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Downgrading India?

India’s banking sector may be hitting a wall. Moody’s certainly thinks so: the ratings agency downgraded India to “negative” earlier this week. A Moody’s official announced:

India’s economic momentum is slowing because of high inflation, monetary tightening, and rapidly rising interest rates. At the same time, concerns have emerged over the sustainability of the recovery in the US and Europe, and the rise in the borrowing program of the Indian government, which could drain funds away from the private credit market.

Strangely though, Standard & Poors upgraded India by one notch a day later. S&P’s Banking Industry Country Risk Assessment for India was moved to 5 from 6, where 10 is riskiest, the same level as China, Turkey and Portugal.  (Of course, none of those are particularly attractive at the moment.)

The Indian tea leaves are hard to read. There have been numerous scandals, half-hearted reforms, and misguided government actions that have contributed to turmoil in India’s economy. Many analysts see worse looming on the horizon. The NYT reports:

The financial system in India is dominated by state-run banks, which control about 75 percent of the market’s assets. They, with their commercial banking counterparts, lent aggressively to the nation’s fast-growing companies, infrastructure projects and private-public partnerships during the recent economic boom years. Corporate lending increased by 21 percent a year in the last fiscal year, even as signs of a slowdown were showing.

The bank lending system now needs to weather a nasty storm, a growing number of analysts and economists say.

“We haven’t seen the worst. We haven’t even seen the beginning of the worst,” said V. Krishnan, a bank analyst with Ambit Capital in Mumbai who downgraded State Bank of India, India’s largest bank with a 1.2 trillion rupee ($24 billion) market capitalization, to “sell” in August.

Conditions will be “meaningfully bad for the entire economy,” predicts Mr. Krishnan, and companies will be unable to pay back bank loans. “Corporates are bleeding operationally, and they have less and less money to service their debt obligations,” he said.

Even experienced and rich capitalist countries with centuries of experience can’t always manage their financial systems well.  Financial systems are fragile and hard to run effectively because credit is such a dynamic force multiplier, investment decisions are inherently risky, powerful vested interests create strong moral hazards and seek to warp the system’s development and because rapidly changing conditions both in the financial system and in the real economy make it difficult for regulators and market participants to assess what is going on.

India and China, two fast growing giants in a period of faster-than-light social and economic change, will be hard pressed to manage their financial systems well in the tumultuous times ahead.  Much depends on how well they do.

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