Financial Crisis: Political and Financial Risk

Introduction

The global financial crisis which started in mid-2007 in the financial sector of the developed economies specifically US has continued to negatively impact other industries in emerging economies (Franklin& Douglas, 2007). Amongst the industries that have been adversely affected is the Indian food industry. According to Indian food industry, the Indian food industry is the second largest from China’s food industry (Anon., 2008). However, despite the fact that India is the largest food producer, the food industry only accounts for 1.5% of the total international trade. This makes the Indian food industry a potential investment destination since the industry has not been completely exploited.

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According to the Indian food industry, the total Indian exports in 1998 were US $5.8 billion compared to the total world export which was $458 billion (Anon., 2008). This shows that the Indian food industry contributed only a small percent of the total world food exports. By 2000, the total industry turnover was Rs 140,000. Most of the firms in the Indian food processing industry are approved by the US Food and Drug Administration (FDA).The food processing industry in India covers a wide range of products which include food and beverages. The industry has not been shielded from the effects of the global financial crisis. This is due to the fact that the increased rate of globalization has resulted in transmission of the effects into the industry.

Various channels are responsible for the transmission of the effects of global financial crisis into the Indian economy. According to Kumar, Ghosh, and Prabhu (2008, p.8), these channels include the exchange rate, financial sector, and exports. The financial sector relates to the equity markets, banks, and the foreign exchange market. The discussion of this paper involves an analysis of impact of global financial crisis on Indian food industry. More emphasis is given to the impact of the global financial crisis on the financial and political risk involved in conduction of international business and international foreign direct investment. It also illustrates how the national government has responded to these risks in relation to international business and international business investment.

Effect of Financial crisis on the financial risk

Financial risk is defined as the inability of a firm to meet the necessary financial obligations. This results from the fact that the firm is not able to generate sufficient cash flows. As a result of the financial crisis, there was a reduction in the level of profits amongst firms within the Indian food industry. Despite the fact that there has been a reduction in price of food commodities from their high level during mid-2008, the food prices in India are relatively high in comparison to the past two years. The Indian pass-through ratio was relatively low during 2008 at 30.4%. The ratio measures the rate at which world food prices are transferred to other domestic economies. Firms dealing with cereals were most affected by the rise in food prices in India. This is due to the fact that cereals are the most consumed food item in India. For instance, the financial crisis resulted in a 60% increase in the price of rice at the beginning of 2009 (Kumar et al, 2008). Kumar et al assert that the increase in the cost of food prices with regard to the cereals resulted in an overall 24.7% increase in the cost of food products within the industry (2008,p.50). Kumar et al (2008, p.50), assert that the soaring in food prices resulted in a 14.3% reduction in the consumers’ purchasing power. The reduction in the consumer purchasing power translated into a reduction in the level of profits amongst firms within the Indian food industry.

Over the previous four years, there has been an influx in the number of foreign investors venturing into the Indian food industry. Some of these firms include Wal-Mart Incorporation and Metro Group. This is due to the lucrative nature of the industry. According to Just foods research, the Indian food industry has been experiencing a rampant growth in the last 4 years (para.3). During 2007, the industry rate of growth was 10.1% with the total sales being US $ 202.6 billion. However the global financial crisis has resulted in a fluctuation in the rate of growth within the Indian food industry. This is due to the fact that the crisis has resulted in an increase in the degree of financial risk. This is evident from the fact that there has been a general reduction in the industry’s level of profitability. Consequently, this has affected foreign direct investment in the Indian food industry. This is due to the fact that the reduction in the level of profits has made the industry to be unattractive to foreign investors (Jarko & Likko, 2009).

Difficulty in raising capital

The financial risk faced by firms in the food industry was also worsened by the fact that the financial crisis resulted in a reduction in credit availability within the banking industry and the equity markets. This is due to the fact that the firms in the food industry utilize these two sectors as the primary source of finances. During 2008, there was a 60% reduction in the volume of trade within the equity market in India. This culminates into a $1.3 trillion reduction in the total market capitalization from January 2008. This is due to the fact that most of the foreign investors within India’s banking sector withdrew their investment so as to strengthen their parent economies (Kumar et al, 2008). According to Kumar et al (2008, p.10), the total amount of withdrawals by foreign investors from India’s banking industry from September to December 2008 was US $ 12 billion.

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On the other hand, the financial crisis resulted in a reduction in commercial credit from foreign sources. This meant that the only source of finance for firms in the Indian food industry is the domestic banks. According to Peter (2009, p.1), the liquidity crisis has resulted in an increase in the cost of capital within the Indian banking sector. Additionally, there has been a reduction in the rate of exchange of the Indian Rupee (Hans & Shahidur, 2009). This is due to the fact that there was a reduction in the volume of foreign remittances.The depreciation in exchange rate of the rupee has resulted in a reduction in the level of confidence amongst foreign investors within the food industry. The reduction in the rate of exchange has also culminated in an increase in the cost of capital in relation to loans from foreign banks.

Strategies to address the financial crisis by the Indian government

With regard to reduction in the amount of credit available, the Indian government has undertaken a number of strategies aimed at increasing the amount of credit within the banking industry (Peter, 2009). These strategies include:

Increasing advances to the banking industry

The government has formulated the Debt Waiver and Debt Relief Scheme through which it will pump Rs 250 billion during 2008/2009 financial year into India’s banking industry and other financial institutions such as the equity markets (Peter, 2009). To increase credit availability to investors in the food industry, the government reduced the liquidity ratio by 1%. In line with this, an additional 0.5% widow was introduced into the banking industry enabling the banks to increase liquidity. On the other hand, the government through the Reserve Bank of India reduced the cash ratio applicable to the commercial banks by a margin of 250 points (Nagesh, 2008).

According to Nagesh, the government has also issued numerous advisories to the commercial banks within India’s banking industry in relation to advancement of credit to foreign investors. These advisories will enable the banks to increase the level of export credit. This means that the both the domestic and foreign firms in India’s food industry will be able to increase their participation in international business. On the other hand the central bank has increased its total lending to the commercial banking. This is by reduction of the repo rate which is the rate at which it lends to the commercial banks from 9% to 5% within a period of six months. According to Kumar et al (2008, p.11), the Reserve Bank of India has also reduced its reverse- repo rate to 3.5%.

To increase the purchasing power amongst the rural individuals, the government has introduced loan waivers to the farmers and subsidies to fertilizers. This will result in an increase in the volume of supplies within the food industry. The effect is that more foreign investors will be attracted to India’s food industry and hence its participation in international business.

Political risk and regulations

Political risk refers to the process through which the government imposes controls in relation to certain industries. The controls can be in relation to rate of exchange or trade restriction. Alternatively, political risk can result from the government restricting firms in the private sector from repaying their debt obligation. According to Lars (2007, p.12), political risk can also result from confiscation of the foreign investors’ assets by the government of the host country.

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There are numerous regulations in relation to international investment in India’s food industry. These regulations relate to the industry to invest in, location of the industry, environment and licensing. These regulations limit international business. The government has only allowed foreign direct investment (FDI) with regard to food processing and not in other agricultural sector. This is through adoption of the automatic route system in relation to FDI. With regard to political risk, India has been violating the various stipulations of the World Trade Organization.

Increased protectionism

There has been increased protectionism in relation to foreign direct investment in India. The financial crisis has resulted in an increase in trade protectionism within India’s food industry ( John & Rajneesh, 2008).The objective of the government in adopting protectionist measures is to protect its domestic market from the spillover effects. This has resulted in a reduction in the number of investors venturing into the industry. On the other hand, the increase in trade protection has resulted in a decline in the volume of international business between India and other countries. Some of the measures that have been adopted in relation to protecting the domestic market are by increasing tariffs (Atul, 2006). For example, as a result of the government adopting high tariffs, some of the commodities that enter India’s food industry become very expensive. This is due to the fact that there are numerous duties that are levied on food products that enter the Indian market. According to Atul (2007, p.1), the total effects of the various tariffs charged within the food industry can result in a 400% increase in the price of food commodities. Atul (2007, p.2) asserts that with the elimination of trade protectionism in relation to food industry, there would be an increase in the volume of exports into Indian market.

Conclusion

The global financial crisis has had an adverse impact on various economies. The financial crisis has affected international business and international direct investment in these economies. This is due to an increase in financial and political risk. The Indian food industry has not been shielded from the financial crisis. The financial crisis has resulted in a reduction in the level of profits of firms in this industry. This is due to the reduction in consumer purchasing power and hence the level of profits. The financial crisis has also increased the financial risk in international business through a reduction in the size of credit available from domestic and foreign financial institutions. This has resulted in an increase in the cost of credit. Various strategies have been incorporated to increase the credit available. The financial crisis has also resulted in an increase in India’s political risk through an increase in trade protectionism in relation to the food industry. This has resulted in a reduction in international business and direct investment within India’s food industry.

Reference

Atul, K.2007. Politics of economic growth in India, 1980-2005: part ii, 1990 and beyond. Bloomington: Indiana University Press. Web.

Franklin, A & Douglas, A. 2007. Understanding financial crises. New York: Oxford University Press. Web.

Gore,C.2009. US wine industry charges India to adopt protectionist measures.(On-line). Food industry in India. Web.

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Hans, P. & Shahidur, R.P. 2009. How infrastructure and financial institutions impact Agricultural output and investment in India. Washington: Caribbean Publishers. Web.

Jarko, F.& Likka, K. 2009. Impact of global financial crisis on business cycles on Asian emerging economies.Journal of Asian economies. Vol. 2, Issue, 24,pp.23-34. Munich: University of Munich. Web.

John, H.& Rajneesh, R.2008.Foreign direct investment and governments. Limburg: University of Limburg. Web.

Just food research. 2009. Featured research: Indian food retail. (On-line). Web.

Kumar, R., Ghosh, J., & Prabhu, J.2008. Global financial crisis: impact on India’s poor. New Delhi: Sage Publishers. 2009. Web.

Lars H. 2007.Political risks in international business. Financial analysis journal. Vol. 19, Issue, 3, pp.11-19. New York: Business International Publishers. Web.

Nagesh, K. 2008.Multinational enterprises and international organizations: case of India. New Delhi: Sage Publishers. Web.

Peter, R.F. & Robert, E.B. 2009. The impact of financial crisis on labor market, Household incomes and poverty: a review of evidence. Boston: Boston University. Web.

Visant, V.2009. Why foreign investors need to look for political risk in India. New Delhi: Business foundation publishers. Web.

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