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The Rupee Depreciation Concerns

Monday, July 29, 2013

The “slide of the rupee cannot be seen in isolation. Whatever intervention the RBI may undertake to stem its fall will only have a transitory effect. In the long run, unless we garner the courage and will to undertake deep rooted administrative and institutional reform, the rupee will continue to remain a highly volatile currency”, says Shailesh Vaidya, President of the Indian Merchants’ Chamber in this exclusive article for ADC.

The rupee has depreciated immensely since 1990-91 when the dollar was worth Rs. 19. With every passing day the rupee is sinking to new lows, having slid well past the psychological danger mark of 60 to the dollar. In the long run, getting stuck on the wrong side of 60 deals is an emotional blow to the economy, which is not easy to overcome. The falling rupee will spur inflation with a short time lag as imports – particularly those of fuels – become costlier. This could prompt the RBI to hike rates and undo all the good work done by it in the recent past.

The uncompetitive interest rate structure of the economy will further disincentivize investment and adversely impact Indian firms for at least a year or two more. With capital flight occurring under such circumstances, India’s already tenuous credit rating could then be at further risk and getting it back to square one will prove progressively difficult.

The situation on the external front is also not too rosy. Foreign debt has risen to a record high, import cover of forex reserves has fallen to just seven months (as against an average of 20 months for the other BRIC nations), and the current account deficit (CAD) is not yet out of the comfort zone due to continuing gold imports. In April 2013, merchandise exports rose just 1.7 per cent to $24.2 billion. With imports rising 11 per cent to $42 bn, the trade deficit was a little over $17 bn against $14 bn a year before. In May, exports declined 1.1 per cent to $24.5 bn.

 With imports rising seven per cent to $44.6 bn, the trade deficit was a little over $20 bn and very close to the unenviable record of $20.96 bn in October 2012. For addressing the CAD issue the Government needs to urgently review import duties on non-essentials under various bilateral agreements.

Furthermore, the US Federal Reserve’s gradual winding up of its stimulus programs will certainly impact capital inflows into India, which needs them now more than ever before, particularly to boost its wobbly infrastructure sector. Most of the world’s investment will now be directed largely towards rebuilding the US economy. Global crude oil prices softened in the middle of the year but then rose. Accompanied by the sharp depreciation in the rupee, this is not good news for the economy since we import over 70% of our oil. The rupee is caught in a vicious cycle of perception whereby a slide causes panic and speculative selling, leading to an even more precipitous fall. In a lighter vein, we fare badly when the US economy is not doing well and even worse when it is doing better.

A country is said to have a balanced economic position if its Real Effective Exchange Rate (REER) stands at a level of 100. If the index is above 100, it indicates the relative strength of the currency and vice-versa. With the revised base of 2010-11 (April-March) = 100, India’s REER stood at 91.77 in 2012-13, as against 97.35 the previous year. Among emerging market Asian currencies, the rupee and the Korean ‘Won’ are the only currencies that have depreciated in REER terms since the end of 2007. All this does not show the country’s external situation in a positive light.

The surge in gold demand since the global financial crisis is also an indicator of the underlying imbalances facing the Indian economy. It could be viewed as a reverse capital flight by Indians which is reflective of a lack of confidence in the government’s ability to deliver them sustained low inflation and currency stability.

A notable hurdle facing small investors in investing in financial instruments is the unduly complex KYC requirements of banks and similar requirements again for investing in other financial instruments such as mutual funds. RBI needs to take the lead in enhancing financial inclusion as well as encouraging investment in financial instruments rather than gold, by simplifying and unifying KYC norms for all financial investments.

The crux of the problem is that we have been a capital-starved and supply-constrained economy for far too long. We desperately need foreign capital, particularly for infrastructure development. But policy actions undertaken with an eye on their political repercussions have made our economy even more vulnerable to adverse global liquidity conditions, as well as to the skepticism of the international investor community. The government deserves a certain amount of credit for taking some long-overdue decisions particularly in the area of disincentivizing speculation, but even these remain largely inadequate relative to the magnitude of the challenges facing us.

As an inseparable part of a global economy undergoing constant mutation, our policy responses to the evolving macro situation are basically a case of too little too late. For example, there has been hardly any worthwhile effort to bring about concrete structural changes in the economy, improve the ease of doing business in the country by minimizing bureaucratic bottlenecks and corruption, ensure predictable tax policy and implement long due tax reform, or make the system more competitive and transparent via strategic checks and balances, all of which are interrelated. These measures would surely have gone a long way in arresting the continuous decline of the rupee and enhancing the image of the country in the eyes of the international investment community.

In conclusion, the slide of the rupee cannot be seen in isolation. Whatever intervention the RBI may undertake to stem its fall will only have a transitory effect. In the long run, unless we garner the courage and will to undertake deep rooted administrative and institutional reform, the rupee will continue to remain a highly volatile currency.

 Political and economic stability, infrastructure development, and creating a business-conducive environment are essential to convince the international community about the genuineness of our long term fundamentals, and thus help in shoring up the rupee. Most of our economic woes ultimately boil down to governance issues – what matters is simply the ability and willingness to taking some tough policy decisions which may be politically inexpedient, but which are necessary to bring about much needed positive and irreversible change. 

(Shailesh Vaidya is a practicing Advocate and Solicitor.  He is a partner in Messrs. Kanga and Company, a reputed firm of Advocates & Solicitorsas also a Director in several public limited companies.)

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