While keeping their independence, RBI and Finance Ministry need to show that they are in control and acting in the interest of the Indian economy. The rupee has crashed below 61 to a dollar. The latest bout of weakness came on signals of improved growth from the US, which increased the likelihood that the Federal Reserve will begin cutting its massive monetary stimulus, known as quantitative easing, as early as September.
But the global factors are only a trigger; back home despite the RBI stepping in to hold up the rupee the Indian currency is taking its own downward route. The weakness is playing out in the stock markets as well. What haven’t helped is the RBI Governor’s comments last week that the central bank doesn’t have a ‘target for the currency.’
The rupee is down 1.4 percent last week alone and has been rolling down for nine straight weeks. The rupee is Asia’s worst performer this year.What’s adding to the fears is the spike in oil prices as Brent crude futures have hit a more than three-month high on Monday. India is a big importer of oil for its needs and this cannot be cut down. This further vexes concerns about India’s current account deficit.
The oil companies are the biggest buyers of dollars in domestic currency markets as they import crude oil. There is talk that the RBI may consider a separate window for oil companies to provide them with US dollars and take it away from the spot market to avoid further volatility.
The overall macro scenario is making it harder for the rupee to reverse. The trade deficit is at a seven-month high, the GDP is down to 5 percent , industrial growth has registered a meager 2 percent rise in April, inflation is below 5 percent but volatile enough to become a threat again. All these factors have once again forced the country’s central bank to skip cutting key policy rates in its last policy, which in turn help bring down interest rates on loans.
With very little sign of any major reform towards attracting greater investments, which means more dollars into the country, the rupee continues to fall as demand for dollars is higher than the demand for rupees. Currency traders now say apart from the current account deficit now the fears of a weak and inconsistent policy focus is adding to the woes. Every fall in the rupee makes India and Indians poorer. The currency is losing its purchasing power – simply defined as how much it can buy. As our currency is benchmarked to the dollar, we now need to spend more rupees to get the same products or services priced at a dollar.
For an import heavy nation like ours, this is a big blow to our bills. We are now spending more of our earnings to buy the same amount of crude, gold or any other product.
Its impact?
A vicious cycle where foreign investment slows down, it inflates the import bills and widens our deficits. When a country’s total import of goods and services is greater than its total export, the situation makes a country spend more dollars than it brings in. High gold and crude oil imports lead to a high Current Account Deficit (CAD).
On the export front this would be a good opportunity for companies selling goods/services in rupee terms but earning in dollars. However our exports expansion too is capped as the rest of the western world – which is our primary export market- is growing slower than India and the demand remains muted.
Where is the money?
The deficits would be easier to manage if there was foreign money coming inwards. India has allowed foreign direct investment in sectors like retail, aviation and is actively considering opening up the telecom sector further. All this in the hope that there will be more permanent investment coming into India. The challenge though remains that much of the capital flows into India are often the short term ‘portfolio’ investment that are used towards buying shares. The anticipated FDI flood is not on the horizon as investors are still finding their feet under the new liberalised rules and some are even wary of India’s political uncertainties in the run up to the elections. Analysts see serious FDI interest picking up only once the next government is well in place.
One hope is that the government targets the Sovereign Wealth Funds i.e. countries that have their own funds to invest in other countries. For example Singapore, Abu Dhabi, etc that manage hundreds of billions of dollars. But then in such cases, a sore example would be Abu Dhabi’s investment in Jet through Etihad airlines and how it lies stuck in controversy. Meanwhile, Finance Minister P Chidambaram is due to travel to the United States next week to lobby for more foreign direct investment, particularly in the infrastructure sector.
What has worked for the government is a crackdown on gold imports through a tax. It has shown results in the last month as Indians who are highest consumers of gold could not get gold in as a result demand for dollars fell. The RBI may have more acts up its sleeve. It could tell banks not to hold large overnight positions on the rupee dollar trade, which can cause massive fluctuations in the exchange rate. This move could cushion the volatility. It may also ask exporters who hold dollar accounts to carry out their normal work to first convert the outstanding amount in the domestic market thus increasing supply of dollars.
But most important is a signal that both the finance ministry and RBI need to give to the market that they both are not foes acting in opposite direction. Right now the feeling is that they both are out of sync hence wielding very little influence on where the rupee is headed. While keeping their independence, RBI and Finance Ministry need to show that they are in control and acting in the interest of the Indian economy and Indians.
