Economic Highlights

New Delhi, 12 April 2013

Sliding Rupee & CAD

WILL INDIA REVISIT DARK 1990?

By Shivaji Sarkar

The clock is ticking. Current account deficit is leading to a severe balance of payment situation. The rupee is losing its sheen every day. India’s forex reserves have shrunk and would be just enough for imports of less than seven months, slightly better than June 1991. Then the country had reserves for t

 hree weeks only.

Solutions are simple but not plausible. It would have been easy if payments could have been made in rupees, but this is not happening. Further, western measures against Iran are closing option for such payments which it was making for oil imports. Worse, the measures have even stalled the oil pipeline that was envisaged as a way for easy import and possibly cheaper oil than international rates.

India is indeed in a critical situation. It needs to weigh whether the step against Iran is not aimed against India’s progress. It appears so because both Europe and the US are not imposing such strict conditions for Pakistan, which is going ahead with a pipeline with Iran. Perhaps, it needs to be read in the backdrop of West’s assessment of growth forecasts on India. While it acknowledges the two Asian giants, it doesn’t want India to progress a great deal. It has a lurking fear that if India is allowed to go hassle-free it could overtake the western economies, sooner than later.

Except for moving to institutionalise BRICS and developing closer ties with ASEAN, so far New Delhi has not shown much initiative to create a system that could counter the West. Thus, it has to heavily depend on the dollar and pound for its international transactions. Shrinking exports to the Euro zone and the US since 2010 has today led it towards difficult times. Foreign exchange earnings are falling every day. 

Export growth has slowed down considerably. Based on GDP data from the expenditure side, the year on year real exports of goods and services has decreased from a peak of 36 per cent in 2011 to about 4 per cent by 2012-end and merchandise exports have slowed down to -6 per cent

India’s exports have not earned much of the forex even during the best of days. At best it remains exporter of low-end goods i.e. raw materials such as iron ore and other metals, handicrafts and some engineering goods. Most of these are products could expect demand from the West had its economy been booming. However, since 2008, the Euro zone is in severe crisis, unemployment is rising, new jobs are not being created and banks are subsisting on trillion dollar stimulus – loans. Protectionist moves are creating barriers for exports from countries like India.

Additionally, India’s hope to emerge as a giant automobile exporter has been dashed. It was expected to become the global hub of automobile manufacture. Every foreign automobile company opened its unit here with a promise to export a major of their products. This has not happened. They reveled in a growing domestic market. Since many of the components are imported from their countries, instead of bringing in foreign exchange they have only accelerated forex outgo. Undoubtedly, a review of the automobile policy is crucial. The other major reasons for forex outgo are oil and gold imports.   

But everything cannot be blamed on imports. Many corporates took heavy borrowings from foreign sources in hard currency of which major component was short-term, considered unhealthy. In the late 1990s and early 2000, many SE Asian nations had faced severe crisis due to high exposure to such loans. According to the RBI, short term loans have increased by 17.5 per cent during March-December 2012 and comprise 24 per cent of the total external borrowings.

Forex is now just enough to repay 78.6 per cent of the borrowings. Till 2009-10, the country did not face a problem. But the gulf is now widening. In fact, the forex position had never been very comfortable. It was being managed by RBI through purchases of dollar in the open market. Till the rupee was in the range of around Rs 45 to 48 to a dollar, RBI somehow found it easy to create a stockpile. This had created what is now termed as a comfortable forex reserve, helped by the flow of FDI and short-term FII. But as the rupee slid beyond and touches around Rs 55 to a dollar, it has become difficult, more so with FDI flow slowing down critically and FII remaining stagnant.

The reserves, around $290 billion would be just enough to sustain imports for seven months. The annualized rate of return on the multi-currency, multi-asset portfolio of RBI has shown declining trend over the years. It declined from 4.8 per cent in 2008-09 to 2.1 per cent in 2009-10, 1.7 per cent in 2010-11 and below 1.5 per cent now.

The depletion of reserves is also caused by RBI’s steps to sell $20 billion worth hard currency to stem the rupee slide in 2011-12. The pressure on the rupee continued in 2012-13 because of the ongoing Euro zone crisis. The import cover for forex reserves as a result has declined from 14.4 months in 2007-08 to less than seven months now.

This has further hit the rupee. Some estimates are that if the situation doesn’t improve it could go up to Rs 60 and beyond. The RBI is scared of intervention as it has a cost-- leads to further dwindling of reserves. Besides, the liquidity of rupee also increases and it may stoke inflation, which already is high. Therefore, it impacts every aspect of the economy.

Additionally, it is leading to rating crisis. Already the country is just above the junk grade. A further fall has tremendous impact on FDI flows, which Finance Minister P Chidambaram is desperately trying to attract. He is even keen on opening up defence, energy, insurance, banking and other strategic sectors. The problems is that if inflation and the rupee are not controlled, the FDI flow which of late has reduced to $4 billion, may not move up. And, unless it does, the rupee would not appreciate. It is a vortex. It may help in the short-term, if the policy succeeds, but there could be more problems in the long-run.  

Should then the Government go for market stabilization scheme (MSS)? It has been effective in draining excess liquidity from the system and countries like China and Turkey have used cash reserve ratio (CRR) for the purpose. The cost of a particular policy has to be weighed against benefits.

In a scenario of high trade and current account deficit (CAD) reaching over 6 per cent, allowing the rupee to appreciate, could have further negative fallout for the balance of payment by making exports less competitive and imports cheaper.

Managing budget or fiscal deficit is much easier. However, unless imports could be reduced, the solution to CAD is not easy. Production is not increasing. The western crisis is unlikely to abate. The Government alone is not in a position to solve it and the next, in 2014 wouldn’t find it easy to tackle.  

Undeniably, a remedy has to be found. All stakeholders need to brainstorm together to steer the nation out of this crisis. Sadly, the effort is missing. The nagging fear is: Will we be going back to 1990 and have to pawn our gold once again to strive through?—INFA

(Copyright, India News & Feature Alliance)