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India careens toward crisis, but markets unfazed

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India, the world's second most populous country, is on the verge of financial Armageddon and nobody, including the country's equity investors, seems to care much.

The Indian rupee has not been spared from the mass exodus of investment capital from emerging markets. From May 22, when Fed Chairman Bernanke started the trend by hinting open market Treasury purchases may end, the rupee has fallen 10 per cent against the greenback.

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To stem the tide of depreciation and keep at least some foreign assets invested in the country, India's government undertook a series of measures to protect the currency. These included some complicated changes in interbank lending support that effectively raised interest rates by half a percentage point and, more importantly for Canadian investors, restricted imports of gold bullion.

The rupee has stabilized in recent days and to that extent the government has been successful. But, the vital issue of exploding short term bond yields remains.

The yield on three month government debt jumped 300 basis points to almost 11 per cent in the 10 days after July 15 this year, a move that Sober Look's Walter Kurtz described as "going no-bid." The spike in yields substantially raises borrowing costs for an economy in constant need of financing due to a large current account deficit.

Higher borrowing costs, both for the government and Indian corporations, come at a highly inopportune time when the economy is already struggling. Industrial production for May came in at -1.6 per cent, three per cent below economist expectations. Higher interest rates will crimp the growth further by discouraging borrowing for investment.

So far, the country's equity benchmark has plodded forward unfazed by the mayhem in bond markets. The primary equity benchmark, the SENSEX, is roughly flat for July although local marketwatchers point out that most of the buying is in the highest-quality names available.

The current level of Indian interest rates will cripple both government finances and the nation's economy if they stay at current levels. India, which has been a significant contributor to global growth in the past few years, is now becoming a detractor to global economic activity, to the detriment of all global investors.

Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

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