Stumble of the INR

[Sathyamurthy U]

Hi All - The following is a blog that I wrote for my company's website. It is about the recent fall in value of the rupee. Please provide your comments.

 

Over the last few months, Indian rupee witnessed the largest fall in value against the US dollar, at a speed that created fear among investors at large.  The fear was not irrational in a country that is claimed to be largely insulated from the troubles of the developed world and a potential economic superpower.

High inflation in the country and the large current account deficit, financed primarily by capital inflows has been the key problem. The trauma in global markets due to risk aversion has caused capital flows to dry up.  Companies are struggling to find dollars from euro-zone banks, which supply about half of India’s foreign loans, cutting off credit lines.

India’s growth plan has been to maintain a low current account deficit, financed through capital flows from foreign direct investment and portfolio investments. Neither of these has worked favorably so far. The country’s current account deficit is likely to be higher than 3% of GDP.  Exports declined faster than imports and are likely to continue considering the nature of imports (commodities and oil).  Investment climate has weakened due to the persistently high inflation, high interest rates and slower GDP growth.

The falling rupee has essentially reflected India’s economic weakness. The floundering reforms to increase capital inflow are adding fuel to fire. However, one might argue that the cheaper rupee will boost exports and limit imports.  During the recent result season, large number of companies booked losses due to foreign exchange differences on their foreign currency loans. This raises concerns about these companies refinancing their borrowings now.

In order to opine on the INR’s ability to regain its lost value one would want to look at the possibility of three options that India has. One-to enable more high quality capital inflows into the country by easing rules for foreign lending, (steps in this direction have already begun), two- intervene in the currency markets, buy rupee and sell dollars. This will decrease money supply from the system and borrowing costs will increase. Given the already high interest rates which is visibly hampering growth (7.6% to 6.9%), might not be an option that RBI will pursue. Three, politicians should decide to cut fiscal deficit, which might in turn lower the current account deficit, and speed up reforms. The first day of the winter session of the parliament was adjourned due to unruly behavior by politicians – the day the rupee crashed to an all time low.  

Regards,

Sathya

 

[Mani KG]

Nice writeup Sathya..
Some comments
1) I feel enabling foreign inflows will not help or promote foreign
currency flows,as we can't change the perception of other countries,
It should be the other way around, when there is a growth in our
economy it will tend to increase foreign currency flows and our policy
should be such tat this inflow we should be able to absorb.. last year
when there is a huge FII flow tat time itself RBI should have
accumulated more forex reserves, so now it can easily sell dollars and
can curb rupee depreciation
2) the current rupee depreciation is short term and however does not
reflect our weakness in economic policies, its due to the global
scenario changes mainly US economy slowdown and euro debt crisis, also
kind of play by our exporters by booking and cancelling forwards for
taking advantage of dollar appreciation..
3) fiscal policy to reduce current account deficit is a long term view
4) and selling dollars is the only option which RBI is doing right now !

regards,
Manikg

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[manikandan s]

I feel RBI has got nothings up their sleeve to shield India from this currency problem. 

India has to go through this currency problem because RBI cant shell out more than 6% of our forex reserves to intervene in the currency market. By intervening in the market, India will risk itself by exhausting its reserves to fund the Current Account deficit.

Moreover I feel this currency situation is more of a cyclical problem rather than a structural one. All the major currencies have depreciated against the greenback

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MANIKANDAN

[navin kumar Dharman]

Hi all,

It was a interesting write up by Sathya nicely followed up by  the two Mani(s) :)

My views (Queries):

1) Why have the state governments not reduced the sales duty on petroleum products in spite of the central government cutting down on customs duty and excise duty?
Why has the central government not given SLR status to the oil bonds for the relief of OMCs. Isn't this show of politicians to speak for aam aadmi during petrol price hike but not reducing the sales tax (major source of revenue). Isn't this show that the Central government wants to safeguard its borrowing power via: the SLR status to government bonds alone even as the  under recoveries for OMCs pile up.

2) The data for minimum wages act for various states in our country today shows that  masonry and carpentry get highest wage across numerous categories given the level of skill involved. Sadly, the unskilled labour wage has shown highest growth vis-a-vis that of say masonry, carpentry or tractor driver. Today why is lack of skill being given incentives via programs such as NREGA and several other welfare scheme?

3) Though ours is not export driven economy unlike many of our Asian peers, are the  infrastructure facilities in the form of roads (golden quadrilateral), railway freights (Dedicated Freight Corridors), ports (Capacity in (TEUs) is painfully low compared to China's) are robust enough to support our ambitious export targets?

4) Why is this clear in-congruence in policies of the government which runs a expansionary fiscal policy (subsidies & welfare schemes supported by excessive borrowing) and RBI running a contractionary monetary policy (policy rates being hiked by the central bank for record number of times in the past 10 months or so)? Though the tension between the North Block and the Mint Road is understandable, difference on policy decisions is not.

5) If the government is so fundamentally strong, why was in't our government bold enough to impose tobin tax on foreign portfolio investment inflows when the markets were buzzing unlike Brazil? Isn't this a clear show of missed opportunity (or) misplaced confidence on our so called strong fundamentals.

According to Marshall-Lerner Condition, a country cannot make its exports competitive with depreciated currency before a period of burdensome imports, further adversely affecting the balance of payment position of the country.

I think that the present fall in INR against the greenback is not only a result of developed market dynamics alone and we have ourselves to blame to a great extent.Hopefully, economics wins over politics and doesn't stop with half baked measures like introducing Rupee symbol and empty talk of internationalisation of Indian Rupees. 

(All the above comments are my personal views and I would be glad to see the discussion moving forward).

Regards,
Navin Kumar Dharman

[manikandan s]

@Navin 

1.Coming to the SLR status for oil bonds it has been under consideration for the past 5 years and will remain so. With the government borrowing increasing day by day it would not want to constrain its borrowing power by allowing oil bonds to get the SLR status. Why do you expect state governments to reduce the sales tax when the central government wants to reduce its fiscal deficit?Why cant the central government strongly take a stand on the fuel pricing in the country? It pays for under recoveries on one side and increase its revenues on the other side with its customs duty and excise duty. If the government wants OMCs to stand on its own and cut down its losses, it has to take the initiative by bringing its customs and excise duty to a level where it can stop paying under recoveries to OMCs? Is the central government ready to do it?

2. When you want fuel prices to be market linked and RBI to run expansionary policy it is not possible? what you want RBI to do, it has got limited tools to play around

3. When the government is already short of funding its current account deficit, why do you want to impose tobin tax?Does it really make sense for a country which funds its current account deficit with portfolio money flows

4. Increase in wage for unskilled workers? Are you not happy? I dont find any problem. NREGA has had multiplier effect for the economy on one side and created shortfall of labour in the agricultural sector thereby increasing the labour wages in the agricultural sector. Do you want NREGA to be scrapped?

5. India is always known for its execution skills in infra sector

I agree that rupee depreciation cannot be attributed only to global turmoil and india has its own problems to deal with but i dont think situation would be much different had deficit been under control as well.

When the situation is bad, even good news gets discounted and no news is bad news.

Government missed a trick or two by not going ahead with reforms in any sector. We dont have an election unlike UNSC countries, so hope reform wins over politics

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MANIKANDAN

[J Murugavel]

Hi,

Interesting discussion. My two pence ...
a) If we understand the nature of oil bonds, we will see why they cannot be given an SLR status. To my mind, they are just a postponement of a problem. I dont see why state goverments will cut taxation on fuel , when the centre does not. If a government is not willing to cut down on duties,taxes on fuel - I dont think it will be entirely possible to remove subsidies. And subsidies are not an India specific feature.

b) I urge people to read the article by Sainath in BL. I am attaching the link here. It might interest you to know that there has been no rejoinder what so ever to this article ... Probably this will answer some questions, particularly on welfare schemes. The solution to the problem lies elsewhere ...but sadly I dont think we will work on this solution...
http://www.thehindu.com/opinion/columns/sainath/article1514987.ece

Regards
Murugavel

[navin kumar Dharman]

Hi all,

Happy new year to all the members of BIM Finance Group.

My views/ Queries:

1) Regarding SLR status to Oil bonds:

Why should the government share its SLR status of government bonds with that of Oil bonds. Fair enough. But, shouldn't the government also look at increasing its tax revenues via effective enforcement.If the government wants to keep depending on government bonds it would only result in widening yield (though temporarily subdued by opening the doors for FIIs now).Have the state governments reduced the sales tax at the same pace as that of excise/ customs duty at the center? Today, the under recoveries are on the verge of exceeding revenues to the center via excise/ customs duty.With our crude basket more skewed towards Dubai/Oman sour, hard crude than on sweet,light brent crude, isn't the government made to pay for the price volatility on account of political/economic situation in West Asia.I accept that the exploration and upstream refining capabilities of Indian Cos have to be fostered for a long term solution, but the ballooning fiscal deficit cannot be left unchecked.

2) When the market was good, why not make hay while the sun shines? why can't the government take the first step forward when the FIIs were willing to be a part of Indian success story? Why is a minimal tax rate of 0.05%-0.25% on such large portfolio investments seen as a non-starter straight away.

3) Has NREGA done more good than bad is debatable? hasn't the migrant labour from Bihar to the fields of Punjab and Haryana fallen steeply on account of NREGA ? Why make the agricultural sector and manufactories starve for labour when there is neither accountability nor considerable rural infrastructure built up given the scale of the welfare scheme.Are we sure that we are really paying the labourers or feeding the never ending greed of politicians and middle men. Though, any welfare scheme would have the loopholes for the politicians to flourish, but isn't it high time to revisit the inherent weakness of the program ?

4) And yes India is known for its execution in infra sector. Known for cost overruns, time overruns, land acquisition issues, Politicians with vested interests playing spoil sport and what not.

Wondering isn't our country a clear target to the Rating agencies for sovereign bond downgrade in South East Asia given the greater debt to GDP in comparison with the peers.We are already in the lowest investment grade only to land into the speculative grade.
 
Its  an effort to understand the missed opportunities and innumerable opportunities which is going to be missed due to the lack of government will and continued apathy towards economic reality in our country.

Regards,
Navin Kumar Dharman