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A smaller than expected stimulus package may be signs of things to come…

Prime Minister Singh’s government announced a series of economic measures including a 100bp rate cut and reduced fuel prices with much fanfare this weekend, but even the most dedicated India bull found the government stimulus package unveiled yesterday to be a let-down.

At just $4 billion in total with about only $2 billion (less than 0.10% of 2007 GDP) earmarked for new spending in the remaining four months of the fiscal year, the plan is less than a third of some of the amounts rumored in the press earlier in the week.

The small size of the relief package may, in part, underscore the increasingly significant role that external debt has played in the Indian economy since the start of the recent decade of hyper growth, which kicked off at about the same time that IMF repayments ended. As illustrated by the chart below, as total foreign debt levels increased, so too did the percentage of short term debt –over 20% by Q2 of this year, leaving the private sector and, by extension, the government, facing looming refinancing in the midst of a global credit draught.

Plans for the Stimulus package include a provision for a $1 billion domestic offering in March, which will be a significant increase over prior issues. Already the most recent treasury auction came to market for nearly double the size anticipated –in conjunction with an increase of government forecasts for 2009 issuances that exceeded the original target by more than 30%.

In an interview in HT’s financial journal MIN this week, Harihar Krishnamurthy, director of the treasury at the Development Credit Bank, sounded less than confident when he pronounced that the new debt issues “won’t affect the market because by the time of the January borrowing, the advance tax collected in December will come back in the system and there won’t be any liquidity problem”. In other words, by the time the check clears the money will be in the bank.

The yield curve has remained flat since coming off the highs of late July with the 10 year at 6.77 and the 2 year at 6.53 –a nominally low level by historical standards. As the foreign appetite for debt issued by Indian financials drops off on currency volatility and solvency concerns, that trend could reverse rapidly as banks have less money to lend the government. Already last month Tata Financial had to seek regulatory approval to attach warrants to a rights-offering zero coupon issuance in order to find willing offshore buyers.

In announcing the rate cut, Reserve Bank Governor Subbarao admitted that growth would be “less than expected” but there has yet to an official acknowledgement that high double digit growth is impossible for the New Year.

Being short India for the better part of 2008, we have repeatedly underscored our doubt that domestic demand can replace a drop-off in foreign trade. Now we add to that our doubt that domestic credit alone can replace foreign lending.

Andrew Barber