BOON FOR SOME, BUT BANE FOR MANY
India is facing a major crisis scenario, with its currency, the rupee, in a free fall depreciation curve, sending wave after wave of discomfiture and alarm across the economic landscape. While the falling rupee is a boon for some, it is definitely a bane for many, and unless the establishment acts fast to manage the situation, we might be in for a major shake up in all activities commercial in the country. NRI achievers attempts to sample the pulse, and look at how some influential sections of the media are looking at the developments.
This is indeed beginning to sound like a broken record, but the Indian Rupee has once again come under intense pressure, with the RBI, India’s central bank, seemingly having lost even the semblance of a control over the currency. The rupee was 67 to the dollar when we last monitored its value in international markets a while ago – a bottom that was inconceivable just a couple of months ago. So there is no gainsaying that our economy has been hit very hard indeed. Cause for concern ? Yes ! While we do not want to be alarmist, we cannot fail to note that spending has slowed down, and prices are poised to shoot up. Lets look at some examples of opinion from across the media.
Economic Times: Indian companies such as Whirlpool of India Ltd say they can’t plan more than a couple of months out as a fast-falling rupee is driving up the cost of imports, forcing them to raise prices even as consumer spending crumbles. The timing is particularly tough for consumer companies that were counting on India’s September-to-December holiday season to spur sales. India’s consumers, whose spending helped see the country through the global financial crisis in 2008, are closing their wallets fast, squeezing companies from carmakers to shampoo sellers. Companies that import finished goods or raw materials are the worst hit as they scramble to hold onto margins while balancing the need to raise prices without deterring buyers. “We are now planning for a month or three months at best unlike six months or a year earlier,” said Shantanu Dasgupta, vice president for corporate affairs and strategy at Whirlpool of India, the local arm of Whirlpool Corp, the world’s largest home appliance maker.
One would tend to think that with this sort of depreciation underway, our exports ought to help with economic growth. Not quite. This is what Buisness Week had to say:
Business Week: It’s standard macro-economics: When a country’s currency declines, its exporters should soon get a boost as the lower currency makes their goods more competitive. By that rule, India should be enjoying an export boom. Since the start of May, the currency has dropped 23 percent, making it one of the world’s worst performers. Sure enough, exports did go up in July, rising 11.6 percent year-on-year, the best increase in more than 12 months. Consumers worldwide shouldn’t expect to see a surge in Made-in-India products in the coming months, however. The July increase comes after a period of weakness: India’s exports dropped 1.8 percent in the 2012-13 fiscal year. And while the currency has been steadily weakening for two years, the decline of the rupee hasn’t helped narrow India’s current-account deficit. Instead, the trade gap has just gotten bigger, hitting 9 percent of gross domestic product in the first quarter. “The sustained and large depreciation of the [rupee] since mid-2011 does not appear to have had any near-term impact on the current-account deficit,” Mumbai-based Goldman Sachs economist Tushar Poddar wrote in a report published on Aug. 26. Chances of a short-term rebound driven by a weaker currency are “doubtful,” he added. And now the twin risks of serious collateral damage from this devaluation are becoming increasingly real: (1) a sovereign ratings downgrade and (2) the equity market collapse due to foreign investors’ full blown panic.
JP Morgan: – The stagflationary impact of such depreciation is well-known. But, more worryingly, markets have now begun to question whether the currency has entered a zone that could prompt more serious events. Two clear event risks are now appearing on the horizon. First, more currency weakness and its damaging consequences on the fiscal deficit have re-ignited concerns about a sovereign rating downgrade. Second, the risk of a sharp equity outflow has increased. Foreign equity investment is four times that of debt in India, and sustained corporate stress and slowing growth is testing equity investors’ patience. At this stage, rising prices, sharply higher interest rates, and a loss of confidence within the business community will bring economic growth to a standstill, potentially pushing the country into a full blown stagflation.
Andy Mukerjee of Reuters, writing in “breakingnews”, advocated abandoning the plunging rupee to market forces and shift focus to boosting exports and investment:
India’s failing defence of the rupee is doing more harm than good. A country that decides to defend its exchange rate has only two options: impose capital controls, or surrender independence over monetary policy. The Indian authorities have tried a bit of both. They have put restrictions on resident individuals and companies looking to invest overseas and in gold. The central bank has also raised short-term interest rates, thereby giving up its ability to use monetary policy to lift GDP growth from its 10-year low. Capital controls on residents make matters worse because foreigners fear that they might be next in line. Their rational response is to rush for the exit before the gates close. Indian stocks plunged 5.7 percent in two days after the country made it harder for residents to take their money out. The higher interest rates engineered by the central bank since mid-July have also backfired. With the rupee in free fall, global investors are unlikely to be lured by 10-year government bonds, even though their 8.9 percent yield is far more attractive than the 2.8 percent return on comparable U.S. Treasuries. Investors will bite only if they can get a positive return after hedging the currency risk. But strong demand for protection against a rupee collapse means hedging costs are too high for that.
Meanwhile, higher interest rates are hurting banks that are increasingly reliant on short-term money market funding. Rolling over their 3.6 trillion rupees ($58 billion) in market debt at interest rates that are now 3 percentage points higher is bound to squeeze lenders’ earnings, which are already shrinking as loan losses mount. Rising yields on government debt will also force banks to write down the value of their bond portfolios. The longer local interest rates remain high, the greater the risk that the currency crisis turns into a banking fiasco. A better strategy would be to just accept the 15 percent slide in the rupee since early May. India is getting punished because it has an external funding gap when the U.S. Federal Reserve is getting ready to reduce the glut of excess dollars. The Brazilian real, the South African rand and the Indonesian rupiah are also under pressure, and for much the same reason. So how large will India’s external funding gap be if investors take flight? Even a reduced current account deficit of about 3.5 percent of GDP will require $70 billion in financing this fiscal year. To that, add the $172 billion in foreign borrowings by India’s government, companies and banks that need to be repaid or refinanced by March 2014. If all this – plus some inevitable capital outflows – is to be financed out of India’s existing $279 billion in official foreign-exchange reserves, the kitty will soon be depleted.
With elections near, the ruling Congress Party can’t afford the humiliation of asking the International Monetary Fund for a bailout. It may, however, still be possible to tap India’s diaspora. The monetary authority recently allowed Indian banks to pay an extra 1 percentage point to non-resident Indians on dollar deposits of three to five years. That might help lure back the $1.4 billion of foreign-currency deposits that have left the banking system since July 2011. But mobilising at least the $11 billion that overseas investors have pulled out of Indian equities and bonds since June will require much higher rates than banks are ready to pay.
Allowing the market to dictate the exchange rate might drive the rupee down to 70 to the U.S. dollar – from just over 63 on Aug. 21 – and even beyond. Some hedge funds are buying options that will only pay out if the Indian currency sinks to 100 to the dollar in the next year, Reuters reported on Aug. 16. The biggest drawback of this approach would be the impact a collapsing rupee might have on already-strained corporate finances. Between 40 percent and 70 percent of the loans taken out by the country’s 10 most highly leveraged business groups are in foreign currency, according to Credit Suisse, and the increase in these liabilities because of currency weakness since April is already equivalent to 35 percent to 153 percent of last year’s earnings. These strains will make it harder to refinance Indian companies’ $21 billion in overseas debt falling due this year. However, companies that get into trouble can always sell assets, or restructure their debt. If the entire local banking system begins to creak as a result of higher domestic interest rates, then it will be difficult to salvage the situation. The government, which controls many of India’s largest lenders, doesn’t have the cash to recapitalize them.
Choosing not to defend the currency will at least give New Delhi a chance to shift its focus to policies that encourage exports and investment. After all, if exports don’t respond to a more competitively priced currency, the balance-of-payment vulnerabilities won’t go away. One idea could be to pare back India’s minimum alternate tax, which Finance Minister Palaniappan Chidambaram imposed back in 1997, ending the zero-tax regime that Indian exporters used to enjoy. A reduction in the 20 percent levy on book profits would encourage exporters to take greater advantage of the cheap currency. The government’s rickety finances don’t allow it the luxury of sacrificing revenues, so any fiscal handout to exporters would have to be financed by increased consumption taxes and lower public spending.
Overall, fiscal policy should squeeze demand from the economy, so that inflation can ease from near-double-digit levels. That in turn would create room for the central bank to reverse its tight-money policy. A strategy that reduces the share of consumption, government spending and imports in the economy and increases the share of investment and exports will involve short-term pain. But it would also put the economy back on a sustainable growth path, which in India’s case means lowering the chronic current account deficit. The other options on the table just won’t do that.
On DNA, Shastri Ramachandran wrote a piece, which gives a slightly subaltern perspective, and moots a common currency for the region a la Euro. We feel it is worthwhile to reproduce it in toto here:
Every few years the Indian rupee takes a dive. Every time this happens, there is the usual hand-wringing and the finance minister talking the rupee up. Invariably, the rupee’s fall triggers the clichéd debate over growth versus inflation, talk of curbing foreign exchange outflows, sucking cash out of the market and a number of other ad-hoc measures. The rupee ‘stabilises’ at a new low. Until it goes for another spin, and the charade is repeated.
It is no different this time with the rupee at Rs65 to a dollar and forecasts of it being headed towards Rs 70. As it stands (or, falls) today, the rupee does little credit to India as a rising power. In fact, the rupee does not look like ever becoming a currency of power. In the last decade, before the global financial crisis struck, India saw eight per cent growth and Indian capital’s overseas acquisitions suggested that, given the right conditions at home, it had the strength to take big strides abroad. The downturn did not, immediately, sour the climate in emerging economies such as China and India. In fact, the two Asian powers weathered the crisis well, and were considered important for driving the recovery. Now, the scenario has changed. China, although its economy has slowed down, continues to chug along, ignoring the doomsayers and warnings of a catastrophe. Unlike China, India is sliding into a crisis while the US and some of the western economies are recovering. The dollar is regaining its dominant role as both currency and commodity even as the Indian rupee is the worst hit among the currencies of emerging economies.
The falling rupee is treated as a problem of the finance ministry and the Reserve Bank of India, and not as a national crisis; not as an issue that affects India’s self-worth and standing abroad. Foreign policy and diplomacy are increasingly driven by economic objectives. Curiously, the Indian rupee’s fate never figures in our ‘External Affairs’. The government is able to do nothing to raise the strength and stature of the rupee to match India’s international profile. At the very least, the government should be able to make one other country feel affected by the rupee’s fortunes. Far from that, even Indians are sold on the dollar when they see no future for the rupee. Yet, this crisis could be an opportunity for India to re-float the idea of a common currency in South Asia. Conditions may not be conducive for the creation of such a single currency, but acceptance of this as an objective may compel South Asian countries, especially India and Pakistan, to end mistrust, jointly fight terrorism and enhance mutual security for greater cooperation and economic integration.
In 2003, Prime Minister Atal Bihari Vajpayee had mooted the idea of open borders and a single currency. Vajpayee felt that South Asian countries developing greater economic stakes in each other would create sensitivity to shared concerns and promote common interests. Sadly, though the idea drew responses elsewhere in Asia, including Japan and China, in India itself it has not been debated seriously. At the 15th ASEAN Summit in Cha-am Hua Hin in Thailand in October 2009, Japan’s call for adoption of a single Asian currency was backed by China. The plans for a single-currency trading bloc aimed to take in all countries of the East Asia Summit, which brought ASEAN together with Australia, China, India, Japan, New Zealand and South Korea. It is ironic that while other countries are confident of India joining the efforts for creating a common currency area, in India itself the issue is ignored.