The US dollar crossed the Rs 61 mark on Friday, 2nd August 2013. This means that it costs Rs 61 to buy one US dollar. At the beginning of the year 2013, the dollar was around Rs. 54. The rupee has steadily deteriorated this year and this is inspite of a host of measures undertaken by the Reserve Bank of India (RBI) to contain the rupee depreciation. Rupee depreciation is good news for the exporters.
This means that Indian exports will be cheaper overseas compared to the importer’s home currency and this should stimulate the demand for Indian goods being exported. It also means that the exporters will be able to sell dollars in India and get a higher rupee equivalent. For example, if an Indian exporter was to receive US$ 1 million in Jan 2013 and he was to convert it into rupees he would get Rs 5.4 crores.
The very same exporter when he gets US$ 1 million in August 2013 and the exporter converts it into Indian rupees in August 2013 would be getting Rs 6.1 crores. The rupee depreciation in seven months of 2013 adds seventy lakhs to the kitty of the exporter for the same amount of US$ earned. This should surely be sweet music to the ears of our software exporters and gems and jewellery exporters and the exporter fraternity in general.
So where is the problem? Why is the Government so worried? Why is the RBI taking so many steps to curb rupee depreciation and rupee volatility?
This is because India is a net importer by a wide margin. We import more than we export. Our current account deficit is US$ 87.8 billion in 2012-13or 4.8% of the GDP. Our highest import item is crude oil. The second highest import item is gold. The third largest item in our import list is electronics hardware. Rupee depreciation leads to higher costs for oil and gold and electronics hardware items in rupee terms inspite of their value in dollar terms remaining more or less constant. We have a burgeoning current account deficit. Rupee depreciation worsens the already precarious situation. The current account deficit was at a record high of 4.8% of the GDP (gross domestic product) in 2012-13.
The Reserve Bank of India announced a slew of measures to curb rupee volatility and speculation in the rupee-dollar trade. First, it announced that banks will have to maintain 99% of CRR requirements on a daily basis as compared to 70% earlier. This measure will suck out the liquidity from the banking system. CRR is cash reserve ratio. It currently stands at 4% of the net demand and time liabilities (NDTL) of a bank. What RBI has effectively done is that 99% of this 4% (CRR) will have to be kept on a daily basis of every commercial bank’s current account with RBI. This means that there will be less money to lend and also there will be less money available for speculation in the dollar-rupee trade.
Second, the RBI has said that banks can at best borrow RS 37, 500 crores on a collective basis from the RBI on a daily basis under the Repo window. Repo is when a commercial bank borrows from the RBI. RBI lends to commercial banks at 7.25% (current repo rate) under the repo window. Repo is collateralized borrowing. Government of India securities which are above the SLR (Statutory Liquidity Ratio) requirements can be used as collateral for repo borrowings. SLR currently stands at 23%. It is also calculated as a percentage of the net demand and time liabilities (NDTL) of a commercial bank.
RBI has curtailed the daily repo borrowings in an attempt to suck out liquidity from the system and to curb speculative rupee-dollar trades.
These measures have led to a spike in short term interest rates. Yes Bank has raised its base rate i.e. the rate at which it gives loans citing RBI’s moves as having caused a spike in short term interest rates. Other banks have not as yet raised lending interest rates. They are of the view that in case RBI rolls back these measures they will not have to raise lending rates. If however, these RBI moves are not short term measures and long term rates are also impacted, then interest rates in the Indian economy will rise leading to hike in EMIs on home loans and car loans and all other loans.
This leads to the hot debate amongst Indian banking and policy maker circles- Are we sacrificing growth? The RBI is caught in a Catch 22 situation. If it lets rupee depreciate, then the current account deficit will worsen. It will lead to a hike in crude oil prices which will lead to a hike in transportation costs which will lead to inflation. The Wholesale Price Index (WPI) is at 4.86% in June 2013 and the Consumer Price Index is 9.87% in June 2013. Retail inflation is still very high despite RBI Governor D Subbarao hiking repo and reverse repo rates and CRR 13 times. After inflation moderated, he lowered policy rates. Veterans in the banking sector have said that asking banks to keep 99% of CRR on a daily basis amounts to a hike of 50 basis points in CRR. One basis point is equal to one hundredth of a percentage point.
The FICCI chairperson and HSBC CEO, Naina Lal Kidwai had said that any hike in interest rates would be a body blow to the industry.
The RBI has banned proprietary trades of banks in order to curb speculative activity in the rupee-dollar trade.
In order to contain the current account deficit, the Government has tried to discourage the gold imports by hiking import duty on gold from 2% to 8%. It has also said that if gold is imported, 20% of the amount imported has to be exported in the form of gems and jewellery. It has also said that the next shipment of imports will be allowed only when 75% of the 20% imported and earmarked for exports have already been exported. All these measures are to contain our import bill and hence our current account deficit.
Finance Minister P.Chidamabram has announced a slew of measures to attract dollars into the country. Earlier a sovereign bond issue was being contemplated. RBI Governor was not in favour of a sovereign bond issue as of now. He has said that the benefits from such a sovereign bond issue far outweigh the costs. With growth tapering to around 5% and current account deficit at a record high, the country would have to pay a very high interest cost for the sovereign bond issue.
Finance Minister P. Chidamabaram has talked about a quasi-sovereign bond issue. This would entail state owned corporations raising debt from overseas markets and the government of India guaranteeing the debt. While raising debt overseas will bring in dollars which will ease the rupee depreciation, it also has the added benefits of lower interest costs as interest rates in the USA and the Europe are very low, close to zero. Interest rates in the US and Europe (especially Europe) are not expected to rise for some time more. Indian state owned corporations will have to pay more of course ( on account of the poor state of the Indian economy), compared to interest rates in the USA and Europe but it will still be lower than borrowing rates in the Indian economy. However, when the debt repayment time comes, debt will have to be repaid in dollars and if the rupee depreciates yet more, these state owned enterprises will have to repay more than what was borrowed. Rupee depreciation at the time of repayment might outweigh the savings in interest costs by borrowing overseas.
NRI (Non Resident Indians) bonds are also being explored.
Finance Minister P. Chidambaram has also talked about liberalizing foreign direct investment ( a host of measures have already been announced mid July 2013 by the Government), continuing to engage with sovereign funds and pension funds who wish to invest in India and ease restrictions on Indian corporate who wish to borrow from overseas markets.
In the past, whenever rupee depreciated, RBI would intervene and sell dollars in the markets. But this is not a feasible option as of now. This is because our foreign exchange reserves are at an all time low and dollars are precious. We have an import cover of 7 months which means that we have foreign currency to fund imports for 7 months. In the last fortnight we have added about US$ 900 million to our foreign reserves.
The RBI has also instructed exporters to bring the foreign currency into India within nine months of exporting, as opposed to 12 months allowed earlier.
Ben Bernanke, the chairman of the Federal Reserve (central bank of USA) has talked about tapering off of Quantitative Easing (the Fed’s US$ 85 billion a month bond purchase program which injects liquidity in the American system which finds its way into the equity markets and debt markets of emerging markets all over the world via the FIIs (Foreign Institutional Investors)). This would restrict the dollar supply and this has spooked the emerging markets where the domestic currencies have depreciated vis-a-vis the dollar.
Experts have also said that the arbitrage opportunities between the currency markets in India and the NDF (Non deliverable forwards) in overseas markets like Dubai and Singapore have added to the rupee’s woes. All Non Deliverable Forward deals are deals which have to be settled in dollars as the rupee is a non deliverable currency in these foreign markets. Financial institutions and corporates take advantage of the currency differentials in the two markets and buy in one market and sell in another to book profits. These trades add to volatility, are of speculative nature and not genuine trade transactions and genuine hedging and cause the rupee to fluctuate.
The RBI has said that only structural reforms that revive growth and bring in stable FII and FDI dollars will help in the long run. The Indian debt markets have seen huge FII outflows and the high interest rates in India may again attract these debt FII inflows. But high interest rates cause corporate to delay taking loans for setting up factories and infrastructure and they wait for a more benign interest rate regime to expand and create employment, which in turn revives demand and is a GDP growth factor.
High interest rates also cause higher loan defaults as corporate and individuals find it difficult to service their debt obligations at higher rates. Some Indian banks have reported a 100% rise in their Non performing assets in their quarter to quarter financials reporting.
Exports in India are not healthy as the overseas markets are battling the aftermath of the sub-prime crisis and the ongoing European sovereign debt crisis. In order for the currency to be strong, we need a healthy vibrant India with a robust GDP growth. This does not happen in a high interest rate regime. There are so many things which the Government of India can do. It can boost tourism. It costs nearly Rs 1 lakh for a seven day trip to Kerala, while it costs Rs 30,000/- for a seven day trip to Thailand and nearly Rs 50,000/- for a seven day trip to Mauritius. God has been kind to India and there is natural bounty and scenic beauty in India. We have a long coast line and the Himalayas. Tourism can be a money spinning industry and a game changer. If Thailand and Mauritius can offer good rates to woo tourists, why not India?
So can be medical tourism. Indian doctors are amongst the best in the world. If we build world class hospitals in our country along with proper roads and power and other infrastructure, we create employment which helps in poverty alleviation. The best method of poverty alleviation is GDP growth. Medical tourism will create employment and will bring in precious dollars. The world will flock to India for operations and ayurvedic treatments. Already, many people from developing countries come to India for treatment. The trick is to perfect medicine in such a fashion that people from developed countries also come.
India has always been in the forefront of education. IIM Indore has a campus in Dubai. SP Jain has a campus in Singapore, Dubai and Sydney. IITs and IIMs and IISc and ISI should become brand ambassadors of education in our country and attract foreign scholars. They should have campuses overseas so that revenues flow into our country. Education is India’s forte.
India should incentivise best possible use of technology. Fuel efficient engines, cars run by electricity and other domestic fuels should be developed and the Government should incentivize Research & Development in this field. If Brazil can save precious fuel and foreign currency by mixing ethanol with fuel, why not India? Manufacturing sector should be incentivized and their problems looked into. If India catches up with China in the manufacturing side, nothing can stop India from becoming a super power.
The Government should attempt that it is a part of peace keeping forces around the globe. These peace keeping forces earn in foreign currency. The Government should try to host as many important foreign conferences and seminars as possible. This gives a boost to the hotel and aviation industry.
Games can become a game changer for India. The IPL matches generate revenue and now efforts should be made to attract foreign currency. Be it badminton or tennis or football- give world class facilities and have world class matches in India, much in the league of the IPL- foreign tourists and foreign currency should follow.
The game changer for the rupee is going to be growth which comes from structural reforms and benign interest rates. GDP growth leads to poverty alleviation which no Food Security Bill can ever hope to achieve- will the Government please do something?
High interest rates and policy paralysis have led to stalling of infrastructure projects across the country leading to unemployment and stalling of GDP growth. RBI has also admitted that supply side constraints are causing inflation so why should the RBI raise interest rates to temper inflation? It is the Government who should easy supply and supply bottlenecks to ease inflation.
Monetary policy action by the RBI to stabilize the rupee at best is a short term phenomenon- It is not the cure- We are giving crocin but the fever needs antibiotics to cure the patient. The cure can only come from good GDP growth and for that interest rates need to be benign. We need to look into the old system of Central Bank intervention- These might have worked in the developed Western world. With the dollar moving freely across the globe and FII and FDI now making the world a much more integrated place, new thinking into the old system of RBI intervention needs to be debated.
