IN FREE FALL
The government’s recent efforts to arrest the rupee slide are yet to inspire confidence
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.