Thursday, July 4, 2013

To stabilize the Rupee, reboot the Indian economy




By
Randeep Wadehra

A currency’s strength and stability reflect an economy’s health, which is susceptible to a skein of influences both from within and without. Of late, currencies around the world have been on a rollercoaster, although the degrees of their fluctuations have varied. Barring a few hesitant ups, the Indian Rupee (INR) has been sliding down vis-à-vis the US dollar (USD). The fall has been about 11% over the past five months, and 15% since August 2012. Currently, the exchange rate is hovering around Rs. 60 per dollar, which is predicted to fall further to 61.5 in the next three months and reach 62 in about a year. However, such predictions are premised on variables that can change quickly. While keeping a close watch on the trend, it is essential to understand the phenomenon that apparently is the result of several factors operating simultaneously.

First, short term foreign investments – mainly sourced from the US – are being withdrawn from India. These had formed a substantial chunk of our foreign currency reserves. The reasons for these withdrawals are numerous. The government bonds in the United States are now becoming more attractive even as the Indian economy’s growth is refusing to accelerate. The Standard & Poor has revised the US economy’s outlook from “negative” to “stable”, and has given thumbs up to the Obama Administration’s modestly successful attempts at stabilizing the government’s debt levels. These factors have increased the chances of further improvement in the overall economic outlook in the short term, which has reignited investors’ confidence in the US dollar.

This sudden withdrawal of foreign funds from, and cessation of the inflow of USDs into, the Indian economy has had an adverse effect upon the country’s foreign exchange reserves as well as the INR’s standing in the money market. Secondly, India’s Current Account Deficit (CAD) is presently 4.8%, which is way above the acceptable upper limit of 3%. Since our imports are far less than exports, the demand for the INR has become slack, sending its value on the downward spiral. Thirdly, our GDP growth was earlier pegged at over 8% this fiscal, which has now been scaled down to around 7%. Going by the experience, this figure may be reduced even further. Consequently, investor confidence in the INR has taken a hit. The ongoing impasse between the UPA and the Opposition over various economic and fiscal reforms too is taking its toll.

The combined effect of high CAD and falling Indian rupee could rekindle high inflationary trends that had abated, thanks to the reports of good harvests and normal monsoons. Already, prices of petroleum products are being jacked up. This will add to the cost of transportation as well as other sectors of the economy. Although gold prices have shown signs of decline, the fall in rupee will certainly add to the import bill. In the month of May alone, gold imports had touched 162 tons. If this trend continues, despite the import duty hike, the monthly imports may well cross 170 tons by the time festival season begins, thus putting enormous pressure on the CAD. Similarly, import of crude oil is in the region of 18 million tons per year, for which we have to pay mostly in dollars although with some countries like Iran we have had agreements for payment in INRs, or even a quasi-barter arrangement. Imports of assorted petroleum products, including crude oil, were in the region of 170 billion dollars in 2012-13. Going by the annual trend of consumption and the current dip in the INR, this bill is bound to balloon up to about 200 billion dollars, unless domestic production increases significantly. 

Import of edible oils is another factor that will unquestionably contribute to the inflationary trend. In 2012-13, import of edible oils rose steeply by 16% to 11.2 billion USDs from 9.7 billion USDs in 2011-12, crossing the 10 billion mark for the first time. Considering this, we may expect similar jump in the import bill this year too. India imports around 60% of its requirements. Import of such farm inputs as organic chemicals (mainly fertilizers), too rose by 8% to 14.4 billion USDs in 2012-2013 from 13.3 billion USDs in 2011-12, and this too will continue to rise during the current fiscal. Moreover, we all know that once prices start rising, they have a rippling effect across the economy, resulting in price increases in respect of almost every other product and service in the market.

To check the spiraling purchases of gold and to dampen the inflationary sentiment, the government has started selling inflation-indexed bonds for the first time in over a decade, aimed at making investment in gold less attractive. Simultaneously, it is seriously considering the hiking of import duty on gold. Nevertheless, much more needs to be done. We really do not know the exact figures involved in military hardware imports due to lack of transparency in this regard. But, going by the prices of fighter planes alone – as quoted in various media outlets – the bill is going to be in tens of billions in USDs. Here, import substitution by developing indigenous military industrial base can help immensely. It can also help boost our exports. China has harvested considerable international goodwill as well as strategic advantage, not to mention economic benefits, by focusing on arms exports to African and Asian countries. 

India must reboot its economic reforms drive. It is high time to encourage building of infrastructure that would facilitate further industrial growth. Our record in producing quality capital goods has been dismal. Currently, the Indian capital goods industry contributes less than 2% to the GDP. Moreover, it is finding it difficult to compete with imported goods that are both cheaper and qualitatively better. This needs to be rectified by encouraging in-house research and development as well as by providing potent incentives for improving the industry’s productivity levels. It is true that India’s exports have risen tremendously from about 52 billion USDs in 2002 to over 300 billion USDs in 2012. There is a justifiable optimism that the figure may well cross the 500 billion mark this fiscal. However, this can be achieved if it is backed by strong domestic surge in industrial production that will, in turn, depend upon vast improvement in infrastructure as well as conducive economic policies. This is possible, given the political will. In the process, the INR will positively regain investor confidence both in the Indian and international money markets.


Published in The Financial World dated July 04, 2013

 
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