How to rescue the falling rupee
(Any opinions expressed here are those of the author and not of Thomson Reuters)
I can’t predict where the rupee will eventually land and I don’t think anyone else can either.
Of course, we are not the only country at the mercy of the dollar because almost every emerging market is suffering. But surely, that shouldn’t be any consolation.
The rupee has depreciated about 50 percent in the past three years and 15 percent this year. The situation is extremely worrying for us because of the debilitating impact it will have on India’s economic fundamentals that have been pushed to the brink by global factors.
The dollar seems to be flexing its muscle and violently at that. The U.S. Fed minutes did not soothe jangled nerves and markets continue to expect that QE3 tapering will commence in September. The U.S. trade deficit seems far healthier than a year ago and the country’s economy is in better shape. QE3 tapering is a foregone conclusion. But when it does hit us, I expect a lot more pain.
In India, there is a sense of despondency in the wake of policy announcements that haven’t really been executed. There is a sense of loss of credibility. It is unfortunate that these strains have surfaced in the midst of a change of guard at the Reserve Bank of India (RBI).
Sadly, we can’t say we did not see it coming. The RBI has been pointing to the twin deficits – fiscal and trade – for long while waging a losing battle on the monetary front. The International Monetary Fund (IMF) pointed out early this year that our fiscal deficit and inflation were among the highest in emerging markets. Our dependence on hot FII portfolio money was always there for all to see.
Our government, the markets and the rupee hid behind a huge wall of liquidity in the global markets. Looking back, it almost seems as though the RBI commenced its interest reduction cycle a bit too early and the outgoing governor did not wish to leave without correcting what he may believe was an error in policy judgment.
The fall in the rupee is a mere manifestation of the deeper malaise – high inflation, low interest rates combined with low growth.
The root of the problem lies in the consistently negative rate of interest imposed on savers. An open economy has its own ways of correcting artificial imbalances created by its policymakers. Negative real interest rates will almost always break out into currency depreciation. When this happens, no amount of intervention can help till the currency finds its right level.
Holding on to negative real interest rates for a long time has driven household savers into non-financial assets – in India, that means gold.
To begin with, there needs to be a true gold alternative. In the past few years, gold ETFs and loans added to its liquidity. Banks and PSUs pushed gold coins to cash in on the craze. Buying gold in India is as easy as buying a bar of chocolate.
Inflation-linked bonds can never be successful as an alternative to gold unless the government is courageous enough to give post-tax inflation-linked real returns. At the same time, gold loans and ETFs should be made inaccessible.
It’s time to also go back grovelling to the NRIs hoping that they will return for the premiums over international dollar interest rates.
Also, shouldn’t we open up incoming FDI for all sectors, except those considered sensitive to national interests? Especially for infrastructure, capital-intensive and environmentally safe projects. One would rather approve outgoing FDI on a case-by- case basis ensuring that, like in the case of China, they are in national strategic interest.
I do not see anything wrong in heavily taxing imports of luxury consumables and durables; and preventing low-value imports that can be produced locally. Given our vulnerabilities in coal and oil-based energy, pretending that we can do away entirely with capital controls is utopian.
The other day, a friend told me that “it was easier to import than transport” in India and there lies the real solution in the long run. Our manufacturing sector has to grow aggressively and has to be provided with enabling infrastructure. India needs to promote its own economic union with the goods and services tax. We spend an estimated $25 billion on defence imports; after 60 years we surely can do something to substitute this.
While NREGA and food security can be justified, inflation led by fiscal deficit has to be controlled by eliminating indirect subsidies and freeing up agricultural trade. To revive the rupee, we need to rein in the twin deficits. At the same time, painful as it may seem, we need to hold on to interest rates at a ‘real’ level to encourage household savings.
Most importantly, we need a majority government with a clear mandate for development. For now, India will have hold on till the next elections.