming economic growth of over 7%. Economists have scurried to cubicles to update excel spreadsheets.

The trade numbers tell another story. India exported $90 billion and imported $150 billion of goods and services in the first half of the year. For India to be self sufficient in trade it would have to increase exports by 50% in relation to imports, which is hard to do when oil accounts for 30% of the import bill, or over 70% of India’s requirements, and is subsidized for the masses.

This $100 billion annual deficit is met by FDI (Foreign Direct Investment), FII (portfolio investment in stocks), Remittances, ECB’s (External Commercial Borrowings), and Erin Wood's divorce settlement.

Half the deficit is covered by $45 billion remitted by workers from the Gulf, think Dubai. FII runs at roughly $15 billion a year, and FDI recently about the same. The RBI turns on and off the ECB faucet to cover the difference before deciding whether to put the arm on the World Bank recapitalize Public Sector Banks and fund IIFCL.

The capital flows are defensible for investors provided GDP growth is growth, and asset prices rise.

But the RBI would rather hold gold than paper having bought a chunk from the IMF which will need the money to buy the lows if the tax guys are right.