IN FREE FALL

The govern­ment’s re­cent ef­forts to ar­rest the ru­pee slide are yet to in­spire con­fi­dence

India Today - - INSIDE - By Sh­weta Punj & M.G. Arun Il­lus­tra­tion by NILANJAN DAS

FOR ONCE, THE FIS­CAL DIS­CI­PLINE that Union fi­nance min­is­ter Arun Jait­ley painstak­ingly put in place has gone awry, trig­ger­ing panic in the fi­nan­cial mar­kets and send­ing pol­i­cy­mak­ers into a hud­dle. The cul­prit: the free-fall­ing ru­pee, which is mak­ing im­ports in a fuel-guz­zling coun­try like In­dia costlier, widen­ing the cur­rent ac­count deficit (CAD), with the value of im­ports over­shoot­ing that of ex­ports. In­dia’s CAD is ex­pected to widen to 2.8 per cent of the GDP for the fis­cal year 2018-2019 from 1.9 per cent in the pre­vi­ous fis­cal.

The ru­pee, which hov­ered around 68.50 to a dol­lar un­til a month ago, has sud­denly plunged by nearly 4 per cent over the past one month and is inch­ing to­wards the 73 mark (it ended at 72.97 at the close of trad­ing on Septem­ber 18). Ris­ing crude prices at around the $80 a bar­rel mark, con­cern over higher in­ter­est rates in the US, the free fall of the Turk­ish lira fol­low­ing an eco­nomic cri­sis in that coun­try and ten­sions in US-China trade have rocked emerg­ing mar­kets. In­dia’s been no ex­cep­tion. Ris­ing global oil prices, cou­pled with a sharp de­pre­ci­a­tion in the ru­pee, cre­ate a dou­ble blow for the CAD as the coun­try’s im­port bill spikes even as the vol­umes re­main the same.

A weak ru­pee not only hurts the coun­try and its im­porters but it also stokes in­fla­tion. The sit­u­a­tion will be keenly watched by the Re­serve Bank of In­dia (RBI), which may go for an­other in­ter­est rate hike in an ef­fort to con­tain in­fla­tion, mak­ing home and in­dus­trial loans costlier. In Au­gust, the RBI’s Mon­e­tary Pol­icy Com­mit­tee (MPC) had raised the repo rate by 25 ba­sis points (bps) to 6.5 per cent. It was the first time since Oc­to­ber 2013 that the rate was in­creased at con­sec­u­tive pol­icy meet­ings. In June this year, the MPC had in­creased the key rate by 25 bps.

“When­ever there is a loss from emerg­ing mar­kets, coun­tries with a CAD, whether large or small, get hit,” says D.K. Joshi, chief econ­o­mist at Crisil. Those with ex­cep­tion­ally high CAD are worst hit. How­ever, In­dia is less vul­ner­a­ble than be­fore since it has ad­e­quate for­eign ex­change re­serves and has not bor­rowed heav­ily from abroad. As on Septem­ber 7 this year, In­dia had forex re­serves of $399.3 bil­lion or over Rs 29 lakh crore, from $426 bil­lion or over Rs 31 lakh crore in April. When the econ­omy turns pre­car­i­ous, in­vestors flee. “The in­vestor starts dif­fer­en­ti­at­ing with a lag, and then de­cides to move out,” says Joshi. For­eign in­vestors pulled out Rs 9,400 crore from the cap­i­tal mar­kets in the fort­night up to Septem­ber 16 this year.

The past few months have seen a fran­tic dis­ar­ray in the In­dian eco­nomic pol­icy corridors. While the ru­pee has been in free fall, ex­perts say there is no co­he­sive out­look on the ru­pee both in the govern­ment or the RBI. Fi­nance min­is­ter Jait­ley in early Septem­ber main­tained there was no need for panic or a knee­jerk re­ac­tion. He at­trib­uted the ru­pee’s fall to global fac­tors, in­sist­ing that the do­mes­tic fun­da­men­tals re­mained strong. But as the ru­pee inched up to 73 to a dol­lar, the govern­ment sprang into ac­tion. On Septem­ber 14, it an­nounced five mea­sures to shore up the ru­pee and con­tain the widen­ing CAD.

These in­cluded curb­ing non-essen­tial im­ports and in­creas­ing ex­ports, re­view­ing the manda­tory hedg­ing con­di­tion for in­fra­struc­ture loans bor­rowed through ex­ter­nal com­mer­cial bor­row­ing (ECB), per­mit­ting the man­u­fac­tur­ing sec­tor to ac­cess ECBs up to $50 mil­lion with resid­ual ma­tu­rity of a year in­stead of three, ex­empt­ing masala bonds (is­sued out­side In­dia but de­nom­i­nated in In­dian ru­pees, not lo­cal cur­ren­cies) from with­hold­ing tax this fi­nan­cial year and bring­ing for­eign port­fo­lio in­vestors into the cor­po­rate debt mar­ket by re­mov­ing re­stric­tions on their in­vest­ments. Prime Min­is­ter Naren­dra Modi, too, re­viewed the econ­omy with the FM, RBI gov­er­nor Ur­jit Pa­tel and top fi­nance min­istry of­fi­cials on Septem­ber 15.

De­spite these mea­sures, the gen­eral feel­ing is of dis­ap­point­ment over the han­dling of the ru­pee. The cen­tral bank has main­tained a stud­ied si­lence ex­cept for an oc­ca­sional state­ment say­ing it’ll in­ter­vene to man­age volatil­ity. And while it de­fended the ru­pee when it reached Rs 69 to a dol­lar in Au­gust, the bank has been mostly hands-off, sig­nalling that the ball is in the govern­ment’s court.

From within the fi­nance min­istry, too, Sub­hash Garg, sec­re­tary, depart­ment of eco­nomic af­fairs, in a state­ment on Septem­ber 10 said there was noth­ing to worry about and even an 80-level is not a “se­ri­ous thing” as long as other cur­ren­cies were also de­pre­ci­at­ing. That was four days be­fore the govern­ment un­veiled its five-point plan. In Au­gust as well, when the cur­rency was plum­met­ing, Garg was quoted as say­ing: “Even if the ru­pee falls to 80, it will not be a con­cern, pro­vided other cur­ren­cies also de­pre­ci­ate.”

Too lit­tle, too late?

Did the govern­ment keep the cur­rency weak to cor­rect the CAD that was widen­ing due to higher oil prices, and did that lead to the mar­kets crash­ing? A Mumbai-based macro-econ­o­mist seems to be­lieve so. Ab­heek Barua, chief econ­o­mist at HDFC Bank, says, “For three weeks, as the ru­pee kept plung­ing, there was a lot of con­fu­sion about pol­icy and whether the es­tab­lish­ment in gen­eral was in favour of let­ting the ru­pee slide. Ex­pec­ta­tions were that ag­gres­sive mea­sures would be taken, but what came through was a lit­tle tepid.” He feels there should have been co­or­di­na­tion be­tween the RBI and fi­nance min­istry as the ru­pee is ef­fec­tively man­aged by both.

So is In­dia com­fort­able with a de­pre­ci­ated cur­rency? And if it wants the cur­rency to be fair value, what is this value? The govern­ment and RBI have to de­fine it. “Let­ting the cur­rency de­pre­ci­ate till they reach a fair value be­comes a self-ful­fill­ing prophecy. This is a vi­cious cy­cle and it may be­come dif­fi­cult to break it,” says an econ­o­mist, re­quest­ing anonymity.

Hy­po­thet­i­cally, if the govern­ment were to de­cide that the ru­pee at 72 is fair value, the strat­egy on how to keep it there will be de­ter­mined ac­cord­ingly. Economists say if RBI is tar­get­ing in­ter­est rates, then it can­not be ex­pected to tar­get the ru­pee ex­change rate as well. If the ru­pee is the symp­tom of the prob­lem and CAD or the lack of cap­i­tal in­flows the cause, then it could take steps to shore up the lat­ter. The two in­stru­ments the RBI has are for­eign ex­change in­ter­ven­tion and in­ter­est rates. “The RBI has not been ag­gres­sive and the sig­nal it has given is that the govern­ment needs to ad­dress the is­sue of ru­pee de­cline. This may be be­cause the global storm is about to pick up and forex re­serves would be used then. What­ever the rea­son, RBI in­ter­ven­tion has gone down,” says the econ­o­mist.

Mar­kets in tur­moil

Mean­while, the mar­kets have been giv­ing clear signs that they won’t tol­er­ate a cur­rency freefall. De­spite the new five-point plan, mar­kets fell by over 500 points on Septem­ber 17 and by 294 points the day after. Hard-hit­ting mea­sures re­quire a fair amount of home­work which ev­i­dently there wasn’t time for. “Frankly, a lot of this weak­ness is driven by sen­ti­ments,” says Ja­mal Meck­lai, CEO, Meck­lai Fi­nan­cial Ser­vices. “What the govern­ment an­nounced is mar­ginal. The fi­nance min­is­ter said

it will keep the fis­cal deficit on track, but that hasn’t helped much.” Ac­cord­ing to him, the RBI should have in­creased in­ter­est rates when the ru­pee touched 70. “The mar­ket is not like a voter. If you tell the voter you will do some­thing, they may wait pa­tiently, but the mar­ket sim­ply will not fall in line.” In the short term, the ef­fi­cacy of these mea­sures will largely de­pend on ru­pee sta­bil­ity, says a re­search note from the State Bank of In­dia. Masala bonds, for ex­am­ple, would be suc­cess­ful only in the event of the ru­pee gain­ing sta­bil­ity, it says.

Pronab Sen, the for­mer chief statis­ti­cian of In­dia, is crit­i­cal when he says, “All this is do­ing is trans­fer­ring de­mand to banks abroad. Hav­ing In­dian banks as un­der­writ­ers is a ter­ri­ble idea be­cause it de­feats the idea of a masala bond. If the bond is not sub­scribed, then the resid­ual falls on the un­der­writer. The In­dian bank will have to pay the bor­rower dol­lars from its own ac­counts. En­cour­ag­ing In­dian banks to be­come mar­ket mak­ers in masala bonds is the worst idea.”

“These re­lax­ations, eas­ing of poli­cies, typ­i­cally do not bring that much in­flow,” says an­other econ­o­mist. What the govern­ment ought to do, ac­cord­ing to a slew of economists, is to in­crease the duty on non-essen­tial im­ports. “In to­day’s world, be­ing pro­tec­tion­ist is good,” says the econ­o­mist. Adds Sen, “I’m per­fectly OK with go­ing pro­tec­tion­ist, as the events hap­pen­ing are tem­po­rary in na­ture. Ex­porters re­quire some amount of cush­ion­ing. But the trick is to just do it. When­ever you make open-ended state­ments, you cre­ate un­cer­tainty.”

Mean­while, ac­cord­ing to rough es­ti­mates by the Fed­er­a­tion of In­dian Ex­porters Or­gan­i­sa­tion (FIEO), order books of ex­porters have in­creased about 10 per cent. And if In­dian ex­ports clock 15-20 per cent growth, they will cross $350 bil­lion or over Rs 25.5 lakh crore, the high­est in the past five years.

In­dia is star­ing at too many open ques­tions, the global sit­u­a­tion, the pos­si­bil­ity of a wors­en­ing US-China trade war, and will have to use all its weapons ju­di­ciously. But in a coun­try mov­ing to­wards gen­eral elec­tions in 2019, the govern­ment hardly has the lux­ury of play­ing a wait-and-watch game.

The way ahead

So what could be the next step or con­tin­u­ing steps? Ac­cord­ing to Joshi, once things set­tle down, the ru­pee might strengthen from the cur­rent lev­els. “Right now, there are too many mov­ing parts. What the RBI is do­ing is to cur­tail volatil­ity, which it should con­tinue to do,” he says. The govern­ment is try­ing to do things like tax lux­ury items to re­duce im­ports and at the same time try­ing to open the win­dow for for­eign cap­i­tal to come in or for In­di­ans to go out and ac­cess cap­i­tal abroad.

Meck­lai sug­gests other ways to shore up the ru­pee. “Many PSUs have drawn lines of credit in dol­lars from the Asian Devel­op­ment Bank, In­ter­na­tional Mon­e­tary Fund, etc. It might be to the tune of $10 bil­lion.” This money can be brought in and placed with the govern­ment at a cer­tain in­ter­est rate.

Ac­cord­ing to Soumya Kanti Ghosh, group chief eco­nomic ad­vi­sor of the SBI, the RBI could sell at least an ad­di­tional $25 bil­lion from its re­serves to sup­port the ru­pee. He says is­su­ing an NRI bond could be a less pre­ferred op­tion, as the costs could out­pace ben­e­fits. Third, as an im­me­di­ate mea­sure, oil com­pa­nies must buy all their dol­lar re­quire­ments from the RBI through a sin­gle bank as in 2013. Fourth, man­u­fac­tured goods im­ports from China, of which elec­tron­ics are a pri­mary com­po­nent, “need to be looked into”. Do­mes­tic man­u­fac­tur­ing of mo­bile phones and other elec­tronic prod­ucts needs to be pro­moted and “the govern­ment must se­ri­ously con­sider im­port curbs”, he says. Fifth, ex­port in­cen­tivi­sa­tion mea­sures should be an­nounced. “For ex­am­ple, we must bring back the pol­icy of pro­mot­ing spe­cial eco­nomic zones (SEZs).”

Where will the ru­pee go from here? Although un­pre­dictable, economists like Joshi be­lieve by March 2019, the ru­pee will have strength­ened. But that should be no rea­son for com­pla­cency, and the govern­ment should make the “right noises” to rein it in. “It’s like tak­ing ve­hi­cle in­sur­ance. You need to be pre­pared for the worst,” he adds.

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