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the US – are being withdrawn from India.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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