Indian stock markets tanked on Friday, the 16th August 2013. The BSE’s (Bombay Stock Exchange) bellwether index Sensex crashed by 769 points to close at 18598.18. It was the steepest crash in four years. The reasons being ascribed to this free fall is the fear of USA’s central bank, Federal Reserve tapering off its US$ 85 billion a month bond purchase program. This fear is based on the fact that fewer people applied for joblessness claims which in turn points to the fact that the US economy is reviving. The Fed’s chairman Ben Bernanke had hinted that once the US economy starts reviving this bond/asset purchase program will be tapered off.
This program is called Quantitative Easing (QE) and this was introduced post the sub-prime crisis which had its epicenter in the USA and which engulfed the entire world.
QE was supposed to inject liquidity in the American banking system to stimulate growth and create employment in the US but QE money found its way into the stock markets of the emerging markets and the BRICS (Brazil, Russia, India, China, and South Africa) economies, which led to the stock markets of these countries touching new highs. The world is today a global village and when USA/Europe sneeze, the entire world catches a cold. Ben Bernanke has not yet tapered his bond buying program.
The very indication of the tapering of QE which would mean an end to easy liquidity in the stock markets across the world is creating mayhem. FIIs (Foreign Institutional Investors) chase returns which they find in a country’s GDP (Gross Domestic Product) growth. Macroeconomic fundamentals are closely monitored and followed in their (FII’s) quest for superior returns. With the early signs of US recovery, FIIs are shifting focus back to the stock markets and debt markets of USA where valuations are currently cheap.
But there is another more sinister problem to Friday’s bloodbath on Dalal Street. The Indian rupee has been in a free fall. It breached the psychological level of Rs 62 per dollar on Friday, the 16th of August 2013 and finally closed at Rs 61.65 per dollar. The Reserve Bank of India (RBI) announced fresh steps to protect the rupee. Indian residents were earlier allowed to use up to US$ 200,000/- per annum for investments overseas. This limit has now been slashed to US$ 75,000/- per person per annum. Similarly, Indian companies were earlier allowed to invest up to 400% of their net worth outside India to purchase assets. This has now been restricted to 100% of a Company’s net worth. These measures of RBI spooked the market participants that India was returning to a regime of capital controls. India followed a path of economic liberalization in 1991 and it seems that the economy has come a full circle.
The then Finance Minister, Mr. Manmohan Singh had unshackled the Indian economy leading to a spate of economic liberalization and economic reforms under the then Prime Minister, PV Narsimhan Rao. It is ironical that Mr. Manhohan Singh is the prime minister of the country and we are witnessing such steps to bolster the rupee. Economic reforms are much needed now and real economic growth will attract both FII and FDI (Foreign Direct Investment), leading to an influx of dollars which will support the rupee. But the RBI cannot be faulted. Steps have to be taken to check the downward slide of the rupee. Seeing the carnage on the stock exchanges, Government officials tried to allay fears and soothe nerves. The Economic Affairs Secretary, Arvind Mayaram issued a statement that there would be no more import curbs and gold, silver and platinum are considered non essentials by the Government and so these items had import curbs. He also said that these measures were not capital controls and there were no restrictions on outflows of dividends, royalties, profits or any kind of commercial outflows that happen in the normal course.
The RBI has also raised the rates on foreign currency deposits and exempted such deposits from CRR and SLR in order to attract US$ inflows.
The RBI has also prohibited Indians from investing overseas in overseas property. While the rupee’s downward spiral is a structural issue, this step of RBI is not without merit. According to the data released by Dubai’s Land Department, Indians are the largest foreign investor in Dubai’s property market. Indians in the first half of 2013 had pumped in US$ 132.6 billion in Dubai’s property market, compared to US$ 149 billion they invested in Dubai’s real estate market in the whole of 2012. While the amount of outflow from India is significant, it is still a small chunk of the amount of total dollar inflow required. It is a correct step by RBI nevertheless as though the ultra high net worth individuals will be restricted to some extent in their quest for superior returns, this move is for the larger Indian community. According to a Knight Frank report, property prices grew by 8.5% in the first quarter of 2013 and according to data from Global Property Guide, Dubai saw an increase of 29% in the last two years.
On Friday, 16th August 2013, when the Sensex crashed 769 points, gold was an all time high of Rs 31,000/-. This is because the Government has hiked the import duty on gold to 10% on August 8th 2013. Market experts are warning that such high import duties would lead to smuggling and the Government would lose precious revenue. It is a well known fact that tax rates and duties should be benign to ensure maximum collection. We seem to be moving a full circle again to the days of Hindi cinema when Amitabh Bachhan ruled supreme and in almost all movies, the villain Ajit’s smuggled gold would land up along the Mumbai coastline. The demand for gold in India has reached a feverish pitch. Stockists are stocking up in anticipation of a good demand with the upcoming festive season and marriage season.
Monsoons have been good this year barring a couple of states like Bihar which have been declared drought hit. Good monsoons lead to good rural demand. The Finance Minister, P.Chidamambaram appealed to the citizens of India to buy less gold but his requests fell on deaf ears. We had already imported in the first quarter of 2013 what we had imported in the first half of 2012. Gold is the second largest import item of our country behind oil. India is the largest importer of gold in the world. Market experts are warning that gold jewellery locally produced will be more costly than imported jewellery from Thailand, Italy etc and many jewelers plan to import gold jewellery from these countries for the upcoming festive season and the marriage season.
This, market experts point out is not a good thing for more than 11 lakh artisans employed in the jewellery business. The RBI had earlier imposed stringent conditions on gold import. 20% of the gold imported had to be exported and proof of export had to be submitted before the next shipment could be imported. The next shipment could be imported only when 75% of the 20% to be exported had already been exported. The Government has banned gold coins and medallions. As early as June 24th 2013, the Indian jewelers’ association asked members to stop selling gold coins and bars which amounted to 35% of their business. On July 10, 2013, the association further extended the voluntary ban on sale of gold coins and bars for a period of six months.
The traditional Indian mindset loves gold. Parents down the centuries have gifted gold on marriages and have advised children to invest in gold. Gold is seen as the perfect inflation hedge and perfect investment asset. Till about 2-3 years back, financial planners were advising their clients to have 5% to 10% of their portfolio invested in gold. While the Indian love for gold and gold jewellery will not change overnight but the Government can certainly offer innovative products suited to the Indian context. One scheme which was introduced with great fanfare by the Government was inflation indexed bonds. These bonds were touted as the perfect hedge to inflation.
These bonds are linked to the WPI (Wholesale Price Index) and not to the CPI (Consumer Price Index). The WPI as of date stands a tad above 5% while the CPI is around 9.5%. How can the Government offer such a product to the masses? Linking it to the WPI means that the interest a common man will get will be pegged to the WPI which is nearly half of the CPI in the current context. Why would anyone with a little bit of financial acumen invest his hard earned money which will not even cover the CPI? The Government is now jumping hooplas to contain gold import. Inflation indexed bonds where interest rates were linked to the CPI and not the WPI could have been a game changer.
Secondly, it is estimated that Indian households and temples hold about 20,000/- tones of gold. The Government and the RBI have to find a way to make this huge booty productive. People could be incentivized by way of interest if they deposit their gold with the Government and banks. While such a scheme would work well with gold bars and coins, people are generally attached to their gold jewellery and this mindset could take some more time to break or maybe a tweaking of the scheme could help. These gold deposits would be returnable but while they are deposited with the Government/banks, they could be used and this use should drastically bring down imports.
There was an article in The Business Line wherein the author talked about an amnesty scheme for gold bought with black money. This scheme has its merits. It makes gold bought with black money legitimate and garners huge revenue for the government.
People still have faith in gold as there are too few avenues for superior returns. Stock markets are not understood by the vast majority. Both the Bombay Stock Exchange and the National Stock Exchange run investor awareness programmes. The Institute of Chartered Accountants of India also conducts Investor Awareness programmes. The RBI conducts financial awareness programmes and quizzes. The stock markets are a difficult investment avenue for the masses. They do not understand the stock markets and when they do invest, they invest based on tips given in newspapers, TV channels, by friends and family etc.
This leads to erroneous judgments and which in turn leads to these investors booking losses. The stock markets have given returns which are in the region of 15% to 20% over the long term and can be an inflation hedge. But a lot needs to be done to make this a success with the masses. Mutual Funds are a good alternative which the masses can depend upon. But in recent times the stock markets are faring poorly. This is on account of slowdown in the Indian economy which the Government can certainly address by lowering interest rates, removing corruption and policy paralysis and giving a fillip and a push to stalled infrastructure projects and power projects.
Dollars are precious and our main source of dollars should be exports and not FII or FDI inflows. There is the aftereffect of the sub-prime crisis in the US and Europe was in recession on account of the sovereign debt crisis. The growth in Germany and France in the last quarter has pulled out the Euro zone out of the recession. All these factors have led to our exports being hit. There was a newspaper article that our handicrafts exports have actually grown on account of newer export destinations and revival in growth in the USA. The SBI Chairman, Pratip Chaudhuri is right when he says that RBI should be looking to extend and enlarge the scope of export refinance in order to boost exports. Exports should be encouraged and incentivized and the Government should look at ways and means of boosting exports not only of software but also of manufactured goods and agricultural produce along with handicrafts.
Innovation and creativity should be encouraged. Bihar is today witnessing power production from husk. An Indian engineer came back from the US and started this project in Bihar. It is mindboggling that a product such as husk which at most becomes cattle feed is being used to generate electricity for hundreds of villages in Bihar and he has created thousands of jobs. Wait! there is more ! With the ash of the husk, this innovative genius is making incense sticks or agarbattis, giving employment to the village women.
Brazil had started mixing ethanol in petrol many decades back- they successfully brought down oil consumption. Why has India failed to emulate Brazil is beyond imagination. India imports about 80% of its oil consumption and mixing ethanol with oil could mean substantial reduction in our highest import item. Dollar requirement by this would come down by at least 10%. Similarly, the third largest item in our import bill is electronic hardware- It is amazing that in the land of IITs and NITs and IISc, we find it difficult to manufacture electronic hardware internally in the country. There has to be an environment of innovation and high productivity and encouragement to entrepreneurs to make this happen. A conducive ecosystem should be developed to stop the brain drain. Our archaic labour laws and factory laws and different municipal, panchayat cess, levies and taxes have made our manufacturing sector uncompetitive in the global scenario.
As of now, excise duty is levied based on the size of the car. Excise duty should be linked to the fuel efficiency of the car engine. Greater the fuel efficiency, lower should be the excise duty. Cars with higher fuel efficiency will always be sold more and the Government will get extra revenue. Also, incentivizing research to attain higher fuel efficiency, will further bring down oil consumption, saving precious dollars.
According to newspaper reports, on account of falling rupee, the Indian tourism industry is seeing a revival both on account of domestic tourists and foreign tourists. But the foreign tourists are hiring bodyguards as India is unsafe. Is it not ironical that in the land of Shakti and Goddess Durga and Maa Sita, women are not safe? Indians should understand that these foreign tourists mean precious dollars and should be treated with respect. Respecting women, per se, may take another couple of centuries for the average Indian male.
According to David Gornall, the London bullion market association chairman, the RBI could swap 200 tonnes of gold RBI bought from the International Monetary Fund (IMF) in 2009 for dollars. He clarified that he was not advocating a sale, but a swap of gold for dollars, without divesting its holdings or incurring any further interest charge to access US$ 23 billion. India would remain the owner of gold but could access dollars for a specified period of time.
Last but not the least, I had mentioned in one of my previous articles that in this era of globalization and hyperactive FII flows the role of RBI as only inflation controllers needs to be revisited. RBI tried to contain inflation by raising rates. What was required was lowering of rates to spur growth and superior distribution and cold storage facilities to check supply side inflation. Removal of obstacles by outdated Government laws was the need of the hour. Inflation was not brought down to acceptable levels and growth suffered greatly.RBI needs to study what actions could have been effective as the actions taken by RBI have failed to achieve the desired objective.
The RBI has sacrificed growth in the name of inflation control and the Government is looking for Food Security Bill to come to power for a third time in a row. High GDP growth would have alleviated poverty, pulled FDI & FII flows into India like a magnet and good exports (of software, hardware and agricultural produce) would have led to a dollar inflow. Restricted imports on account of superior products being made locally and good financial alternatives being available would have been the icing on the case. The rupee would be holding its head high in a tumultuous world.
