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Straight from the Specialists

Time to get used to a weak rupee

July 22, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

The fall of the rupee has become politically embarrassing. When the rupee crossed 60 to the dollar, the government and the Reserve Bank of India (RBI) thought it was time to act. The RBI tried to suppress speculation that had exaggerated the rupee’s fall and the government sought to increase foreign resources to fund the current account deficit (CAD).

The RBI complied half-heartedly. “We let our exchange rate be largely market determined, but intervene in the market to smooth excess volatility and/or to prevent disruptions to macroeconomic stability,” Governor Duvvuri Subbarao said in a speech in London.

The RBI raised the cost of borrowing under the marginal standing facility (MSF), narrowed the window for banks wanting to borrow from it, and issued bonds to raise dollar funds – although that missed the target completely. The rupee did harden against the dollar but too little for any comfort.

The government focused on foreign direct investment. That’s how it’s been all along. Foreign assistance and FDI increase the current account deficit and finance it as well. That’s not the case with FII investment. It does not increase CAD and is available to cover it. The current account has almost always been in deficit mainly due to insufficient exports and was funded from FII portfolio investment and external commercial borrowings apart from foreign investment.

What hit the rupee in June-July was the huge increase in deficit and the declared intention of the U.S. Federal Reserve to taper quantitative easing. The latter prompted FIIs to pull out. During the same period, there was an outflow of $10 billion that forced the RBI to draw down foreign exchange reserves.

The only options for the government were to borrow overseas, which would have affected India’s credit rating, and to encourage foreign investment. Under pressure like in 1991, the government raised equity holdings by foreign companies to make investment attractive. Thirteen sectors, principally telecom and defence, would benefit.

But will foreign investors jump in?

Only 48 hours after the government’s announcement, two major companies have pulled out. ArcelorMittal and POSCO had planned steel projects with a total investment of 800 billion rupees. Agreements were signed three years ago but even today, there is no land to set up industry and no licence to extract ore. These are not exceptions. It is not only foreign investors or the steel sector that has such problems. Even domestic investors feel the pinch. Last year, Indian companies invested more overseas than foreign investors in India. Why?

There are many reasons. GDP growth has plunged, the market has shrunk, industrial growth is zero, food inflation is high, interest rates are exorbitant, profitability is down, CAD is excessive, land acquisition for industry has become impossible. And so on. All because of poor governance. Foreign investment does not need an invitation. It pours into economies that are dynamic and progressive. We are far from that.

No wonder the rupee stayed put at 59-60 to the dollar and did not respond either to the RBI or to the government. That is the new saddle point we have to get used to.

 

Comments

Fully Agree, I am not sure why this UPA govt has fallen to such lows !! We had lot of hope on Manmohan singh and Chidambaram we thought they were capable.. is it fatigue ?, No interest to work ? or something UPA is deliberatly doing to give a problem as big as possible to the next party which ever forms the govt at center, i am sure UPA is clear that they are not going to win the next elections.

Posted by Divakar1 | Report as abusive
 

I think you can also tell the Indian public to not be surprised to see Rs.5000, Rs.10000, Rs.25000 notes released by RBI in immediate future.

Posted by Divakar1 | Report as abusive
 

The UPA govt has done nothing to make India as favourite Investment destination for FII’s but only made promises in last 2 terms.I am too sure UPA wont come to power and they are making last minute attempts and have abosolutely no forecast.

Posted by Rajnish1 | Report as abusive
 

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